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What can we expect from the stock market over the next 3 months?

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Troy
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Summary:
Despite today’s selloff, the stock market remains near all-time highs. After a solid half year, many investors are wondering if their year-to-date gains will evaporate. Today’s headlines: 20% year-to-date Macro weakness in housing High sentiment Dow breadth Oil diverging from stocks Ray Dalio says “buy gold” Go here to understand our fundamentals-driven long term outlook. For reference, here’s the random probability of the U.S. stock market going up on any given day. 20% year-to-date As of this Monday, the S&P had rallied 20% year-to-date. It’s not common for the stock market to rally this much by July, and the next 3 months usually experience choppiness with the stock market going nowhere. Let’s look at some of the recent cases individually. Here’s 1998: Here’s 1997:

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Despite today’s selloff, the stock market remains near all-time highs. After a solid half year, many investors are wondering if their year-to-date gains will evaporate. Today’s headlines:

  1. 20% year-to-date
  2. Macro weakness in housing
  3. High sentiment
  4. Dow breadth
  5. Oil diverging from stocks
  6. Ray Dalio says “buy gold”

What can we expect from the stock market over the next 3 months?

Go here to understand our fundamentals-driven long term outlook. For reference, here’s the random probability of the U.S. stock market going up on any given day.

What can we expect from the stock market over the next 3 months?

20% year-to-date

As of this Monday, the S&P had rallied 20% year-to-date. It’s not common for the stock market to rally this much by July, and the next 3 months usually experience choppiness with the stock market going nowhere.

What can we expect from the stock market over the next 3 months?

Let’s look at some of the recent cases individually. Here’s 1998:

What can we expect from the stock market over the next 3 months?

Here’s 1997:

What can we expect from the stock market over the next 3 months?

Here’s 1995:

What can we expect from the stock market over the next 3 months?

Here’s 1989:

What can we expect from the stock market over the next 3 months?

Here’s 1987:

What can we expect from the stock market over the next 3 months?

I think 2019’s easy gains are over. The next 3 months are unlikely to see strong gains. Sideways or downwards are more likely.

Macro weakness in housing

U.S. macro still mostly points to more economic growth. But rarely will macro be 100% positive or negative, and housing is one of the negative factors right now. Housing remains weak, and Building Permits just hit a 2 year low.

What can we expect from the stock market over the next 3 months?

This chart demonstrates that Building Permits trends downwards before recessions begin (recessions in grey):

What can we expect from the stock market over the next 3 months?

On its own, this is not a good sign for stocks. Here’s what happened next to the S&P when Building Permits fell to a 2 year low for the first time.

What can we expect from the stock market over the next 3 months?

What can we expect from the stock market over the next 3 months?

What can we expect from the stock market over the next 3 months?

6 month forward returns lean bearish. Overall, this tends to happen before a bear market and recession begin

  1. April 2006: 1.5 years before a recession and bear market began
  2. May 2000: bear market started, recession 9 months away
  3. April 1987: 1987 stock market crash began 3 months later
  4. January 1979: 1 year before a recession began
  5. July 1973: bear market and recession started
  6. December 1969: bear market and recession started

No macro indicator should be taken in isolation. My takeaway:

The economic expansion has probably 1 year left. If anything, this economic expansion is late cycle, so this bull market will not continue for years and years

Breadth

The Dow McClellan Summation Index is a long term breadth indicator. Breadth has been positive (above zero) for 123 consecutive days.

What can we expect from the stock market over the next 3 months?

What can we expect from the stock market over the next 3 months?

Similar historical streaks were mostly bullish for the S&P 6-12 months later.

What can we expect from the stock market over the next 3 months?

To show you how this indicator is useful in trading, this is what happens when:

  1. You buy the Dow when the McClellan Summation Index is above zero (orange)
  2. You buy the Dow when the McClellan Summation Index is below zero (grey)

What can we expect from the stock market over the next 3 months?

Clearly, it’s better to buy when breadth is positive.

Sentiment

As the stock market rallies, sentiment is somewhat elevated. Here’s the S&P 500’s Daily Sentiment Index.What can we expect from the stock market over the next 3 months?

Here’s what happens next to the S&P when the Daily Sentiment Index’s 1 month average exceeds 71.

What can we expect from the stock market over the next 3 months?

While the stock market may experience a pullback in the short term, 6-12 month forward returns are more bullish than random. Higher bullish sentiment is a feature of bull markets, not bear markets.

Stocks and oil

The S&P 500 and oil have diverged recently, after being tightly correlated over the past year. This has some traders concerned that oil’s weakness demonstrates an economic slowdown that will eventually hurt stocks.

What can we expect from the stock market over the next 3 months?

So how bearish is this? Here’s what happens next to the S&P when it rallies more than 7% over the past 7 weeks while oil falls more than -3% (divergence), while these 2 markets have a 7 month correlation > 0.7 (corrrelated).

What can we expect from the stock market over the next 3 months?

What can we expect from the stock market over the next 3 months?

Similar historical cases were slightly bearish for stocks 2-3 months later.

Here’s what oil did next

What can we expect from the stock market over the next 3 months?

Ray Dalio on gold

And lastly, Ray Dalio said today that gold is a good investment. From CNBC:

What can we expect from the stock market over the next 3 months?

While Dalio’s prediction may or may not come true, it’s important to not get carried away by Dalio’s belief. Ray Dalio is saying that “gold has a place in everyone’s portfolio”. He’s not saying that you should go balls-to-the-wall long gold. As of Dalio’s latest filings, 3% of his portfolio is in GLD (gold ETF).

3%.

What can we expect from the stock market over the next 3 months?

We don’t use our discretionary outlook for trading. We use our quantitative trading models because they are end-to-end systems that tell you how to trade ALL THE TIME, even when our discretionary outlook is mixed. Members can see our model’s latest trades here updated in real-time.

Conclusion

Here is our discretionary market outlook:

  1. Long term: risk:reward is not bullish. In a most optimistic scenario, the bull market probably has 1 year left.
  2. Medium term (next 6-9 months): most market studies are bullish.
  3. Short term (next 1-3 months) market studies are mixed.
  4. We focus on the medium-long term.

Goldman Sachs’ Bull/Bear Indicator demonstrates that risk:reward favors long term bears.

What can we expect from the stock market over the next 3 months?

Click here for more market analysis

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