How does one know when stocks have bottomed and are poised to trend higher over the ensuing months?
Although there’s no way to know for sure when stock prices, in general, have bottomed, three things usually occur at around the same time that stocks are in the process of bottoming and are poised to trend higher over the ensuing months.
1. Stocks of companies that operate in cyclical sectors of the economy outperform stocks of companies that operate in so-called “defensive” sectors for several consecutive weeks after the opposite of that occurred over the prior months.
2. The readings on several so-called “technical” indicators – on statistics that illustrate the trading action in a given stock or overall stock market – turn positive after previously being negative for several months.
3. The readings on several leading economic indicators increase for a few consecutive months after declining substantially over the prior 6-18 months.
As an example of the correlations mentioned above, all of the bull markets in U.S. stocks that took place from 1969 to 2015 began at around the same time that each of the developments outlined above occurred. And, those relationships appear to be in the process of developing once again.
Stocks of companies that operate in cyclical sectors of the U.S. economy (i.e. the industrial, basic materials and energy sectors) outperformed stocks of companies that operate in defensive sectors (i.e. the consumer staples, utilities and healthcare sectors), on average, over the nine weeks ended March 18, 2016.
That’s after defensive stocks outperformed cyclical stocks from December 1, 2015 to January 15 of this year.
In regard to the recent readings on some key “technical” indicators, a larger number of stocks that trade on the New York Stock Exchange rose during each of the past five weeks than the number of NYSE-traded stocks that declined during that period.
Also the percentage of NYSE-traded stocks that closed above their respective 200-day moving average also rose during each of the past five weeks.
During that same period, the so-called “fear index” – the Chicago Options Board Volatility Index (“VIX”) – trended lower after rising sharply from December 24, 2015 to February 11 of this year.
The financial market developments mentioned above suggest that U.S. stocks, in general, might have already bottomed and that they’ll continue to move higher during the months ahead.
However, the most-recent readings on numerous leading economic indicators, which continued to move lower over the past few months, suggest that stocks will soon resume their November 4, 2015 to February 11, 2016 downturn.
For instance, the construction of new homes – new housing starts – peaked during June 2015 and trended lower over the past 8 months. And, recent reports from both the National Association of Home builders and the National Association of Realtors suggest that new housing starts, which is a very reliable leading economic indicator, will continue to decline over the next few months.
Secondly, postings of employment advertisements on Internet web sites, which has historically served as a reliable leading indicator for both the U.S. employment market, and the future direction of the entire U.S. economy, peaked during November 2015 and trended lower over the past three months.
The following leading economic indicators also trended lower over the past few months: (1) the ratio of business sales to business inventories, (2) the year-over-year change in household installment debt, and (3) Americans’ expectations regarding the direction of the U.S. economy over the next six months.
My review of more than 1,200 business operating results for the fourth quarter of 2015 indicates that the corporate profits of U.S. companies declined for the second consecutive quarter during the three months ended December 31, 2015.
That would be a very significant development because the level and direction of stocks is determined ultimately by the level and direction of corporate profits.
So, I urge you to not get overly optimistic about the recent rebound in stocks.
Although the recent trading action in stocks suggests that stock prices, in general, will continue to move higher over the next couple of weeks, the readings on the leading economic indicators mentioned above suggest that stocks have not yet bottomed.
And, statistics issued by Investor’s Business Daily, State Street Research and the Investment Company Institute suggest that a relatively small number of short-term traders were responsible for the recent upturn in stocks.
The institutional investors, as well as long-term oriented individual investors, have been reducing their investment allocations to stocks since July 2015.
If you would like to be notified of when our economic and stock market forecasting model, which is based primarily on 23 leading economic indicators, 9 technical indicators and our proprietary sector rotation index, I encourage you to subscribe to our Free Weekly Commentary. Click here to subscribe now!
Until next time,
David Frazier is President and Chief Market Strategist of Frazier & Mayer Research, LLC, an independent investment research firm that offers customized research and analytical services to registered investment advisors, hedge funds and high net-worth individual investors. You can check out his latest insights at: www.investorsmonitor.com.