A Simple Insight Into Market Direction

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 |  Includes: SPY
by: Paulo Santos

The insight that follows isn't mine. But it's so good that I have to share it here anyway, for the benefit of all. What follows was presented first by Not Jim Cramer in his Twitter stream.

The thesis is simple:

1) S&P 500 (NYSEARCA:SPY) follows earnings (or in this case, forward earnings estimates);

2) Earnings estimates follow the ISM Index;

3) The ISM Index follows real-time surveys (Philadelphia and Empire surveys).

So presently we have the real-time surveys falling, which means the ISM will track them and fall as well, which in turn means the earnings estimates have further to go down. Which ultimately means the market will have a rough time ahead.

Not Jim Cramer produced a powerful set of graphs illustrating the insight, which I reproduce here:

Click to enlarge

This could all have been turned on its head if the Federal Reserve had decided to do more quantitative easing. But the Fed decided not to act, so now the most likely path for the market, for a while, is down - until the Fed acts (or it becomes clear that it will act).

There can be an exception this next week due to quarter-end window dressing as well as the options expiry, but the above realization should be strong enough to provide for a lower S&P level in the weeks ahead. Sentiment is not presently negative enough to provide for a contrarian signal, either. And at the same time the weekly ECRI has been registering lower and lower levels as well.

Conclusion

The insight regarding S&P following earnings, earnings following ISM and ISM following the real-time surveys seems powerful enough to make for a lower market level right ahead of us. This will later be negated either by Fed action or by sentiment turning too bearish - but such is not the case now, so we have to agree that it is likely we will see a lower market in the weeks ahead.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.