One Economic Indicator To Watch For Any Major Correction In S&P 500

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Includes: CRF, DDM, DIA, DOG, DXD, EEH, EPS, EQL, FEX, FWDD, HUSV, IVV, IWL, IWM, JHML, JKD, OTPIX, PPLC, PPSC, PSQ, QID-OLD, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RWL, RWM, RYARX, RYRSX, SBUS, SCAP, SCHX, SDOW, SDS, SFLA, SH, SMLL, SPDN, SPLX, SPSM, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU-OLD, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TALL, TNA, TQQQ, TWM, TZA, UDOW, UDPIX, UPRO, URTY, USA, USSD, USWD, UWM, VFINX, VOO, VTWO, VV, ZLRG
by: WingCapital Investments

Summary

U.S. equity markets continue to climb the wall of worry to reach ever higher highs to start 2017.

Historical analysis shows Initial Jobless Claims to be a leading indicator for the previous two 30+% corrections in S&P 500.

Aside from short-term pullbacks, the U.S. stock market looks set to record further gains in 2017 absent a job recession or disordered up move in interest rates.

Almost 2 months into 2017, and almost 1 month since President Trump entered the White House, the U.S. equity markets continue to defy gravity with the Dow (NYSEARCA:DIA), S&P 500 (NYSEARCA:SPY), and Nasdaq (NASDAQ:QQQ) making fresh record highs day in and day out. Indeed, the 5% gain in S&P 500 in the first 31 trading days of 2017 is the best start to a year since 2013, as the fear of an unwind of the Trump rally has not materialized.

Year

SPX Last Year's Close

SPX After 31 Trading Days in Year

YTD Return %

1999

1228

1224

-0.33%

2000

1469

1402

-4.57%

2001

1320

1316

-0.33%

2002

1148

1116

-2.75%

2003

880

835

-5.11%

2004

1112

1157

4.05%

2005

1212

1210

-0.15%

2006

1248

1280

2.54%

2007

1418

1457

2.72%

2008

1468

1349

-8.14%

2009

903

789

-12.63%

2010

1115

1100

-1.40%

2011

1258

1328

5.60%

2012

1258

1343

6.81%

2013

1426

1521

6.67%

2014

1848

1839

-0.53%

2015

2059

2100

2.01%

2016

2044

1927

-5.73%

2017

2239

2349

4.93%

Like previous bull market runs, there has been no shortage of skepticism in this latest eye-popping rally. According to ZeroHedge, massive short covering by a hedge fund was the catalyst behind the surge in S&P 500:

"After today's price action (and more color from trading desks) we are starting to see the 'fingerprints' of what appears to be a multi-billion dollar forced short cover, reportedly by Catalyst Funds' Hedged Futures Strategy Fund (MUTF:HFXAX), that has almost perfectly correlated with the linear surge in US stocks."

Will stock markets finally correct from here? Without a doubt, stocks are overstretched from a technical perspective. Per the analysis from WingCharts, the SPY closed above its upper Bollinger Band 5 days in a row, a statistical phenomenon which occurred only 5 times since 2000, 4 of which followed with an average of -2.7% drop within the next 20 trading days. Note that the upper Bollinger Band is defined as two standard deviations above its 20 day moving average:

SPY vs. # Days above Bollinger Band

SPY Above Bollinger Band 5 days in a Row

Next 20-Day Return %

2017-02-15

?

2014-05-30

+2.12%

2012-03-19

-1.26%

2011-07-07

-11.16%

2009-12-24

-2.82%

2003-06-05

-0.57%

Average

-2.74%

(Source: WingCharts)

That being said, we are in the camp that any dips would most likely be bought with ensuing new record highs. As suggested back in end of 2016, one of the main reasons is SPY's relative value vs. bonds. To recall:

The S&P 500 Has Further Upside Potential Heading Into 2017

In brief, SPY's dividend yield remains relatively attractive relative to the 10-year Treasury yield (NYSEARCA:TLT), which has remained stable and hovering around 2.50% in 2017. We concluded that until we see a disordered spike up north of 3%, odds continue to favor further upside in SPY especially considering the dividend growth picture.

Another key macro variable that continues to suggest continuation of the bull market is the jobs growth picture. In particular, we observe that the bull and bear cycles in S&P 500 follow closely with the seasonally adjusted initial jobless claims:

Initial Jobless Claims vs S&P 500

As shown above, the two major market corrections since 2000 coincided with the trough in initial jobless claims (inverted in the chart). More precisely, in both 2000 and 2007, the broad equity market corrections started just when initial jobless claims persistently stayed above its 100-week moving average (more than 3 weeks in a row):

Date when Initial Claims Above 100-Week Moving Average 3 Weeks in Row

SPX - Before

Date when Initial Claims Back Below 100-Week Moving Average

SPX - After

Change %

2000/7/29

1420

2003/6/21

996

-30%

2007/10/13

1562

2009/11/21

1091

-30%

While about 8 months late in marking the bottom in 2009, in both cases, the economic indicator was able to detect a multi-year 30% decline.

Meanwhile, fast forward to today, since the bear market low in 2009, initial jobless claims has been grinding lower and spiked no more than 2 weeks in a row above its 100-week moving average during the 8 year bull market. As of the week of February 4th, the initial jobless claims plunged to fresh cyclical lows to 234k while the 100-week moving average stands at 267k. This indicates the employment market remains healthy and hence economic growth prospect remains strong.

In summary, the above analysis recommends staying long the market and buying dips until initial claims stay above its 100-week moving average for more than 3 weeks in a row. While seemingly simple, the fundamental intuition is that as long as job growth remains strong, the economy and earnings growth would most likely continue to be resilient and supportive of a bull market in equities.

Disclosure: I am/we are long SPY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.