Stocks Outlook - Friday, Sept. 28

The economy and stock market move in the same direction in the medium-long term. Hence, leading economic indicators are also leading indicators for the stock market.

First signs of the bull market topping process

We’ve recently seen the first signs of U.S. economic deterioration. A bull market’s top is a long process.

1. The economy first shows signs of economic deterioration. Housing is usually (but not always) the first sector to deteriorate. Meanwhile, the stock market goes up.
2. The economy deteriorates a little more. The labor market (e.g. Initial Claims) starts to deteriorate. Meanwhile, the stock market goes up but the rally becomes even choppier.
3. Finally, the stock market tops and starts to go down.
4. Lastly, the economy begins a recession.

We are now in Step 1 of this process.

Housing is starting to deteriorate

Housing indicators are usually the first to deteriorate. As the biggest of the big-ticket purchases, housing activity is usually the first to slow down when consumers are tapped out.

Housing indicators have deteriorated a little recently. Remember: the month-to-month fluctuations in economic data are meaningless. It’s mostly statistical noise. Focus on the overall trend in economic data.

As you can see in the following chart, New Home Sales has deteriorated a little recently.

This is not a big concern yet, but watch out in case New Home Sales continues to deteriorate. It has been 9 months since New Home Sales printed an economic expansion high (November 2017). This isn’t unprecedented: it took 14 months for New Home Sales to make a new high from February 2015 – April 2016. But if new Home Sales doesn’t make a new high by Q1 2018, that’s a big warning sign that Stage 1 of the bull market topping process is complete.

Likewise, Building Permits have trended down a little recently.

I am not too concerned yet is because Housing Starts has yet to show any meaningful deterioration.

So the bottom line is simple: Housing has shown a little bit of deterioration recently. This isn’t significant, but watch out if it continues to deteriorate for a few more months.

Labor market

Yesterday’s reading for Initial Claims made went up a little (from 202k to 214k).  The key point is that Initial Claims are still trending lower right now.

While Initial Claims are still trending downwards, it is very low right now. Initial Claims will probably start to trend upwards in 2019.

So don’t worry right now, but watch out next year.

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

Continued Claims echo the downwards trend in Initial Claims. Continued Claims went up a little from the previous week’s reading (from 1.645 million to 1.661 million). However, the key point is that Continued Claims are still trending downwards.

In conclusion, the labor market has yet to deteriorate. It will probably start to deteriorate in 2019. The labor market might improve a little more, but we’re close to “as good as it gets”.

The difference between models

The Medium-Long Term Model has recently taken 1 BIG step to flipping from “long-term bullish” to “long term bearish”. It is still bullish, but at this rate, will probably turn bearish sometime in the first half of 2019 (probably Q2 2019).

The Medium-Long Term Model tries to catch the stock market’s exact top. More often than not, it sells too early (i.e. by a few months). On the other hand, the Initial Claims Model is trend following model. It tells you to sell AFTER the bull market’s top is guaranteed to be in. We use a version of the Initial Claims model as a stop-loss indicator in the Medium-Long Term Model.

Seasonality and insider selling

With September almost over, I would like to bring 2 points to your attention.

The S&P 500’s seasonality in October is middle-of-the-pack.

Values S&P 500 Seasonality (% change)S&P 500 seasonality (% change)JanuaryFebruaryMarchAprilMayJuneJulyAugustSeptemberOctoberNovemberDecember-2-10123

However, the stock market’s daily volatility in October is typically higher.

Meanwhile, corporate insiders sold $10 billion of stock in August 2018.

While this is commonly seen by the finance community as a “bearish sign” for stocks, it isn’t. Corporate insiders are no better market timers than mom and pop. Corporate Insiders are not “smart money”. They’re good at running their companies, not trading their stocks.

In fact, corporate insiders have been “dumping” their stocks pretty much throughout the entire course of this bull market.

1. July 2018 from CNN: “CEOs are dumping stock in their companies. Here’s what that means”
2. February 2017 from CNBC: “Companies are dumping stocks at levels ‘rarely seen’, report indicates”.
3. March 2015 from Market Watch: “Tech insiders dumping stocks as their companies buy them back”
4. March 2014 from Market Watch: “In-the-know insiders are dumping stocks”
5. August 2009 from Reuters: “Bears prowl Wall St as insiders dump stock”

 

Outlook

Here’s what I think will happen based on my discretionary outlook.

1. The S&P 500 has approximately 1 year left in this bull market (bull market top sometime in 2019).
2. I will scale out of my long positions throughout 2019 (see why)

I am 67% long SSO right now (2x S&P 500 ETF) because my Medium-Long Term model does not foresee a big correction or bear market at this point in time. (This is a step down from being 100% long SSO previously). I ignore small corrections. I only sidestep big corrections and bear markets.

I have been long the S&P 500 since September 7, 2017, when it was at 2465.