December 27, 2018: fundamental outlook for stocks


*Go to the blog for my latest market outlook. Members can go here to see our trading model’s latest updates and how we’re trading the U.S. stock market right now based on these models.
The economy and stock market move in the same direction in the long term. Hence, leading economic indicators are also leading indicators for the stock market.

Thoughts

*We’re seeing mixed readings in the leading economic indicators right now. Some are still bullish while others are turning bearish. This is typically what happens towards the end of bull markets, when leading indicators start to deteriorate one at a time.

  1. Inflation-adjusted net value added of nonfinancial corporate business is trending sideways. A late-cycle symptom.
  2. Delinquency Rate is trending downwards. This is a long term bullish factor for the stock market.
  3. ISM manufacturing new orders index is still relatively high. Suggests that the bull market isn’t over.
  4. Initial Claims is trending sideways. Not long term bearish for U.S. stocks yet, but will be bearish in Q1 2019 if Initial Claims starts to trend upwards significantly.
  5. Continued Claims are trending sideways. Not long term bearish for U.S. stocks yet, but watch out if this starts to trend upwards.

1 am: Inflation-adjusted net value added of nonfinancial corporate business is trending sideways. A late-cycle symptom.
The inflation-adjusted net value added of nonfinancial corporate business is trending sideways. (The recent slight increase is most likely due to Trump’s tax cut. Reagan’s tax cut in the mid-1980s resulted in the same thing).


This suggests that we are in the late stages of this economic expansion and bull market.
*This is not a tool for timing the bull market’s top.
1 am: Delinquency Rate is trending downwards. This is not how bear markets start.
The latest reading for Delinquency Rates made a new low for this economic expansion. But more importantly, delinquency Rates on loans from commercial banks are still trending downwards.

This is a medium term bullish sign for the stock market and economy. As you can see in the chart below, Delinquency Rates tend to trend higher before equity bear markets and economic recessions begin.

1 am: ISM manufacturing new orders index is still relatively high. This suggests that the bull market isn’t over.
The ISM manufacturing new orders index is still relatively high, at 62.1

In the past, bear markets and recessions started when the ISM manufacturing new orders index was at 50-55, or lower.
This suggests that the bull market is not over. However, if it falls next year, then this will no longer be a long term bullish factor for the stock market in 2019.
Initial Claims is trending sideways. Not long term bearish for U.S. stocks yet, but will be bearish in Q1 2019 if Initial Claims starts to trend upwards significantly.
Yesterday’s reading for Initial Claims went down a little from its previous reading (from 217k to 216k). While Initial Claims have mostly been trending lower throughout 2018, they are mostly trending sideways now. Perhaps Initial Claims will start to significantly trend upwards in Q1 2019.

*Initial Claims leads the economy and stock market. Historically, it trends higher before a bear market in stocks started (see study).

We are watching out for any SUSTAINED increase in this data series because Initial Claims are very low right now (historically speaking).
If Initial Claims starts to consistently trend upwards in 2019, then we will know that a bear market has probably begun.

Continued Claims are trending sideways. Not long term bearish for U.S. stocks yet, but watch out if this starts to trend upwards.
Yesterday’s reading for Continued Claims went down a little (from 1.705 million to 1.701 million). However, the key point is that Continued Claims are trending sideways.

Like Initial Claims, Continued Claims lead the stock market and economy.

We are watching out for any SUSTAINED increase in this data series because Continued Claims are very low right now (historically speaking).
If Continued Claims starts to consistently trend upwards in 2019, then we will know that a bear market has probably begun.
This chart demonstrates the inverse correlation between the S&P 500 and Continued Claims. A downwards trending Continued Claims = medium-long term bullish for the stock market.

Read Stocks on December 20, 2018: outlook

Conclusion

Here is our discretionary market outlook:

  1. For the first time since 2009, the U.S. stock market’s long term risk:reward is no longer bullish. This doesn’t necessarily mean that the bull market is over. We’re merely talking about long term risk:reward.
  2. The medium term direction is still bullish  (i.e. trend for the next 6 months). However, if this is the start of a bear market, bear market rallies typically last 3 months. They are shorter in duration. Bear market rallies are choppy and fierce.
  3. The short term is a 50/50 bet

Goldman Sachs’ Bull/Bear Indicator demonstrates that while the bull market’s top isn’t necessarily in, risk:reward does favor long term bears.

Our discretionary outlook is not a reflection of how we’re trading the markets right now. We trade based on our quantitative trading models, such as the Medium-Long Term Model.
Members can see exactly how we’re trading the U.S. stock market right now based on our trading models.
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