Market Outlook: So Many Extremes In The Stock Market. What’s Next

The S&P 500 experienced a week of nonstop selling.

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 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 direction.

*I do not define “bear markets” via the traditional -20% decline. I define “bear markets” as 40%+ declines that last at least 1 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).

Housing Starts and Building Permits have been trending sideways/down over the past year. Historically, these economic data series trended downwards before bear markets and recessions began.

Source: FRED

Homebuilder sentiment is trending downwards. In the past, homebuilder sentiment trended downwards before bear markets and recessions began.

Source: TradingEconomics

Meanwhile, the labor market remains healthy. Initial Claims and Continued Claims have not yet trended upwards. These 2 leading indicators trended upwards before prior bear markets and recessions began.

Source: FRED

Of lesser importance are corporate profits and inflation-adjusted Retail Sales (monthly data is more useful than quarterly data). Corporate profits and inflation-adjusted Retail Sales are still trending higher. In the past, these 2 data series trended downwards before bear markets and recessions began.

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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 models, such as the  more

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