Thanks to all of you who generously took the time to give me comments and feedback on my white paper about the relationship between the economy and the stock market. I found many of your ideas extremely helpful, and I am going to incorporate several of your suggestions in the next volume of the paper. I have set a goal for end-of-October to get volume II published.
In case you missed it, here’s the link to the white paper. Fair warning: it’s a long document (about 90 pages), so it’s not exactly a quick and easy read. But it is a very robust analysis of something that every serious investor needs to know. Having the ability to anticipate the next recession – and reduce your exposure to stocks before it arrives – is invaluable. This white paper shows you how to do exactly that.
Weekly Recap
The stock market continues to struggle, caught in the quicksand of the current correction that began on May 21st and accelerated last month. But it’s not all bad news. From both a technical and a fundamental perspective, the prognosis for the market is good. The probability that the current correction will worsen, and become a bear market, is very low.
The Technical view is that the market bottomed, at least temporarily, on August 25th. Since then, it has logged a series of higher highs and higher lows – in a stair step pattern that chartists seem to like. It’s a pattern of “two steps forward, one step back.” As long as the market doesn’t fall all the way back to the recent low water mark of 1,867 I will view the technical pattern as favorable.
The Fundamental view is also positive, because the economy is still expanding, corporate earnings are growing, interest rates are low, inflation is in check, and there is no indication of a recession coming anytime soon. When the economic backdrop is as favorable as it is today, history tells us that corrections are shorter, shallower, and less painful than average.
Correction Watch
The next chart shows all of the corrections since the current bull market began in March 2009. We recently got our first official “correction” since 2011. So far this has been a healthy development for the market, because it took some of the air out of the valuation bubble that’s been building since the end of 2013. But if we don’t pull out of this correction, and instead continue to make new lows, it might be an indication of more serious trouble ahead.
Keep an eye on 1,867 for the S&P 500. Although I think it’s very unlikely that the sellers will take it out, it could happen. And if it does, I think the market is in for a prolonged (but not necessarily deep) correction.
Recession Watch
The good news for investors, job-seekers, and business owners is that the threat of a new recession remains very low. We base this on a number of economic indicators as summarized in the table below. Our primary indicator – the R-score – has been above 500 since April and shows no sign of dipping below the danger zone of 200, anytime soon. We call this our primary indicator because it combines the 4 most powerful metrics we study. Namely, long term interest rates, short term rates, unemployment rate, and inflation. As long as this number remains above 200, the likelihood of a recession hitting between now and 8 months from now, is virtually nil.
The other items in the table are “coincident” indicators, which help us understand some of the undercurrents that drive the R-score.
In addition to our table of key indicators, we also keep an eye on other metrics that might give us an early warning of trouble.
Interest rates and credit spreads
- 39% BAA corporate bonds up +0.04%
- 21% 10 year treasury bonds down -0.02%
- 17% credit spread between corporates and treasuries up +0.06%
- 93% mortgage rate, 30 year conventional, down -.06%
Bank lending rates
- 342 TED spread up +0.021 w/w (3 year high)
- 2160 LIBOR up +0.0096 w/w (3 year high)
Mortgage applications
- -9% w/w Purchase applications
- +5% YoY Purchase applications
- -4% w/w Refinance applications
Real Estate loans
- -0.1% w/w
- +4.5% YoY
M1 money supply
- -0.6% w/w
- -1.6% m/m
- +7.3% YoY Real M1
M2 money supply
- Unchanged w/w
- +0.8% m/m
- +6.1% YoY Real M2
Trade-weighted US Dollar
- Down -0.41 to 120.16
Commodity prices
Journal of Commerce/ECRI
- Down -1.01 to 90.87 w/w
- Down -27.44 YoY
BBG Industrial metals ETF
- 83 down -3.20 w/w
Employment metrics
Initial jobless claims
- 264,000 down -11,000
- 4 week average 272,500 up -3,250
The American Staffing Association Index
- Down -1 to 8
- Down -2.66 YoY
Income Tax Withholding
- $107.0 B for the first 12 days of September vs. $113.7 B one year ago, down -$5.9 B or -5.9%
- $162.7 B for the last 20 reporting days ending Thursday vs. $155.9 B one year ago, up +$6.8 B or +4.4%
- Oil up +$0.20 to $44.98 w/w
- Gas down -$.06 to $2.38 w/w
- Usage 4 week average up +3.8% YoY 9157 vs 8975
Steel production
- Down -2.7% w/w
- Down -9.8% YoY
Consumer spending
- Johnson Redbook +1.7% YoY
- Goldman Sachs -3.1% w/w, +1.3% YoY
- Gallup daily consumer spending 14 day average at $87, up +$5 YoY
Transportation metrics
Railroad transportation
- Carloads up +0.4% YoY
- loads ex-coal up +8.1% YoY
- Intermodal units up +17.0% YoY
- Total loads up +8.0% YoY
Shipping transportation
- Harpex down -13 to 528
- Baltic Dry Index up +142 to 960
[Source: NewDealDemocrat]
That’s it for this week. To recap, keep an eye on the 1,867 level for the S&P 500. Although I think it’s very unlikely that the sellers will take it out, it could happen. And if it does, I think the market is in for a prolonged (but not necessarily deep) correction.