NEW YORK - If we live long enough, almost all of life’s activities are cyclical.
After large gains have been achieved, I look to when the giveback period is likely to begin.
Economic and stock market cycles are not identical, but they tend to “rhyme”. If stock prices do their job correctly, they should anticipate the economic cycle. This often happens, but not always.
Several contrarian indicators showed up shortly after election night. Contrarian indicators normally have a better record of predicting subsequent market trends than nicer cheerleading indicators. What follows is a list I use that suggests a future market decline:
- The US stock market has been in a narrow trading range since the highpoint reached on 2 September. The three main market indices are all now resting after their recoveries since 23 March: 58.56% for the Dow Jones Industrial Average (DJIA), 60.24% for the Standard & Poor’s 500, and 72.42% for the NASDAQ Composite. During the resting period the indices gave very little back: the DJIA -0.24%, the S&P 500 0.00% and the NASDAQ -1.88%. However, in the week ended last Thursday, the DJIA and S&P 500 gained +2.43% and +0.76% respectively, while the NASDAQ lost -1.53%. To me, the trading acumen of those who dominate each of the indices is sending a cautionary signal:
- The public pays more attention to the DJIA
- Institutions and particularly ETFs pay more attention to the S&P (more than half of the net $26 billion that went into equity ETFs this week went into the SPDR 500)
- More sophisticated traders are prominent in the NASDAQ. I suspect this group is particularly concerned about control of the Senate, which won’t be known until after 5 January, probably after the beginning of any new tax legislation’s effective date. (In some respect the NASDAQ is the smart money crowd)
- Market leadership is shifting more toward so-called ‘value’ and away from ‘growth’. Last week, value focused mutual funds rose +3.58%, while growth funds rose +0.54%. While it is comforting the performance gap is finally being addressed, the relative value of dividends and capital gains need a lot of work. Also, payout ratios may need to be addressed if tax rates go up.
- The change in leadership can be seen in the 104 equity fund investment objectives. For the week, 59 produced returns higher than the average S&P 500 index fund, confirming that ETF players tend to be followers of popular news, not investment fundamentals which are another worrisome indicator.
- I have often commented on the sample survey of the members of the American Association of Individual Investors (AAII), a contrarian indicator published each week. The three outlook choices for the next six months include: bullish, bearish, and neutral. A normal distribution is between 30% and 40% and this week bullish registered at 55.6%, among the highest on record. Bearish registered at 24.9% and neutral at 19.7%. The latter shows a greater level of confusion as to direction and is probably in record territory.
Economic cycle showing pluses
The positive indicators are as follows:
- Copper has often been called Dr. Copper because copper tends to capture a great deal of industrial demand. Currently, the price of copper is at a two-and-a-half year high, largely due to the recovery in China, which consumes half of the world’s production of the red metal. Aluminium and nickel are also strong again, due to a rise in Chinese and other Asian steel production.
- China is not only the current leader in industrial production, it is also showing some significant technological advances. Last week, Chinese officials announced the deployment of numerous 6G satellites in space.
- Despite the pronouncements of price stability from the central banks, the industrial goods price index is up +10.56% over last year. A longer duration indicator is the dollar denominations one can get from many ATMs, now $20 and $50. Banks are making the judgement as to what their customers need most for their transactions, leaving merchants to provide smaller bills.
Investment strategy implications
- The first job for long-term investors is to be in a position to benefit from long-term technological improvements and a more productive population.
- The second is to avoid panicking in the coming decline. (Timing is uncertain, but the decline is not.)
- In preparation for the decline examine current investments, separating those likely to hit historic highs within the remainder of this cycle from those perceived to have higher highs in future cycles.
- Have a trading attitude for the first group on the way up and exit quickly on the way down. Look to add to the second group optimistically when short-term problems depress their prices.
A former president of the New York Society for Security Analysts, Michael Lipper was president of Lipper Analytical Services Inc. the home of the global array of Lipper indexes, averages and performance analyses for mutual funds. His blog can be found here.