There is a distinct possibility that the bond market, the stock market and the economy all peaked in the third quarter of 2019. Something is wrong. Beyond the Bull author Ken Norquay says the normal rules seem to have been suspended this time around.
In my stock market book, Beyond the Bull, I observed that in the financial world: “Everything’s connected to everything else.” What financial trends correlate to others? Most analysts measure the performance of the US stock market by referring to the Standard and Poor’s 500 Index (S&P500), the Dow Jones Industrial Average (DJIA) or the National Association of Securities Dealers’ Automated Quotations Index (NASDAQ).
When ‘the market’ is in a down trend, we expect a correlation between these three statistics—all three should be going down together. When that does not happen, market technicians call it a divergence. When markets diverge, we should be on the lookout for a trend change.
Another useful feature of the interconnectedness of markets is looking at how some financial markets ‘lead’ others. Beyond The Bull’s counter-cyclical model uses the relationship between the bond market (long term interest rates) and the stock market to anticipate trend changes in the stock market. Normally, the bond market peaks around six months before the stock market. Normally, the stock market peaks six to twelve months before the economy. ‘Normally’ is the key word: when something that is not normal occurs, it’s important.
Let us review the usual financial trends with an eye on divergences and normal lead-lag financial relationships.
US stock market
The all-time high for the DJIA occurred on July 16, 2016, and the S&P500 and NASDAQ on July 26. Statistically, the US market is still in an up trend, but for reasons explained in many previous issues, we are persuaded that those July highs were the ultimate highs, and that the US stock market has peaked. Because the top was so recent, there are no important divergences at this stage. But an abnormal lead-lag anomaly may be unfolding between the stock market and the economy.
Certain economic news over the past few weeks indicates the economy might be cooling off. Normally, we would have expected positive economic news for at least six months after the July stock market top. Signs of economic weakness should not materialize until January. But weakness has already appeared, only two months into the bear market. The most dramatic times that this happened in the past were 1929 and 1937. The 1937 top had two more things in common with the 2019 top. First, both followed a period of dramatic economic stimulus. And secondly, both followed a record-breaking bull market. In the early 1930s, the market went up around 400% in 4 years, the steepest rise ever. The current top was preceded by the longest bull market in history: 124 months.
Canadian stock market
The all-time high for the TSX Composite Index was Friday, September 20, only a few weeks ago. Statistically, the market is still in an up trend, but for reasons outlined in previous issues, we are calling it a top and encouraging investors to sell now.
The US bond market
The high occurred on Wednesday, July 28, 2019, the same day as the stock market high. Normally, a bond market down trend begins about six months before a stock market down trend. What does the current abnormality mean? Stock market bulls would argue that falling interest rates are positive for the stock market. This is true in the early stages of a stock market up trend; both bonds and stocks go up together. But the stock market has been rising for a record-breaking ten years! It is not ‘the early stage’ of an up trend. In the late stages, bonds normally fall as stocks rise. That lead relationship was occurring until November of last year, when US bond prices started a spectacular short-term rise into the July high.
‘Normal’ isn’t happening this time: normally bonds peak, then stocks, then the economy. Is it possible that all three peaked in the third quarter of 2019? We will continue to monitor this unusual situation.
The Canadian bond market
The high for the Canadian bond market occurred on Friday, July 16, 2019. It’s not normal for the Canadian stock market to peak only two months after Canadian bonds. The norm is six months. Something is wrong.
Although both the US and Canadian bond markets have both experienced sharp short term up-to-down reversals, we are maintaining our neutral interpretation of the long term trend of twenty-year interest rates.
US dollar vs. basket of non-US currencies
Trade wars? Protectionism? Tariffs? Economic weakness? Brexit? Through all this the US dollar has held steady for 4 1/2 years. Currency traders must be bored. Since March 2015 the US dollar has been trading between 95 and 100, except for a brief flurry up to 102.5 and a brief decline to 90. The long-term trend is neutral.
Canadian dollar vs. US dollar
The long-term trend is neutral—neither up nor down since spring 2016.
Gold vs. US dollar
The cyclical low in gold prices in December 2015 was followed by a sharp rally until July 2016. Then, after a long, slow 35 month down-drift, the up trend began again this spring. A short-term rally took gold from $1,270 to $1,566 in four months. It’s time to increase your holdings of precious metals. A good entry point lies just ahead, when gold’s current short term down trend reverses to up. The long term trend is up.
A word of warning about short-term speculation in gold and silver mining shares. The lead-lag interconnectedness of gold and gold mining stocks is not what most people think. US market technician, John Murphy, CMT, discovered that the price of gold mining stocks leads the price of gold bullion. Most investors intuitively feel it should be the other way around.
To further complicate the interrelationship, at the 2008 stock market top, gold stocks became a powerhouse of relative strength. (Relative strength refers to the performance of a stock or industry sub-group relative to overall market averages. ‘Relative strength’ measures a sub-group relative to the whole market.)
Gold mining shares went up in early 2008, even as the US stock market averages went down. Gold mining shares have also performed very well relative to the averages at this top. Volatile mining stocks can be fun for traders. Trading rules and strategies are important. Long-term investors should look more to bullion or bullion funds.
Oil prices vs. US dollar
‘Going no-where fast.’ As volatile as energy prices are, there is no strong long term trend. The slight long term up trend is characterized more by volatility than a trend.
What conclusions can we reach based on the unusual interconnectedness of these various markets? There is a distinct possibility that the bond market, the stock market and the economy all peaked in the third quarter of 2019. Something is wrong. The normal rules seem to have been suspended this time around.
Because the markets are not performing as they normally do, our thinking should not be normal. Mental flexibility is important. Portfolio flexibility is important.
Maybe the old ‘rules of thumb’ do not apply. For example: society’s current belief is that international trade is good and tariffs are bad. Is that still true? Free floating currencies are good and pegged currencies are bad. Is that still true? The US dollar is the most stable currency in the world, and, as such, should continue to be the reserve currency of the world’s banking system. Oh, really? Is this still true? Stocks are still safe investments in a long-term up trend and the all time highs registered this summer prove it. And the fact that long-term interest rates are still going down, supports that bullish view. Is this true?
Historically, every time there has been a major stock market top, there were analysts who warned of the risk based on repetitive economic patterns and on investor psychology. And, every top brought the counter argument: “But this time it’s different.” Persuasive sales people pointed to certain economic reasons why this time the market would continue up, even though in the past when these signs appeared, it went down. And, now, this writer is telling us: “Yes, this time it really IS different,” and warning that it’s the difference that is making it dangerous. Is the difference between this time and ‘normal times’ still a reason to be optimistic? Or is it time to implement a ‘less risk’ strategy in our portfolios?
Ken Norquay, Chartered Market Technician, is the author of the book Beyond the Bull which discusses the impact of your personality on your long-term investments: behavioural finance. He can be reached at email@example.com.
This is an edited version of an article that was originally published for subscribers in the October 2019/Second Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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