Watch for these bear traps being set to snare the bull market.
• When the unemployment rate makes a cyclical low (Fig. 1).
• Initial unemployment claims scream, "Get out! Get out!" (Fig. 2)
• Buying stocks when the yield curve is flat and on the verge on inverting. (Fig. 3).
• Buying stocks when the Fed is raising interest rates can work for a while, until higher rates trigger a financial crisis, which often turns into a credit crunch and a recession (Fig. 4) and(Fig. 5).
• Rising bond yields aren’t always bad for stocks, until they are (Fig. 6).
• Those times late in an expansion when the profit margin exceeds its mean tend to set it up for a bruising reversion to the mean and even below, which is bad for profits and bad for stocks (Fig. 7).
• Buying stocks when valuations are extremely high?"Fuhgeddaboudit!" (Fig. 8).
A Bloomberg article earlier this month was titled "Goldman Bear-Market Risk Indicator at Highest Since 1969: Chart." The Goldman indicator neatly converts all of the major bear traps into one series: "A Goldman Sachs Group Inc. indicator designed to provide a ‘reasonable signal for future bear-market risk’ has risen to the highest in almost 50 years. The firm’s Bull/Bear Index, which is based on measures of equity valuation, growth momentum, unemployment, inflation and the yield curve, is now at levels last seen in 1969. While the gauge is at levels that have historically preceded a bear market …"
So why does the stock market bull continue to charge ahead? Last Friday, the S&P 500
closed a whisker below its record high of 2930.75, and iss rapidly approaching my 3100 target for this year (Fig. 9)). The benchmark is up 9.6% so far in 2018, and has recovered nicely from the nasty 13-day correction earlier this year, up 13.5% since the year’s low on February 8 (Fig. 10). During the current bull market, I count five corrections (exceeding 10%), one near correction (that rounds up to 10%), and a total of 61 "panic attacks" that were followed by relief rallies.
The latest relief rally reflects mounting confidence that Trump’s trade war won’t escalate into one that depresses the economy and corporate earnings, which continue to soar. In addition, there is less fear lately that the Fed’s policy normalization will trip up the bull market. Earlier this year, there was fear that a 10-year U.S. Treasury bond
yield above 3.0% would be bearish for stocks. It recently rose back slightly above that level, yet it was widely deemed to be bullish for financial stocks. Go figure.
So what will it take to snare the bull ? Recession. That’s all there is to it.
While Goldman and everyone else is on the lookout for this event, both the Index of Leading Economic Indicators (LEI) and the Index of Coincident Economic Indicators (CEI) rose to new record highs during August (Fig. 11). The LEI did so even though the yield curve spread, which is only one of this index’s 10 components, has been narrowing fairly steadily since 2013, but remains positive. It only subtracts from the LEI when it is negative. So it is still contributing positively to the LEI, though to a lesser extent. History shows that the CEI, which is a good monthly proxy for quarterly real GDP, falls when a financial crisis occurs, triggering a credit crunch and a recession. There’s no sign that scenario is about to play out anytime soon.
I have argued that there was a growth recession during 2015 caused by the collapse in commodity prices. Credit-quality yield spreads widened dramatically, especially in the junk bond market. Yet here we are near record highs in the S&P 500.
Ed Yardeni is president of Yardeni Research, Inc., a provider of global investment strategy and asset allocation analyses and recommendations. He is the author of “Predicting the Markets: A Professional Autobiography”. (2018). Follow him on Twitter and LinkedIn.