February 19, 2019: fundamental outlook for stocks


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. This is typically what happens towards the end of bull markets, when leading indicators start to deteriorate one at a time.
*An imminent recession is very unlikely right now.

  1. High yield spreads did not widen before the recent correction. This is different from the 2000-2002 and 2007-2009 bear markets.
  2. Homebuilder sentiment is trending downwards. A long term warning sign.
  3. Latest reading for truck tonnage fell. Not yet a long term concern, but something that the bulls should watch out if it persists.
  4. The yield curve has not yet inverted. This is not yet a long term bearish sign for stocks, but will be when the yield curve inverts.

High yield spreads did not widen before the recent correction. This is different from the 2000-2002 and 2007-2009 bear markets.
As the stock market fell in Q4 2018, high yield spreads widened. And as the stock market is rallying right now, high yield spreads are narrowing right now.

The key point is that high yield spreads were narrowest in September 2018, just before the stock market crashed. This stands in contrast with previous bull market tops in 2000 and 2007. High yield spreads had widened before those bull market tops, which makes this a leading indicator.

Since this indicator made a low when the stock market made a top in September 2018, it suggests that September 2018 wasn’t the bull market’s top.
*This indicator only has 2 reference points (2000 and 2007), so take it with a grain of salt.
Homebuilder sentiment is trending downwards. A long term warning sign.
The latest reading for NAHB Homebuilder Sentiment went up from its previous reading.

The key point is that NAHB Homebuilder Sentiment is trending downwards. This downwards trend is not significant, so it is not a clear long term bearish sign for stocks yet. It is merely a long term warning sign.
If NAHB Homebuilder Sentiment continues to improve over the next few months, then this won’t be a warning sign for stocks.

Latest reading for truck tonnage fell. Not yet a long term concern, but something that the bulls should watch out if it persists.
Truck Tonnage measures the volume of the movement of freight in the U.S. This indicator tends to flatten or fall before an equities bear market or economic recession begins.
The latest reading for Truck Tonnage fell, after it made a new high in its previous reading. This is not yet a long term bearish concern for the stock market. It will only be a long term concern if this weakness persists. Bulls should not be worried, but should be vigilant.

This is a longer term chart for Truck Tonnage (not updated, from Bill McBride).

The yield curve has not yet inverted. This is not yet a long term bearish sign for stocks, but will be when the yield curve inverts.
The main parts of the yield curve have not yet inverted.

  1. 10 year – 2 year yield curve
  2. 10 year – 3 month yield curve



In the past, economic recessions and bear markets came AFTER these parts of the yield curve inverted.


Not yet long term bearish for stocks, but something to watch out for because the yield curve is so close to inverting.

Conclusion

Here is our discretionary market outlook:

  1. The U.S. stock market’s long term risk:reward is no longer bullish. In a most optimstic scenario, the bull market probably has 1 year left. Long term risk:reward is more important than trying to predict exact tops and bottoms.
  2. The medium term direction (i.e. next 6 months) is mostly neutral. There are a few more medium term bullish studies than medium term bearish studies
  3. The stock market’s short term has a bearish lean due to the large probability of a pullback/retestFocus on the medium-long term (and especially the long term) because the short term is extremely hard to predict.

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.
Members can see exactly how we’re trading the U.S. stock market right now based on our trading models.
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