Simple Rule Remains Bullish

May 5, 2021

Almost one full year has gone by since we posted that our Simple Rule has flashed a bullish signal. And the 11 months since this post have strongly supported the signal. The S&P 500 has soared since that time, setting all-time record highs in almost every month since late 2020.

Today, the signal remains intact. While the fundamental portion of the Simple Rule is still showing a bearish signal (mostly due to the employment data in the US), the Simply Rule’s technical signal does not confirm the bearish fundamental signal. Instead, the technical signal in our Simple Rule is still firmly bullish.

So we remain bullish on the S&P 500.

Simple Rule Flips to Bullish

June 4, 2020

As of Friday, May 29, our Simple Rule switched back to a bullish outcome.

Several comments about this:

First, the timing of our bearish signal worked well. An exit from the S&P500 on that day, February 28, would have allowed one to avoid huge losses, losses that peaked in the second half of March….about three weeks after the bearish signal was generated.

Second, the timing of this subsequent bullish signal is not typical. All bullish reversals over the last several decades in US market history have taken more than three months to occur. Since this current flip back to a bullish signal took only three months, there may be an increased risk of a false signal, and therefore a possible whipsaw if the Simple Rule flips back to being bearish in the near future.

Third, while this new bullish signal has materialized in the S&P500 index, it has not materialized in other indices such as the Russell 2000. Also, the primary reason behind the recent strength of the S&P500 is the out-sized positive impact of several huge tech stocks such as Amazon, Apple, Google and Microsoft. Without these top five or six tech names, the rest off the S&P500 would still be in a bearish condition, as defined by out Simple Rule.

So these next few months will be critical in determining if the recent rally in the S&P is truly the start of a new bull market cycle or if it’s simply a huge bear market rally that will soon break down.

Simple Rule Flashes Red!

March 1, 2020

On Friday February 28, 2020, our Simple Rule generated an overall bearish signal, for the first time in over a year. This means that not only did our fundamental signals generate a bearish signal but that our technical signals also confirmed this bearish signal. Clearly this happened after the monstrous sell-off in the US equity markets in the week ending February 28th.

It’s very important to remember that this bearish signal does not apply to any single equity security. Instead, it applies only to the entire S&P500 index as a whole.

So as of now, our Simple Rule is suggesting that one should exit any long positions in the S&P500 index, and go to cash or cash-equivalent securities.

Simple Rule Flashes Yellow

October 28, 2019

In the third week of October, our Simple Rule finally signaled a change: while still giving an overall bullish signal on the S&P 500 index, it did so with a caution message attached.

Our Simple Rule is based on two fundamental buckets of analysis—one fundamental and one technical. A few weeks ago, the fundamental bucket turned bearish, and this happened due to the breakdown in US economic reports.

In our system, the bearish signal in the fundamental bucket proceeded to activate the technical bucket. And the technical analysis that we use is still—as of the end of October—bullish on the S&P 500 index.

As a result, we remain bullish on this large cap index. However, this bullish signal is now closer to reversing (to a bearish signal) than it has been since the beginning of this year.

No Change in Stance—Still Bullish the S&P500

July 31, 2019

While two months have passed, our Simple Rule continues to work. The rule signaled a bullish stance back in May, and in fact the S&P500 has risen since then.

Today, at the end of July 2019, our Simple Rule remains bullish, on the S&P500 index overall. As a reminder, this signal does not pertain to any individual component of the S&P500, but to the aggregate of the 500 components.

While both the fundamental and technical categories of our Simple Rule are bullish, the fundamental component is still edging closer to generating a bearish signal. If the US economy moves towards contraction (and judging by the fact the the Federal Reserve is scheduled to lower interest rates today…for the first time since 2007….it’s looking more likely that a recession is approaching), then we expect that this fundamental signal will rapidly switch to being bearish.

Let’s see what happens to US economic data in August.

Simple Rule is Still Bullish

May 20, 2019

After sliding about 5% over the last four weeks, and then recovering a couple of percentage points, the S&P500 still sits only about 3% below its all-time highs.

Two economic reports that form the core of our Simple Rule were released last week. While both reports suggest that the US economy is weakening over the last month, these reports are still suggesting that the US economy is growing. In addition, the remaining economic components of our Simple Rule also suggest that the US economy is not contracting.

Since all of the economic components of our Simple Rule are showing expansion, the investment signal is still bullish…for the S&P500 index as a whole.

We update the economic reports in our Simple Rule on a monthly basis, and until the economic reports begin to show contraction, we will submit summary comments on the US equity markets only once a month. Until the economic reports that we follow turn down, more frequent analysis would not materially affect our position on the US equity markets.

S&P500 Continues to Climb Higher

April 22, 2019

Despite two weeks of weakening US economic data, the S&P500 continued to push higher. As of Friday’s close….at 2,905….the large cap index now stands at less than 1% below its all time highs, highs reached last fall, about seven months ago.

So without any major news or developments, the S&P500 has almost recouped its entire 20% loss, the loss that peaked at the end of December 2018.

Over these last two weeks, industrial production missed badly. Wholesale trade also missed. Factory orders shrank. Consumer and producer inflation came in hotter than expected. On the positive side, retail sales have rebounded slightly from their abysmal drop two months ago. And initial jobless claims continue to hover near 40 year lows.

At the same time, the Federal Reserve’s balance sheet continues to shrink, which is ironic because when the S&P500 was bottoming in late 2018, many experts were pointing to the Fed’s quantitative tightening as one of the leading culprits behind the market losses. But now, several months later….after the S&P has bounced massively….the Fed’s balance sheet is substantially smaller than it was in December 2018. Apparently, the impact of the Fed’s balance sheet is less than many experts had feared it was.

The technical picture for the S&P is now mixed. The weekly charts are now solidly bullish, but the daily charts are starting to show some weakness. Perhaps a modest pullback is around the corner; even a 2-4% drop would be sufficient to satisfy the weakness shown in the daily charts.

Finally, our Simple Rule is still bullish, after temporarily turning bearish a couple of months ago. That said, the fundamental components of this Simple Rule are weakening; while they’re still positive, it would not take much more weakening in US fundamentals to flip them to a bearish stance. Let’s see what the US economic data does over the next several weeks.

S&P500 Continues to Rally as the Fed’s Balance Sheet Shrinks

April 8, 2019

Impressively, the S&P500 gained another 2% last week. Volume was light, and volatility inched downward. This most recent rally brings the S&P500 back to within a few percentage points of its all-time high, which was reached in early October 2018, about six months ago.

What’s also impressive is that this recovery has happened as many US economic indicators have disappointed. Just last week, retail sales (both headline and ex-autos) missed badly. Retail sales are very important because it’s a sign of how much consumers are spending, and in an economy that’s about 70% dependent of consumption, this result is concerning. At the same time, PMI manufacturing, ISM services, and durable goods orders all registered drops. While the headline jobs report beat consensus estimates, the labor force participation rate worsened, and most disturbingly, average hourly earnings missed badly. So as the US stock market powers on to reclaim old highs, the US economy is not supporting this advance in stock prices.

Another major divergence with the US stock market rally is the stealthy reduction in the Federal Reserve’s balance sheet. Through last week, the Fed’s balance sheet has dropped by $525 billion. What makes this so interesting is that on the way up, the Fed’s balance sheet’s growth correlated fairly well with the rise of the S&P500 since mid-2009. Naturally, many market experts took this correlation a step further and argued that is was actually a causal effect–in other words, the Fed’s quantitative easing helped to drive stock prices higher. So it was not a big step to then argue that when the Fed shrinks its balance sheet, US stock prices would struggle to retain their gains. And when the 20% drop was registered in late December 2018, this argument looked like it was correct.

But since then, it’s broken down. As the Fed has continued to shrink its balance sheet in January, February, and March, the S&P has continued to move in the opposite direction–up.

Many experts are now arguing that the effect of the balance sheet is merely delayed. They point to the fact that the Fed started growing it’s balance sheet many months before the S&P started to rally in March 2009. So they’re arguing that something similar…but in reverse….may be happening now.

Even with the Fed recently announcing that the balance sheet roll-off will end near the end of 2019, the total balance sheet reduction by then will be approaching $1 trillion. It will be interesting to see if this massive reduction….with passage of even more time….will finally act to pull down the S&P500 by any meaningful amount.

S&P500 Bounces

April 1, 2019

After losing ground the previous week, the S&P500 bounced right back and gained 1.2% last week. Volume was light, which has been very typical in this multi-month advance. And volatility crept back down—the VIX index dropped back to the lower teens.

What was odd about the advance in the US stock market is that it happened during a week when the US economic reports were exceptionally weak. Well over 10 reports disappointed, when compared to consensus estimates. And only a handful beat their respective estimates:  consumer sentiment, new home sales, and international trade in goods. So investors are beginning to look beyond the dismal economic data and instead, they’re starting to bank on more monetary easing from the Federal Reserve, which is now—at least in the view of the markets—expected to cut interest rates in 2020, instead of hiking them as everyone had expected in 2018.

This massive shift in expectations for US monetary policy has not only helped to prop up the stock markets over the last couple of months, but it has driven down longer US interest rates dramatically. The US 10 year Treasury yielded over 3.3% last fall; last week, it dropped all the way down to a 2.3% handle.

Another more ominous interpretation of this drop in US Treasury yields is that the Fed has over-tightened in the last 12 months. As a result, the odds of a recession in the US have risen dramatically…..and the drop in US yields reflects the bond market’s anticipation of this upcoming recession.

Ironically, if this recession materializes, then corporate earnings….and presumably US stock prices…would fall. So we are now witnessing a dramatic divergence between the US Treasury market and the US stock market, where the Treasury market is bearish and the stock market is bullish.

This divergence will not be resolved over a couple of days or weeks; it will likely take several months. And when it does get resolved, one of these markets will very likely get repriced….in a very meaningful way.

S&P500 Stalls…and Retreats

March 25, 2019

After advancing earlier in the week, the S&P500 had a very bad day on Friday (on which it lost 2%) to close the week down almost 0.8%. Volume was light, and volatility spiked into the mid-teens. That said, a mid-teen reading on the VIX is still not a level associated with panics.

Interestingly there was no big piece of news that drove the late week sell-off. In fact, several economic reports surprised to the upside—factory orders, initial jobless claims, the Philly Fed survey, leading indicators and existing home sales all beat their respective estimates. Only the housing market index, and PMI composite flash disappointed. So in many ways, the US economic picture brightened a bit last week.

On the technical front, the S&P500 has still not returned to old highs set in early October 2018. And last week’s decline….somewhat close to the prior level of resistance at 2,800….suggests that this technical resistance has yet to be broken. The 200 day moving average is now essentially flat, and prices are only slightly above this critical marker. So it’s far from clear, technically, where this market is headed next….especially over the next several days and weeks.

One of the major drivers of last week’s sell off was, ironically, the recent dovish u-turn made by the Federal Reserve. After a couple of years of tightening, the recent decisions to scrap further increases in the Fed Funds rate and to stop the balance sheet wind down later this year both suggest that the Fed is now worried that it may have over-tightened and that a recession is more likely to arrive in the near future.

The US stock markets, picking up on this interpretation, may be starting to sell off in anticipation of this recession and the consequent reduction in corporate earnings.

Sure there are other plausible explanations, but this one was getting a lot of press after Friday’s big sell-off. Let’s see what the next week or two brings to the S&P500.