Cracks are beginning to form in the real economy.

And the markets know it.

The overall stock market has been extraordinarily strong since the April lows. And for the most part, the rally has been broad-based involving most sectors in the S&P 500.

You can see this clearly in the below chart in which overall breadth rose steadily from April through September. This was a clear signal that this was a raging bull market in which most stocks were rallying. Put another way, practically every market sector was participating in the rally.

However, starting in September, things began to change. Breadth peaked in mid-September and has since been struggling to catch a bid. This was a red flag momentum was stalling out and the rally was beginning to weaken.

Indeed, multiple sectors with close ties to the real economy have been struggling. Specifically, homebuilders, banks, and retailers are all breaking down. This is a warning that despite the stock market hitting new all-time highs, thing are NOT well in the real economy. The breakdown in homebuilders is particularly concerning because eight of the 11 recessions since World War II started in housing. In this sense, housing can sometimes be construed as “the canary in the coal mine” for the overall economy.

In this context, the big question for investors is whether this deterioration in these economically sensitive sectors indicates the economy is rolling over into a recession that will trigger a stock market crash. After all, if the REAL economy is collapsing, it’s only a matter of time before stocks crater.

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