Market overview: weighing the bullish and bearish evidence
The U.S. stock market continues to swing up and down each day near all-time highs. Here's my market outlook:
- Long term risk:reward doesn’t favor bulls. Valuations are high, but valuations can remain high for years before stocks crash.
- Fundamentals (6-12 months): still bullish because there is no significant U.S. macro deterioration, but this could change IF macro data deteriorates significantly over the next few months
- Technicals (3-6 months): neutral/bullish
- Technicals (1-2 months): no clear edge in either direction.
Fundamentals (6-12 months)
The economy and the stock market move in the same direction in the long term. Hence, leading economic indicators are also long term leading indicators for the stock market.
Overall, there is no significant U.S. economic deterioration right now. This is bullish for the stock market on a 6-12 month time frame. The main weak points in U.S. macro revolve around trade, manufacturing, and the yield curve. Moreover, soft data is worse than hard data. For more details and charts, please see my weekly fundamentals post.
What will happen to macro in the future? I don't know. Instead of trying to guess the future, the constant stream of macro data tells us how to react and allocate capital day-by-day depending on what's happening right now.
Here are some other long term and fundamental indicators we looked at this week:
Conference Board LEI
The Conference Board Leading Economic Index's latest reading fell -0.1% from the previous reading. But more importantly, the year-over-year % change has fallen below +1%:
When the LEI's year-over-year % change came close to being negative, the S&P's returns over the next 2 months weren't necessarily bearish. This was a necessary-but-not-sufficient sign for recessions and bear markets (i.e. plenty of false bearish signals).
Even if we isolate for the historical cases in which unemployment is under 5% (late-cycle)....
...the S&P's forward returns weren't consistently bearish. Why? While the Conference Board LEI is popular, it is not the most accurate leading indicator for market timing. From a total return perspective, applying the LEI to trend following models will lag other fundamental-driven models.
Margin debt
Despite the S&P 500 going up in September, margin debt continues to fall. This is highly unusual because the S&P and margin debt usually move in the same direction. Perhaps the ongoing trade war and nonstop talk about "impending recession" aren't helping.
Margin debt is now less than 1% above its December 2018 bottom, while the S&P is near all-time highs. This combination (no increase in margin debt, strong rally sometime over the past year) was mostly bullish for stocks over the next 3-12 months:
Money stocks
Jason noted that the rate-of-change in M2 (money supply) is increasing:
This is typically a positive factor for stocks over the next year since it means that the lending environment is healthy:
Manufacturing
Manufacturing continues to be a weak point in the U.S. and global economy. For example, Industrial Production's year-over-year growth is now negative, which in a late-cycle or high valuation environment (e.g. right now) is not encouraging for stocks over the next 6 months:
Housing
But with that being said, housing continues to be a bright spot in the U.S. economy. As I mentioned on Friday, the NAHB Housing Market Index has reached a 20 month high:
When it did so in the past, the S&P's returns over the next year were mostly pristine. Housing indicators are extremely useful and timely, which is why the Macro Index leans much more heavily towards housing than manufacturing. Manufacturing indicators tend to lag more often than lead.
Technicals (3-6 months)
The majority of our stats suggest that the stock market's 3-6 month outlook is bullish, although there are some bearish stats as well. Let's start with the bullish stats, and then we'll look at the bearish ones.
Bullish:
Exposure & flows
As Jason noted on Thursday, there have been massive equity fund outflows in recent weeks/months and hedge funds are quite pessimistic towards stocks. A rolling 20-week beta between a Hedge Fund Research equity index and the S&P 500 demonstrates hedge funds' bearishness:
Domestic funds continue to witness strong outflows:
As one would expect, strong outflows were mostly positive for stocks over the next 3 months:
Alternating leadership
As Bloomberg noted, cyclicals and defensives have alternated leadership for 5 consecutive weeks, which demonstrates a relatively long period of indecision for the stock market.
When markets were this indecisive in the past, the S&P's forward returns were mostly bullish over the next 2 months, particularly since 2009:
Here's what happened next to cyclicals:
As for defensives, forward returns were mostly inline with random.
Put/Call
Various pockets of investor and trader sentiment continue to exhibit fear, despite stocks being near all-time highs. For example, Jason mentioned that over the past 3 weeks, the ROBO Ratio of small trader sentiment has averaged near 71% (relatively high put buying). From a contrarian point of view, this is bullish for stocks over the next few months:
Similarly, the Index Put/Call ratio has been quite high in recent weeks:
Elevated Index Put/Call ratio's were mostly positive for stocks on all time frames:
Neutral/bearish:
Range compression
If you feel like the stock market has gone nowhere over the past few months, that's because it hasn't. There have been no sustained breakouts, and no sizable corrections. As a result, Steve Deppe noted that the 20 week Bollinger Bandwidth has fallen below 7% for the first time since 2017:
When the stock market's range became compressed for the first time in 100+ weeks, the S&P's forward returns were worse than random (not consistently bearish, but with large drawdowns):
Breadth
Breadth is neither a consistently bullish nor bearish factor for U.S. stocks right now. For example, Jason noted that as the broad S&P 500 approached all-time highs, fewer issues are above their 200 dma's:
When stocks approached all time highs and participation was lackluster, the S&P's forward returns were below average, but not quite consistently bearish either:
Technicals (1-2 months)
I don't have a strong conviction on the U.S. stock market over a 1-2 month period. The short term is usually hard to predict, unless there is a compelling extreme. And right now, there are few compelling short term extremes.
Price pattern
As Jason noted on Tuesday, the S&P is attempting its 4th breakout since February (and so far is still stuck under 3000). Most of these breakout attempts saw the S&P reach marginal new highs, followed by a pullback. In short, these breakouts were not sustained:
When the S&P attempted multiple breakouts within a 6 month period, it usually rallied higher over the next 2 months:
AAII sentiment
As Jason noted on Thursday, the AAII Bull ratio jumped from a very low level:
When this happened in the past, the S&P usually pushed higher over the next 2 months. The one big exception was January 2009, when the S&P was in midst of a massive bear market and recession.
To recap
- Long term risk:reward doesn’t favor bulls.
- Fundamentals (6-12 months): still bullish because there is no significant U.S. macro deterioration.
- Technicals (3-6 months): neutral/bullish
Got any questions/comments? Feel free to email me at [email protected]