The first quarter is over, so I thought I would provide an overview of how things look to me at this point based on the indicators that I follow.
First, the US economic picture looks generally sound. It’s not going to break any records in terms of growth, but as of today a recession in the immediate future seems unlikely.
The unemployment rate is low and has not started rising. Increasing unemployment has historically started the clock on the end of the business cycle and market tops.
Real retail sales are still positive year over year.
Industrial production is strong year over year.
Finally, home prices continue to grow year over year.
If the US were about to go into a recession in the near future, I would expect one or more of these indicators to be rolling over. Since none is, the more likely outcome is no recession on the immediate horizon, which means that a recessionary bear market is unlikely.
Despite the generally positive economic background, global equity markets have been under pressure since peaking this quarter. Many risk on/risk off technical indicators are showing weakness.
$IEI (5-7 year US treasuries) has been outperforming $JNK (high yield bonds) over the past 3 months as credit spreads have begun widening.
$IEI has also been outperforming $EMB (emerging market bonds) over the past 3 months.
The percentage of NYSE stocks below their 200 DMA is less than 50% showing that weakness is fairly broad.
Cumulative new highs - new lows has rolled over and is trending lower.
Gold has been outperforming copper over the past 3 months.
Not surprisingly, rates have started falling as gold has been outperforming copper.
Taken together, these indicators suggest that some caution is warranted.
However, barring a rapid deterioration in economic fundamentals or some geopolitical black swan, I believe that this is just a correction in an ongoing bull market. It could be a severe correction, but I do not think that we have seen the highs for this bull market.
Momentum at the recent top was extreme as shown by the 12-month rate of change on the chart of global equities below.
It would be rare for this type of strength to be a top. Obviously, nothing is impossible, but in my opinion it is unlikely.
As well, if there were serious concerns about global equities and financial conditions, I do not think the frontier markets would be holding up as well as they have been. $FM is barely down and instead looks like it is ready to make new highs.
April is usually a strong month so a bounce in global equities from current levels would not be surprising given current sentiment.
However, after April, seasonal weakness usually begins, especially during mid-term election years, as shown in the chart below from Ned Davis Research.
In summary, a number of indicators are showing that there is reason to be cautious. However, given the economic conditions and the market’s momentum at the highs, I believe that this is likely just a correction in a bull market and that the highs have not been seen. With seasonal weakness beginning after April, it would not be surprising to see weakness and volatility persist into the summer, perhaps after a short term bounce to relieve extreme negative sentiment.
In terms of positioning, my long term systematic model has reduced its equity exposure by 25% as of last week’s close. This gets updated weekly. In this highly volatile environment, there is a strong chance that whipsaws will occur.