Market Outlook: Another Week, Another Failed Rally. What’s Next For Stocks

After a solid start to the week, the S&P 500 once again sits at the bottom end of this correction.

Source: Investing.com

The economy’s fundamentals determine the stock market’s medium-long term outlook.  Technicals determine the stock market’s short-medium term outlook. Here’s why:

  1. The stock market’s long term risk:reward is no longer bullish.
  2. The stock market’s medium term leans bullish (i.e. next 6 months).
  3. The stock market’s short term is mostly a 50-50 bet.

We focus on the medium and long term. Let’s go from the long term, to the medium term, to the short term.

Long Term

While the bull market could very well still last until Q2 2019, the long term risk/reward no longer favors bulls. Past a certain point, risk/reward is more important than the stock market’s most probable direction.

Some leading indicators are showing signs of deterioration. The usual chain of events looks like this:

  1. Housing – the earliest leading indicators – starts to deteriorate. Meanwhile, the U.S. stock market is still in a bull market while the rest of the U.S. economy improves. The rally gets choppy, with volatile corrections along the way.
  2. The labor market starts to deteriorate. Meanwhile, the U.S. stock market is still in a bull market but getting close to a long term top. This will likely happen in the start of 2019. We are almost there right now.
  3. The labor market deteriorates some more, while other economic indicators start to deteriorate. The bull market is definitely over.

Let’s look at the data (aside from our Macro Index).

The labor markets remain healthy. The KC Fed’s Labor Market Conditions Index is still relatively high. This indicator was much weaker before prior bear markets and recessions began.

Source: FRED

Meanwhile, Initial Claims and Continued Claims have not yet trended upwards. These two leading indicators trended upwards before prior bear markets and recessions began.

Source: FRED

The year-over-year change in nonfarm payrolls is flat. Historically, this figure trended downwards before bear markets and recessions began.

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