This is a Guest Post by: Troy Bombardia @markethistory his website is MarketHistory.org.
This is still a bull market, and there is no significant correction on the horizon.
Even short term stock market traders should understand the fundamentals of the economy. Why? Because the fundamentals determine whether the market is in a bull or bear market. In a bull market, it’s much easier to only trade from the long side than it is to trade from both the long and short sides. A lot of traders who went both long and short in 2013 lost a lot of money on their shorts. Conversely, it’s much easier to only trade from the short side in a bear market. A lot of traders who tried to catch the falling knife got killed in 2008.
The fundamentals always deteriorate before a bear market begins. And we don’t define “bear markets” as 20% declines. We only defined the 1969-1970, 1973-1974, 2000-2002, and 2007-2009 decline as bear markets. 20% declines are very different from 40%+ declines in terms of characteristics. Fear is pervasive in a real bear market, but fear is not be pervasive a lot of big 20% corrections. That’s why those big corrections can end on a dime, to be followed by a massive rally.
Right now, the fundamentals of the U.S. economy are solid. Before a bull market can top, we need to see deteriorating fundamentals. We don’t even see deteriorating fundamentals right now.
Big corrections (i.e. 13%+ declines) tend to happen because the market has rallied too much (i.e. mean reversion). For example, the S&P made a big correction in 2015 because it had been too long since the last big correction occurred in 2011. The S&P’s 16% rally in 6 months (since Trump’s election) is hardly a big rally, historically speaking. Hence, it is unlikely that a big correction will happen right now.
So if there is no big correction or bear market, then the stock market has a natural bullish bias right now. Thus, you should trade for a long side.
*Historically speaking, foreign problems have not caused bear markets.
Why it’s a bull market
Most of the important U.S. economic data are improving. There are no signs of a slowdown yet.
*You need to focus on the overall trend in the data. You cannot focus on the month-to-month change in the data. A lot of the month-to-month changes are statistical randomness. No economy will grow in a perfectly linear line.
*It is not a good idea to look at small unknown economic indicators. A lot of small economic indicators are very niche. We need indicators that cover a broad swath of the economy.
Housing
The housing market and home construction aren’t the biggest parts of the US economy. However, housing is one of the most volatile components. This means that it has a big impact on economic cycles. In addition, housing is one of the best leading indicators for the economy.
All housing indicators dipped a little last month. But overall, the U.S. housing market continues to grow and improve. It’s also important to note that housing is at a very low level, historically speaking. The housing market has far from fully recovered, which means that it still has a lot of room left to grow before this economic expansion peters out.
Here are charts for housing starts, new home sales, and building permits respectively.
Initial claims and the unemployment rate
The jobs market is painting a very rosy picture for the US economy. Before every economic recession, initial claims and the unemployment rate both tend to tick up. Both of these indicators are still falling right now.
Some people are concerned that initial claims are too low. This is not a real concern. Initial claims often flatten for one year at the bottom before starting to rise.
The first chart is Initial Claims, the second chart is the unemployment rate.
Corporate profits
Corporate profits are improving after a 2 year slump. With oil consolidating around $50 and interest rates going up on Fed hikes, energy sector and financial sector profits should continue to improve. These two sectors were driving down the S&P’s earnings in 2015 and early 2016. Instead of being bearish factors, they are now bullish factors.
The global economy
The global economic picture is improving. Despite a tiny deterioration in its economic data, China’s economy bottomed in early 2016 and has continued to improve since then. Here is a chart for Chinese industrial production.
Europe’s economy is also improving rapidly after a multi-year slump. Germany’s best leading economic indicator is the IFO survey. The IFO survey is improving right now.
Bottom line
Make no mistake: we are in the final quarter of this economic expansion cycle. Although it is aged, age alone cannot stop an economic expansion. Based on our model’s current fundamental projections, this bull market has at least 1-2 years left.
You can follow Troy Bombardia on twitter at @markethistory and read more from him on his website at MarketHistory.org.