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February 7, 2019: fundamental outlook for stocks

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Summary:
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. *An imminent recession is very unlikely right now. However, a recession is possible in late-2019 or 2020. Wait and see the latest data. Net earnings revisions is solidly negative. A necessary but not sufficient condition for bear markets and recessions. Year-over-year trend in nonfarm payrolls still suggests that the economic expansion is not over. Labor market

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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.

*An imminent recession is very unlikely right now. However, a recession is possible in late-2019 or 2020. Wait and see the latest data.

  1. Net earnings revisions is solidly negative. A necessary but not sufficient condition for bear markets and recessions.
  2. Year-over-year trend in nonfarm payrolls still suggests that the economic expansion is not over.
  3. Labor market conditions still suggests that the economic expansion is not over.
  4. Initial Claims are trending sideways. Not long term bearish for U.S. stocks yet, but will be bearish in 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 will be bearish in 2019 if Continued Claims starts to trend upwards significantly.
  6. The nonfinancial sector’s Unit Profits are trending sideways. A late-cycle sign

Read A major bear market for stocks in 2020?

Net earnings revisions is solidly negative. A necessary but not sufficient condition for bear markets and recessions.

As of January 2019, the S&P 500’s net earnings revisions is solidly negative.

February 7, 2019: fundamental outlook for stocks

The S&P 500’s Net Earnings Revisions turns negative before economic recessions and equity bear markets begin. During economic expansions, it has shown mixed performances because analysts tend to downgrade their earnings expectations as the year goes on. That’s why negative Net Earnings Revisions is a necessary but not sufficient requirement for equities bear markets and economic recessions.

This “necessary but not sufficient requirement for bear markets” is now triggered.

Year-over-year trend in nonfarm payrolls still suggests that the economic expansion is not over.

The year-over-year trend in nonfarm payrolls is still trending upwards.

February 7, 2019: fundamental outlook for stocks

This suggests that the economic expansion is not over.

This indicator is more useful for predicting economic expansions than bull and bear markets. For example, sometimes nonfarm payrolls will trend higher even at the end of a bull market (see 2000-2001).

Labor market conditions still suggests that the economic expansion is not over

The Kansas City Fed creates a Labor Markets Conditions Index, which is turned into a momentum indicator. This measures the strength of the labor market.

The U.S. labor market is healthy right now. This suggests that the bull market in stocks, although late-cycle, is not over. You can see that labor market conditions fell to zero at the top of previous bull market peaks.

February 7, 2019: fundamental outlook for stocks

February 7, 2019: fundamental outlook for stocks

Initial Claims are trending sideways. Not long term bearish for U.S. stocks yet, but will be bearish in 2019 if Initial Claims starts to trend upwards significantly.

Yesterday’s reading for Initial Claims went down (from 253k to 234k). The key point is that Initial Claims has not yet trend upwards.

*The recent spike is probably related to the government shutdown.

February 7, 2019: fundamental outlook for stocks

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

February 7, 2019: fundamental outlook for stocks

We are watching out for any SUSTAINED increase in this data series because Initial Claims are very low right now (historically speaking).

Continued Claims are trending sideways. Not long term bearish for U.S. stocks yet, but will be bearish in 2019 if Continued Claims starts to trend upwards significantly.

Yesterday’s reading for Continued Claims went up (from 1.778 million to 1.736 million). Continued Claims are trending sideways now, and could potentially trend upwards over the next few weeks/months

February 7, 2019: fundamental outlook for stocks

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

February 7, 2019: fundamental outlook for stocks

We are watching out for any SUSTAINED increase in this data series because Continued Claims are very low right now (historically speaking).

The nonfinancial sector’s Unit Profits are trending sideways. A late-cycle sign

February 7, 2019: fundamental outlook for stocks

The latest reading for nonfinancial sector’s Unit Profits went up from the previous reading.

February 7, 2019: fundamental outlook for stocks

However, the more important point is that Unit Profits are trending sideways. This is a typical late-cycle sign for the stock market and economy. In the past, Unit Profits trended sideways or downwards for several years before bull markets and economic expansions ended.

February 7, 2019: fundamental outlook for stocks

*While this is a late-cycle sign, it is not a timing indicator for the stock market and economy. It cannot be used to approximate when the bull market and economic expansion will end.

Conclusion

Here is our discretionary market outlook:

  1. 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. Long term risk:reward is more important than trying to predict exact tops and bottoms.
  2. The medium term direction (i.e. next 3-6 months) is neutral. Some market studies are medium term bullish while others are medium term bearish
  3. The stock market’s short term has a slight bearish lean. Focus 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.

February 7, 2019: fundamental outlook for stocks

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.

Click here for more market studies

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