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Bear Traps for Stocks?

Summary:
In the past, the worst time to buy stocks typically has been when the unemployment rate was making a cyclical low (Fig. 1). Needless to say, initial unemployment claims was doing the same at the same time—and screaming “Get out! Get out!” (Fig. 2). Buying stocks when the yield curve was flat and on the verge on inverting has also been a bad idea (Fig. 3). Buying stocks when the Fed is raising interest rates can work okay for a while, until higher rates trigger a financial crisis, which often turns into a credit crunch and a recession (Fig. 4 and Fig. 5). Rising bond yields aren’t always bad for stocks, until they are (Fig. 6). Those times late in an expansion when the profit margin exceeds its mean tend to set it up for a bruising reversion to the mean and even below, which is bad for

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Bear Traps for Stocks?
In the past, the worst time to buy stocks typically has been when the unemployment rate was making a cyclical low (Fig. 1). Needless to say, initial unemployment claims was doing the same at the same time—and screaming “Get out! Get out!” (Fig. 2). Buying stocks when the yield curve was flat and on the verge on inverting has also been a bad idea (Fig. 3). Buying stocks when the Fed is raising interest rates can work okay for a while, until higher rates trigger a financial crisis, which often turns into a credit crunch and a recession (Fig. 4 and Fig. 5). Rising bond yields aren’t always bad for stocks, until they are (Fig. 6). Those times late in an expansion when the profit margin exceeds its mean tend to set it up for a bruising reversion to the mean and even below, which is bad for profits and bad for stocks (Fig. 7). As for buying stocks when valuations are extremely high, anyone could tell you “fuhgeddaboudit!” (Fig. 8).

All of the above bear traps may be set to snare the current bull market. A 9/10 Bloomberg article was titled “Goldman Bear-Market Risk Indicator at Highest Since 1969: Chart.” The Goldman indicator neatly converts all of the major bear traps into one series:

“A Goldman Sachs Group Inc. indicator designed to provide a ‘reasonable signal for future bear-market risk’ has risen to the highest in almost 50 years. The firm’s Bull/Bear Index, which is based on measures of equity valuation, growth momentum, unemployment, inflation and the yield curve, is now at levels last seen in 1969. While the gauge is at levels that have historically preceded a bear market …”

So why does the stock market bull continue to charge ahead? Last Friday, the S&P 500 closed a whisker below its record high of 2930.75, hit on Thursday—rapidly approaching my 3100 target for this year (Fig. 9). It is up 9.6% ytd. It has recovered smartly from the nasty 13-day correction earlier this year with a gain of 13.5% since the year’s low on February 8 (Fig. 10). During the current bull market, I count five corrections (exceeding 10%), one near correction (that rounds up to 10%), and a total of 61 “panic attacks” that were followed by relief rallies.

The latest relief rally reflects mounting confidence that Trump’s trade war won’t escalate into one that depresses the economy and corporate earnings, which continue to soar. In addition, there is less fear lately that the Fed’s policy normalization will trip up the bull market. Earlier this year, there was fear that a 10-year US Treasury bond yield above 3.00% would be bearish for stocks. It recently rose back slightly above that level, yet it was widely deemed to be bullish for financial stocks. Go figure!

So what will it take to snare the bull in the bear traps? It will take a recession. That’s all there is to it. While Goldman and everyone else is on the lookout for this event, both the Index of Leading Economic Indicators (LEI) and the Index of Coincident Economic Indicators (CEI) rose to new record highs during August (Fig. 11). The LEI did so even though the yield curve spread, which is only one of this index’s 10 components, has been narrowing fairly steadily since 2013, but remains positive. It only subtracts from the LEI when it is negative. So it is still contributing positively to the LEI, though to a lesser extent. History shows that the CEI, which is a good monthly proxy for quarterly real GDP, falls when a financial crisis occurs, triggering a credit crunch and a recession. There’s no sign that scenario is about to play out again anytime soon.

I have argued that there was a growth recession during 2015 caused by the collapse in commodity prices. Credit quality yield spreads widened dramatically, especially in the junk bond market. Yet here we are at a record high in the S&P 500. Arguably, there has been an emerging markets crisis this year, yet here we are at a record high in the S&P 500.

Bear Traps for Stocks?
Dr. Ed Yardeni
Dr. Ed Yardeni is the President and Chief Investment Strategist of Yardeni Research, Inc., a provider of independent investment strategy and economics research for institutional investors. In this blog, we highlight some of the more interesting relationships and developments that should be of interest to investors. Our premium research service is designed for institutional investors.

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