It's no secret that the current bull market and economic expansion are getting long in the tooth. Eventually, the market will turn bearish, and history tells us that we're likely to see a recession six to nine months after the bull market's peak.
These five indicators can help you spot market tops and recessions on the horizon. Think of them as alarm bells. None is ringing loudly at the moment, but if several go off in unison, consider paring back risk in your portfolio.
The indicator: The Conference Board's Consumer Confidence Index, released monthly, tracks consumers' attitudes about business and economic conditions.
Why watch it: Consumer spending drives nearly 70% of U.S. economic activity. “A sharp drop in confidence implies that a recession is imminent,” says Ed Clissold, chief strategist at investment research firm Ned Davis Research. On average, recessions have occurred when the index dips to a level of 63 or below, he says.
What it says now: At 133.4, the Conference Board index is far from recession territory, says Clissold.
The indicator: The advance-decline line represents the cumulative number of NYSE stocks with advancing share prices minus those that are declining, plotted over time.
Why watch it: The A-D line tells you how many stocks are participating in a trend. If the generals are charging while the troops are in retreat, a bear market may be on the horizon, says James Stack, publisher of InvesTech Research.
What it says now: Although tech titans make headlines, the market's gains remain broad-based, says Clissold. The A-D line has stayed positive this year as U.S. indexes have climbed.
The indicator: The number of stocks hitting new 52-week highs or lows on the New York Stock Exchange.
Why watch it: The number of stocks hitting new highs or lows can signal whether bulls or bears are driving market sentiment—whether the overall market is trending up or down. In a healthy market, fewer than 50 stocks per day on the NYSE sink to new lows, says Stack. One hundred in a day could be a temporary blip. But if you see 100 per day over several weeks, it's a sign that bearish leadership is building.
What it says now: Aside from a spike in February, new lows have hovered between 20 and 40 in 2018. But note that new highs typically peak one year, on average, prior to market tops. The peak for new highs in the current market was in December 2016.
The indicator: The monthly report from the U.S. Census Bureau that tallies housing starts—the number of new homes breaking ground—compared with the same month a year ago.
Why watch it: Housing starts indicate economic strength. “Who is going to buy a house if they're not certain they'll keep their job?” says Sam Stovall, chief strategist at investment research firm CFRA. Within three months of every recession since 1960, housing starts have logged a double-digit decline compared with the same month in the previous year. Average prerecession drop: 25%.
What it says now: June figures show a 1.4% dip year-over-year, on top of a 5.5% decline a month earlier.
The Fed & inflation
Why watch them: Historically, bear markets have begun when the fed funds rate far exceeds inflation, says Stovall. Since 1959, the market has entered bear territory when the fed funds rate exceeds inflation by 2.7 percentage points, on average.
What they say now: At a current annual rate of 2.7%, inflation exceeds the fed funds rate by less than a percentage point. But Stovall expects inflation to fall below the fed funds rate by the third quarter of 2019, as the Fed continues to hike rates.
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