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Late Cycle Bull Market Rally?



Its official the current decade old stock market rally is now the longest bull market since the Great Depression. No matter when it ends, the recovery from the Great Recession is not only impressive in terms of returns (354% so far) but also very resilient in terms of duration (126-months and counting). It has frustrated many of the bears and surprised even a few bulls. This historic bull run all started from the depths of the global financial crisis from a climatic low of 666.79 on 3/9/19 as SPX lost 57.69% of its overall value in 17-months. The current bull, and the thirteenth one since the 1920s, has now surpassed the Roaring 90s - Oct 1990 bull of 113-months and gains of 417% as well as the Post-war boom - Jun 1949 bull of 86-months and returns of 266%. As with all good things, this bull will also come to an end. So, how will we know when it will end?


History has shown US bull markets do not end abruptly. Rather, there are often warnings such as market corrections of 10% or more and increasing market volatility ahead of the next bear decline. Since the US stock market discounts the US business cycle, then one should monitor the divergences between the stock market and the economy for clues to gauge the beginning and ending of major bull and bear markets. That is, the stock market is forward looking, and the economy is backward looking. The stock market often peaks or troughs months and quarters ahead of business cycle tops and bottoms. The stock market and the economy, at least in the US, almost always follow a defined path of early expansion, mid-cycle expansion, late expansion and contraction/recession.


As economy matures business risk also increases. In turn, this results in investors demanding higher returns to compensate for taking more risks. If we are indeed entering into the later phase of an US economic cycle, then the following conditions often occur during this phase of the cycle: (1) rising interest rates leads to an inverted yield curve; (2) asset bubbles may occur and in equities this is denoted by an excessive stock market valuation in relationship to historical average; (3) investor and consumer confidence tends to peak; (4) credit tightens as denoted by the widening of credit spreads between high yield securities and investment grade; and (5) signs of rising inflation. It is interesting that we are getting mixed economic signs on the above factors suggesting the US stock market/economic cycle may be in a state of confusion possibly heading toward a critical juncture.


From a stock market perspective, you can expect to witness the following: (1) one of the best returns occur just prior to the start of a bear market. For instance, (1) small-cap equities tend to decisively outperform large-cap equities 1-year before the beginning of a bear market; (2) intermediate-term bonds perform very well approximately 2-years ahead of the start of a bear; (3) S&P 500 Industrials, Energy and Materials (including Gold and Silver) tend to attract a lot of interests in the press and media into the late-to-peak expansion phase; and (4) defensive and income related S&P 500 sectors such as Consumer Staples, Healthcare, Utilities and Energy begin to relatively outperform peers into the start of a contraction/slowdown/recession. It is also astounding that given the current length and magnitude of the current bull rally we are also detecting rather mixed readings in many of the leading stock market indicators. Perhaps this hint of the potential for one final speculative type rally that culminates in the elusive parabolic blow-off market top.


Attached are some of the more important financial, economic and stock market indicators to monitor for early signals of a major market turning point:



Source: Courtesy of StockCharts.com


Source: Courtesy of StockCharts.com

Many are focusing on the inversion of the yield curve as the long-end of the US treasury yield curve fall below the short-end of the curve. Although the inversion of the US treasury yield curve has been a good proxy to contractions and recessions in the past we believe it is when the spreads between the long (i.e., 10-year treasury  yields) and the short end (i.e., 3-month treasury yields) decline to an extreme level (i.e., -0.60 to -0.77) and most important, begins to rise sharply higher that this has triggered a major stock market sell-off.  For instance, the sharp contraction in yield spreads to -0.77 during 2001 led to a subsequent sharp expansion in spreads from 2001-2002 thereby leading to the Tech/Telecom bear market. This same phenomenon occurred once again during the sharp contraction in spreads to a low of -0.60 in 2007 and the equally sharp and explosive expansion in spreads from 2007-2009 that triggered  the great recession.
Many are focusing on the inversion of the yield curve as the long-end of the US treasury yield curve fall below the short-end of the curve. Although the inversion of the US treasury yield curve has been a good proxy to contractions and recessions in the past we believe it is when the spreads between the long (i.e., 10-year treasury yields) and the short end (i.e., 3-month treasury yields) decline to an extreme level (i.e., -0.60 to -0.77) and most important, begins to rise sharply higher that this has triggered a major stock market sell-off. For instance, the sharp contraction in yield spreads to -0.77 during 2001 led to a subsequent sharp expansion in spreads from 2001-2002 thereby leading to the Tech/Telecom bear market. This same phenomenon occurred once again during the sharp contraction in spreads to a low of -0.60 in 2007 and the equally sharp and explosive expansion in spreads from 2007-2009 that triggered the great recession.

Source: Courtesy of StockCharts.com

Late cycle sectors such as Materials including Gold and Silver tend to excel during the later stage of an expansion cycle. We suspect investors including many professional investors begin to favor the defensive nature of sectors or asset class that is inversely correlated to the stock market. So, can the recent interests in Gold ignite another rally back to its all-time high of 1,826.90? Will a breakout in Gold to new all-time highs signal a peak in soft assets such as equities?

Source: Courtesy of StockCharts.com

It is unusual for US small cap (RUT) and US large cap (SPX) to show such a large divergence against its historical norm. That is, you would expect after RUT has severely underperformed its larger cap counterpart for the past 8-years it would begin to show signs of a leadership shift. However, this has not been the case as evidenced by the relative strength breakdown of the RUT/SPX chart during the early part of 2019. This is in sharp contrast to the historical norm of the small cap market (RUT) dramatically outperforming the large cap market (SPX) approximately 1-year ahead of a bear (i.e., 1999-2000 and 2005-2006). So, was this brief period of outperformance from RUT during mid-2018 a warning suggesting the typical small cap/large cap outperformance cycle has already occurred?

Source: Courtesy of StockCharts.com

Is Utilities sector a proxy for income investing (dividends) and doing well in recent years because of the historically low interest rate environment or is this S&P 500 sector a leading indicator for risk aversion? The monthly price momentum (MACD) has already broken out but the long-term uptrend price channel and relative strength have yet to complete their respective breakouts. If the price and relative strength breakout then this may signal a major leadership shift in the marketplace.

Source: Courtesy of StockCharts.com

Consumer Staples have been reliable in the past as this classic defensive minded S&P 500 sector have successfully warned of major stock market tops and economic contractions/recessions. For example, ahead of the Tech/Telecom crisis of 2000-2002 the Consumer Staples outperformed its S&P 500 sector peers during 2000-2001. A similar relative outperformance cycle occurred during 2007-2008 preceding the 2007-2009 great recession/global financial crisis. The relative strength has begun to relatively outperform SPX over the past year.

Source: Courtesy of StockCharts.com





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