Last week, following the release of economic data that were perceived to be positive, conventional market wisdom experienced yet another violent sentiment shift, once again coming to believe that the recession scenario is no longer viable. Unfortunately, noisy data trends tend to become even more so during periods of economic transition and it remains likely that the US will enter a new recession during the next two quarters. The following charts, courtesy of Prieur du Plessis, display the manufacturing PMI trends for the largest economies around the world, along with the average global PMI trend.
At the moment, the US economy is the only one that has not trended down into contraction territory. However, if the global recession continues to intensify, it is highly likely that the US will follow suit. Hoping that the US will somehow weather the storm and maintain its tepid growth rate falls into the dubious “this time is different” mode of thinking, which has an extremely poor track record from a historical perspective.
The mainstream financial media celebrated the sharp move higher by the stock market last week, noting that the weekly gain of 7.4% was the largest since 2009. However, as always, short-term moves only have meaning when analyzed in their proper context and last week’s rally was simply another extreme move engendered by the current environment of elevated volatility that has persisted since the long-term breakdown in July.
During periods of heightened market volatility, it is instructive to review the big picture, which requires starting with the secular trend and then moving in toward shorter time frames. The US stock market is currently in the middle stage of a secular bear market that began in 2000. The previous secular bull market from the early 1980s accelerated into a prototypical speculative blow-off phase in the late 1990s before forming the most recent secular top.
Our Secular Trend Score (STS), which uses a large basket of fundamental, technical, internal and sentiment data to identify highly likely secular trend inflection points, issued a sell signal in December 1999, predicting the start of a 10 to 20-year secular bear market. Since then, the stock market has behaved exactly as expected, moving sideways in typical fashion for a secular downtrend.
The STS has remained deep in negative territory for most of the 11 years since the secular bear market began, although it has moved up toward positive territory after rebounding off of the most recent low in late 2009, indicating that the bear market is maturing. However, at a current value of -16, the STS remains a long way from buy territory at the 80 level, so it is likely that we are still several years away from the start of the next secular bull market.
Secular trends are composed of cyclical trends that have typical durations of two to five years. There have been four confirmed cyclical trends since the secular bear market began in 2000.
When they occur during a secular bear market, cyclical bull markets have an average duration of 33 months. The cyclical uptrend from March 2009 was 30 months old when it broke down in July, signaling that the high in April was likely a long-term top.
Additionally, our Cyclical Trend Score (CTS), which has correctly predicted more than 90% of the cyclical turning points during the last 70 years, issued a confirmed sell signal in September, indicating that a new cyclical downtrend likely began in May. However, even if the cyclical uptrend from 2009 is still in progress, at a current duration of 33 months, it could terminate at any time, so the risk/reward ratio is very poor with respect to US equities, especially given the deepening global recession.
As always, anything is possible when it comes to financial market forecasting and the best that we can do is identify possible scenarios and their associated probabilities. At the moment, the odds strongly favor the continuing development of a new cyclical bear market in US stocks accompanied by a return to economic contraction, so we will remain defensive until presented with compelling evidence to the contrary.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.