Market Outlook: Stock Market Is Bouncing After Being Extremely Oversold

Once again, there is a bearish lean over the next 1-2 weeks. Extreme crashes (very oversold) + bounces = usually a retest

The most important 10 year – 3 month yield curve will invert soon.

Source: FRED

This isn’t necessarily an immediate long term bearish sign, but it is a warning sign of late-cycle activity. You can see that forward returns start to deteriorate 1 year later.

Correlation and specific sectors (secondary importance)

Sometimes other markets and specific sectors can give us a clue about where the S&P 500 will go.

Right now, many sectors are flashing warning signs. While these may seem bearish, they are of secondary importance to the S&P 500’s own factors (as mentioned in the market studies above).

As we mentioned on Friday, safe haven assets gold and Yen have been going up while the S&P has been trending down from December – present.

Gold’s uptrend is not bearish for the S&P.

And the Yen’s uptrend (USDJPY’s downtrend) is not consistently bearish for the S&P either

*It’s interesting how many of these cases happened after the S&P crashed 30%, 40%, 50%

However, the rising U.S. Dollar is a bearish factor for U.S. stocks. Stocks don’t always fall when the USD rises, but when stocks do fall when the USD rises, stocks tend to fall more over Q1 (retest?)

The upwards trend in interest rates is also a slightly bearish factor. In 2018, the 10 year yield went up while the S&P fell. When this happens, the S&P’s Q1 of next year (Q1 2019) tends to be weak.

XLY:XLP usually moves in the same direction as the S&P. But in December, XLY:XLP went up while the S&P went down.

From 1998 – present, this has happened only in bear markets

*Be careful when using 1998 – present data. Such data overestimates the probability of a 50% decline. More data is better than less data.

Conclusion

  1. The S&P 500’s own factors point to a medium term bounce.
  2. Correlated sectors and markets point to a 1-3 month decline (retest?)

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 is still bullish(i.e. trend for the next 6 months). However, if this is the start of a bear market, bear market rallies typically last 3 months. They are shorter in duration.
  3. The stock market’s short term has a slight bearish lean. Focus on the medium-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.

 

 

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Disclosure:

Our discretionary outlook is not a reflection of how we’re trading the markets right now. We trade based on our quantitative ...

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