Published September 7, 2018
It is said that stock markets climb a wall of worry. As concerns dissipate, investors feel more free to take risk and buy stocks. A sustainable market rally takes hold when the worries are replaced by a “Goldilocks” scenario where market participants view the near-term future as favorable for stock investing. They buy shares with little concern. The lack of concern reaches a point of complacency where investors are undervaluing potential risks. This leads the market to be vulnerable to a shock as most of the buying has occurred, bullish investors are fully invested, and there is little extra willing cash available to buy the next dip. Here, markets can see an outsized reaction to a news item that previously would have been shrugged off. The outsized reaction downward ends the rally and the cycle begins anew. These mini-cycles continue until economic conditions reach a point where investors become concerned enough to sell their “core” or longer-term holdings, take short positions to hedge their portfolios, and/or generally begin favoring bonds or cash to stocks.
There appear to be few worries these days as the S&P 500 last week crossed 2900 for the first time ever. The market has recently shrugged off myriad trade spats and increasing/widening issues related to emerging market currencies en route to these new highs. However, you don’t have to dig far to find indicators that are sounding alarm bells. Our weekly blog post a couple of weeks ago offered some of those. We provide below another couple. It may well be that these indicators come right back around to a healthier state. However, currently, they are trending the wrong way, and building the wall of worry that might be the fuel for a future rally.
Take a look at the Philadelphia Federal Reserve Bank’s report on new orders versus prices paid. While orders have been chopping around for the past 18 months, prices have risen steadily. Typically, we see these two moving a little more in unison with demand for goods pushing prices higher. However, here we see prices remaining elevated even though order growth is flat.
Chart 1: Philly Fed Outlook
Combining these two lines into a single metric gives us the New Order minus Price (NOPE) index. With prices rising while orders hold flat, this indicator has registered a level often seen only at the onset of a recession.
Chart 2: NOPE index points to recession(?)
Another chart causing concern comes from consulting group Fathom showing an explosion in their recession indicator to extreme levels. The green line shows Fathom’s model spiking upward while the New York Fed’s model (blue line) remains quite subdued. You can see that the past three spikes in the green line (Fathom model) has occurred just before a recession (the gray bars).
Chart 3: One firm’s recession model spikes higher
Finally, we offer this chart from Goldman Sachs noting that the market is currently in its longest stretch without at least a 20% decline. We are well overdue for such a downward move. What will bring it about? No one knows. We do know that our reason for existing here at TimingCube is to be on the lookout for such market events so that we can issue signals to protect your wealth. We have protected our subscribers from both severe bear markets in 2000-2002 and 2008. Our models will protect us again the next time the bear shows its claws.
Chart 4: It’s been a long time since a 20% decline
This week stock investors waded into the notorious month of September, the historically worst month of the year for stocks. Trading kicked off Tuesday after Monday’s Labor Day holiday with a slight -0.2% loss as trade talks continued, unresolved, with Canada. Bonds sold off after the long holiday weekend produced no new crises, pushing yields higher. Amazon (AMZN) became the second trillion dollar company Tuesday, joining Apple (AAPL) at that rarified level. It was a one-day wonder though as selling hit the market-leading tech/consumer sector Wednesday, pushing the Nasdaq lower by -1.2% while the broader market was down only slightly. Social media companies Facebook (FB) and Twitter (TWTR) testified before Congress, which may or may not have contributed to the pressure on the sector; those stocks fell sharply perhaps on concerns of stiffer government regulation. Stocks tumbled again Thursday with the S&P slipping -0.4% and the tech/consumer-heavy Nasdaq down almost another -1%. Semiconductors weighed on the Nasdaq with comments from semi maker Micron (MU) regarding weakness in pricing pounding the group. Micron was off -10% on the day. Stocks fell again Friday with attention focused on the monthly jobs report, which showed wage growth (and therefore inflation) picking up. Higher inflation begets higher interest rates, which will eventually be a drag on stock prices. Adding to Friday’s woes was President Trump reiterating plans to implement tariffs on Chinese goods, which would affect many goods used as components by U.S. tech/consumer companies like Apple. The stock market, broadly, was only off -0.2%, oddly, on a day which should have been much worse. Why much worse? Because interest rates pushed notably higher on the wage growth report. The 2-year U.S. Treasury yield hit decade-long highs on the move. Usually such a steep move higher in rates produces a strongly negative reaction from stocks.
One week after the S&P 500 reached 2900 for the first time, stocks sold off, down all four days of the holiday-shortened trade week. The broad market index (SPY) slipped -0.93% for the week. The damage was much worse in the market-leading Nasdaq 100 (QQQ) which tumbled -2.97%. Small-cap stocks (IWM) slid -1.43%. Both small-cap and Nasdaq held their support levels, however.
Warm wishes and until next week.