Everything rallied this week. Stocks, gold, bonds, oil. It’s hard to imagine that just 3 weeks ago everyone was concerned about the trade war and the stock market was down more than -6%. Traders are still concerned, which is reflected in sentiment data.
These sort of quick recoveries could see short term weakness, but were mostly positive for stocks 6-9 months later.
- Fundamentals (long term): no significant U.S. macro deterioration, but the long term risk:reward doesn’t favor bulls.
- Technicals (medium term): mostly bullish
- Technicals (short term): mixed
- *Special note on gold: something isn’t right…
Let’s begin with technicals because most traders prefer technical analysis over fundamental analysis.
Technicals: Medium Term
*For reference, here’s the random probability of the U.S. stock market going up on any given day, week, or month.
Although the bull market is certainly late-cycle, the stock market’s medium term (next 6-9 months) leans bullish.
Bloomberg summed up this week’s theme:
Here’s what happens next to the S&P when the S&P, gold, and bonds all hit 6 month highs together.
*This uses weekly data. 6/17/2019 = the week starting June 17 (i.e. this week)
The S&P has a strong tendency of going up 3 months later.
Here’s what happens next to gold.
Here’s what happens next to bonds.
The sample size is a little small. So what if we only want to look at all the weeks in which both the S&P and Aggregate Bonds are both at 1 year highs?
Stocks are bullish 93% of the time 1 year later.
The stock market made a -6% correction in May and then made a very rapid recovery to new highs.
These quick V-shaped recoveries may see short term weakness, but usually push on for more gains 6-9 months later.
According to the latest AAII data, sentiment is still quite bearish considering where stocks are (at all-time highs). There have been more bears than bulls for 6 weeks in a row.
Similar historical cases (more bears than bulls for 6 weeks in a row, while stocks are up) have been mostly bullish for stocks on all time frames.
The % of issues on the NYSE making new highs continues to expand. More than 10% of issues are making new highs, for the first time since January 2018.
Historically, an expansion in new highs was slightly more bullish than random for stocks 6 months later.
Margin debt tends to increase along with the stock market. However, margin debt has not really recovered from its 2018 plunge even though the stock market has. Is this normal?
Here’s what happens next to the S&P 500 when the S&P rallies more than 9% over the past 5 months, while margin debt increases less than 3%.
This is normal, and is mostly bullish 3-12 months later. A slow increase in margin debt is typical after many long or large corrections. Traders and investors are still scarred by memories of the recent crash, hence they shun debt.
Our Stock:Bond ratio is high, driven by a surge in stocks and a decline in bond yields.
In the past, a combination of surging stocks + falling bond yields was mostly positive for stocks. Here’s what happens next to the S&P when the Stock:Bond ratio was greater than 2 for 17 consecutive days.
Technicals: short term
*The short term is always extremely hard to predict, no matter how much conviction you have. Too many unpredictable factors influence the short term (e.g. trade war news).
As we’ve already mentioned, the S&P made a nonstop decline in May and a nonstop rally in June.
Let’s compare the past 2 months to other 2 month historical periods. Let’s look at the historical cases with a correlation of greater than 0.85 (i.e. very similar to today).
The 2 month forward returns are more bearish than random. These V-shaped recoveries usually don’t keep soaring without a pullback. The average 2 month maximum drawdown is quite large, at -4.81%
The 3 month Treasury yield’s weekly RSI is extremely oversold.
While the interest rates do “eventually” bounce in the short term, longer term forward returns are bearish. Short term rates usually bounce, and then keep going down.
Special note on gold
And lastly, I would like to briefly talk about gold, since this is something that I used to trade. Many traders are excited about gold right now. But they should be looking at silver, which has lagged gold significantly.
As a result, the gold:silver ratio is INCREASING.
So why is this very important and abnormal?
Because in a real precious metals bull market, the gold:silver ratio tends to FALL. Silver is more volatile than gold, which means that when both gold and silver go up in a real bull market, the gold:silver ratio falls.
Since the gold:silver ratio is rising during the recent precious metals rally, silver is not confirming gold’s rally. This is worrisome.
Here’s what happens next to gold when gold rallies more than 9% over the past month to a 1 year high, while the gold:silver ratio increases by more than 3
Even if this is a real precious metals bull market, chasing gold into this kind of sentiment is dangerous.
Moreover, the U.S. Dollar Index has finally fallen below its 50 week moving average for the first time in a long time.
Historically, this was not good for gold over the next 2 months.
Fundamentals: Long Term
The stock market and the economy move in the same direction in the long run, which is why we pay attention to macro.
U.S. leading economic indicators are decent right now, which suggests that a recession is not imminent. Let’s recap some of the leading macro indicators we covered:
Sustained yield curve inversion
The 10 year – 3 month section of the yield curve has been inverted for 5 consecutive weeks. Sustained inversions are more important than brief inversions.
Here’s what happens next to the S&P when the 10 year – 3 month yield curve has been inverted for 5 consecutive weeks (i.e. right now)
Here’s how much time there was between a 5 week inversion and the next recession-driven bear market.
In the most optimistic scenario, this bull market has 1 year left. Know your long term risk:reward.
Housing is a slight negative factor, but could improve
Housing – a key leading sector for the economy – remains weak. Housing Starts and Building Permits are trending downwards while New Home Sales is trending sideways. In the past, these 3 indicators trended downwards before recessions and bear markets began.
Labor market is still a positive factor
The labor market is still a positive factor for macro. Initial Claims and Continued Claims are trending sideways. In the past, these 2 leading indicators trended higher before bear markets and recessions began.
Conference Board LEI
The Conference Board Leading Economic Index’s latest reading was unchanged from its previous reading. But more importantly, the Leading Economic Index is still above its 12 month moving average.
In the past, it was much better to be long stocks when the LEI is above its 12 month average than when the LEI was below its 12 month average.
*To run this backtest, I used the LEI’s reading in April for trading in June, since the LEI is released with a delay of almost 1 month.
Financial conditions remain very loose. In the past, financial conditions tightened before recessions and bear markets began.
Here’s the Chicago Fed’s Financial Conditions Credit Subindex
Heavy Truck Sales
Heavy Truck Sales is still trending upwards. In the past, Heavy Truck Sales trended downwards before recessions and bear markets began.
The latest reading for inflation-adjusted corporate profits fell. In the past, corporate profits fell before recessions and bear markets began. Since corporate profits leads the S&P by 5-6 quarters, this will be a long term bearish factor for the stock market beginning in Q1 2020 if corporate profits continue to fall.
Baltic Dry Index
The Baltic Dry Index – a gauge for global shipping, crossed above its 200 day moving average this week for the first time since December 2018.
Here’s what happens next to the S&P when the Baltic Dry Index crosses above its 200 dma for the first time in more than 3 months.
Mostly bullish 6-12 months later.
Here is our discretionary market outlook:
- Long term: risk:reward is not bullish. In a most optimistic scenario, the bull market probably has 1 year left.
- Medium term (next 6-9 months): most market studies are bullish.
- Short term (next 1-3 months) market studies are mixed.
- We focus on the medium-long term.
Goldman Sachs’ Bull/Bear Indicator demonstrates that risk:reward does favor long term bears.
***All content, opinions, and commentary is by Troy Bombardia and is intended for general information and educational purposes only, NOT INVESTMENT ADVICE.