Stocks on October 31, 2018: fundamental outlook


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The economy and stock market move in the same direction in the medium-long term. Hence, leading economic indicators are also leading indicators for the stock market.

Thoughts

  1. Capital spending is decreasing. Long term bearish for stocks in 2019.
  2. Expect volatility to remain high over the next half year.
  3. Consumer Confidence is extremely high. A sign of late-cycle behavior.
  4. Profit margins are rising. Confirms the bull market in stocks.

Read Sentiment is extremely bearish, setting up the stock market for a nice rally
1 am: Capital spending is decreasing. Long term bearish for stocks next year.
CEO outlook leads capital spending by approximately 2 quarters. Capital spending peaked in Q2, and fell in Q3. With CEO outlook trending downwards, this suggests that capital spending will also trend downwards over the next few quarters.

In the previous bull market, Capital Spending really started to trend downwards after Q4 2006. It was 10 months before the next bear market started.
Capital spending likely peaked in Q2 2018. If we use the 2007 analogy, this suggests that stocks will peak in Q2 2019.
1 am: Expect volatility to remain high over the next half year.
Goldman’s Rocky Fishman said something interesting today:
“What is particularly notable, is that the market appears to be pricing in a longer-duration high volatility period than they did in Q1 2018” consistent with a view that this sell-off is driven more by reduced economic growth expectations than market technicals.”
I also think that the stock market’s rally will remain choppy during the next 6-9 months, which will likely be the last 6-9 months of this bull market.
VIX (and volatility) tends to remain elevated during the final year of a bull market, which is very volatile.
Here’s VIX in 2007.

Here’s VIX in 1999

1 am: Consumer Confidence is extremely high right now. A sign of late-cycle behavior.
Consumer Confidence made a new cycle high this time, almost reaching 138. Historically, Consumer Confidence was this high in the late-1960s and late-1990s. So this is definitely a sign of late-cycle behavior.

Here are all the historical readings of Consumer Confidence exceeding 138, and what happened next to the S&P 500.

On the surface this seems immediately very bearish, but that’s because the data isn’t displayed properly. A lot of these dates are clusters:

  1. 1967-1969
  2. 1998-2000

What we should be looking for is what happens to the S&P when Consumer Confidence >138 FOR THE FIRST TIME in each economic expansion cycle.
There’s a huge difference between:

  1. This is the FIRST TIME in an economic expansion during which Consumer Confidence has exceeded 138, vs…
  2. This is the 5th time in an economic expansion during which Consumer Confidence has exceeded 138.


So close to the bull market’s top, but not quite there yet.
1 am: Profit margins are rising. Confirms the bull market in stocks.
The S&P 500’s profit margins continue to expand.

As you can see in the following chart, profit margins tend to peak at the same time as the stock market’s bull market.

This confirms the bull market’s current rally. If profit margins expand for another quarter, then this means September 2018 wasn’t the bull market’s peak.
Read Stocks on October 29, 2018: outlook

Outlook

Here’s what I think will happen based on our discretionary outlook:

  1. The S&P 500 has less than 1 year left in this bull market (bull market top sometime in 2019).
  2. The recent decline is just a correction in a bull market. The medium term direction is still bullish  (i.e. trend for the next 6-9 months)

Our discretionary outlook is usually, but not always, a reflection of how we’re trading the markets right now. We trade based on our clear, 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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