- The global economy is weakening.
- Consumer sentiment is complacent and one sided.
- The stock rally is technically mature and losing momentum.
- But monetary policy appears to be compensating for these weaknesses.
In recent months, there have been four factors that have created a sweet spot for stocks. Indeed, stocks have rallied, and both the Dow and the S&P 500® Index have reached new all-time highs. But evidence has been mounting that three of these factors may be souring, and that instead of staging a long lasting break-out, the market may in fact be at a peak. For that to be confirmed, the S&P 500 would need to fall below 1,539, which is a level that has contained three sell-off attempts so far. Currently the index is at 1,560, so for now the market appears to be safe.
So, what’s next? Let’s see how my thesis is playing out.
To recap, the four factors that have been supporting stocks are economic momentum, sentiment, the technicals, and monetary policy. (Read my prior Viewpoints on the four factors: Breakout or fakeout?)
Economy: global slowdown
Taking the economy first, there is now clear evidence that the global economy is slowing down. Whether it is just a soft patch—like we’ve experienced in recent years—or something more serious remains to be seen, but the loss of momentum is unmistakable. From nonfarm payrolls rising less than expected to China’s GDP growing only 7.7% despite huge credit growth, there have been a number of misses lately in terms of economic reports. The Citigroup Economic Surprise Indexes are now negative for all major regions of the world, including the United States, Europe, and emerging markets.
Sentiment: optimistic extremes
In terms of consumer sentiment, we continue to see the kind of optimism that one tends to see in a significant market advance. The caveat is that sentiment is merely an attribute of price, so one-sided sentiment on its own is not enough to turn the market. But when sentiment is one sided, it tells us that the risk is high, and that, if the fundamental story changes, there may be too many investors on the wrong side of the market.
Technicals: signs of fatigue
Technically, the rally off the November lows is looking more and more tired, displaying all the telltale signs that the uptrend is at risk of coming to an end. But, possibly most important, while the S&P 500 and Dow are holding above support levels, many other indicators have started to turn negative. Banks in Europe have been trending lower for months now, as has China’s Shanghai Composite. More recently, the German DAX has reversed lower, and here, in the United States, small-cap stocks have lost their leadership. Then there are government bond yields. The 10-year Treasury yield is near its lows, at 1.7%, and German bund yields are making new lows, at 1.22%. So while the major indexes are up near their highs, the rest of the market is telling a different story.
Which prompts me to question why. Why are the S&P and Dow near their highs despite clear evidence that, both technically and fundamentally, things are not as good as they were a month ago?
Monetary policy: big plus for stocks
This brings me to monetary policy. This is the one factor that has not turned sour, and perhaps it’s the only one that matters, at least for now. It’s clear to me that at least the S&P 500 and the Dow are managing to reach highs, even while other risk assets are rolling over, compliments of the Fed’s open-ended QE (quantitative easing), and now, more recently, the Bank of Japan’s bold plan to double the monetary base. This combination of policy accommodation appears to be compensating for the fact that, technically, the rally is mature and losing momentum, sentiment is complacent and one sided, and the global economy is weakening.
Who knows? Maybe all we need to know is that the monetary "printing presses" will keep running and that will keep asset prices climbing. It seems to have worked so far. But in my view, in the short term, only one of four factors is driving the sweet spots for stocks.
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