Market Outlook: Will The Stock Market Make A V-Shaped Recovery?

The stock market crashed and has now bounced. V shaped recoveries are rare, but not impossible. Most crashes are followed by a bounce and a retest of the lows.

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 3-6 months).
  3. The stock market’s short term is mostly a 50-50 bet (although there is a slight bearish lean)

We focus on the long term and the medium 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 long term direction.

*I do not define “bear markets” via the traditional -20% decline. I define “bear markets” as 33%+ declines that last at least one year. E.g. 2007-2009, 2000-2002, 1973-1974, 1968-1970.

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 in a long term topping process. This will likely happen in the start of 2019. We are almost here 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 inflation-adjusted net value added of nonfinancial corporate business is trending sideways. This suggests that we are in the late stages of this economic expansion and bull market. This is not a tool for timing the bull market’s top.

Source: FRED

The Delinquency Rates is still trending downwards. Delinquency Rates tend to trend higher before equity bear markets and economic recessions begin.

Source: FRED

The ISM manufacturing new orders index is still relatively high, at 62.1. In the past, bear markets and recessions started when the ISM manufacturing new orders index was at 50-55, or lower.

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

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