In early March, we noted that the economy was entering a window during which we expected coincident data to begin missing consensus expectations. Since then, key data related to broad economic activity and employment have done just that. The misses were slight at first and then more pronounced during the last several weeks, which is precisely how an economic inflection point of this character develops. Another miss was reported today with the release of the advance durable goods order data for April (pdf), which showed a decline in core orders of 0.6 percent, below consensus expectations for an increase of 0.7 percent.
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This is a highly volatile series, but the overall trend is clearly lower and a move into negative territory for yearly growth would be a bearish development, so it will be important to monitor the data for additional deterioration in June. Although it is still too early to conclude with a useful degree of statistical certainty that an economic inflection point is developing, the recent consensus expectation misses align with the recession scenario and it will be important to continue monitoring the trend in economic data closely.
The stock market has responded as expected to the consensus expectation misses, with the S&P 500 index (SPY) moving sharply lower after topping in April. Following the severe decline during the first three weeks of May, a cycle low setup occurred on May 21, indicating that the short-term cycle low (STCL) we had been expecting occurred on May 18. The S&P 500 has moved gradually higher since then, confirming that a new short-term cycle is in progress.
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The violent decline from early May created an extremely oversold condition last week. However, the resulting reaction has been relatively weak.
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The failure to rebound strongly off of an extremely oversold condition is a warning sign that suggests the cyclical bull market from 2009 is weakening. The deterioration in underlying strength is apparent in market internals such as volume and breadth. The volume and breadth summation indices have been declining sharply since the beginning of the year and they have both returned to levels last seen during the formation of the stock market low in October 2011.
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This deterioration in market internals is a significant bearish development that favors the formation of an extended correction. The ultimate character of the oversold rebound from the beginning of the week will likely provide the next signal with respect to long-term direction, so it will be important to monitor market behavior closely during the next few weeks. We will identify the key developments as they occur in our daily market forecasts and signal notifications.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
