Financial Conditions Will Tighten Soon. What This Means For Stocks?

With the yield curve inverting and the economy in the late-stages of its expansion, financial conditions will tighten over the next few quarters. This is not yet a long term bearish sign for stocks, but will be very soon.

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Let’s determine the stock market’s most probable medium term direction by objectively quantifying technical analysis. For reference, here’s the random probability of the U.S. stock market going up on any given day.

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*Probability ≠ certainty. Past performance ≠ future performance. But if you don’t use the past as a guide, you are blindly “guessing” the future.

Financial conditions will tighten

Financial conditions remain very loose. In the past, financial conditions tightened before bull markets ended.

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Banks have not yet tightened lending standards, but will probably do so soon. From Jamie Dimon (JP Morgan’s CEO):

Jamie Dimon has a message for his employees and investors: When the time comes, J.P. Morgan Chase will rein in loan growth at the nation’s biggest bank.

“We tell our management that we have no problems seeing loan books shrink,” Dimon said in the earnings conference call. “Remember, Warren Buffett used to say in the insurance business, and sometimes this is true in the loan business, [there are times] when you’re better off having the sales force go play golf than make new loans. We are not going to be stupid.”

Still, when the next analyst, Betsy Graseck of Morgan Stanley, asked Dimon if his salespeople were “playing golf all day yet,” Dimon responded with a sharp “No.” 

Dimon’s remarks match what we see in the data. Financial conditions have not yet tightened, but will soon. This is not yet a long term bearish sign for the stock market and economy, but will be soon when financial conditions tighten.

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