The S&P 500 has rallied to all-time highs in the new year, led by the information technology, basic materials and energy sectors.
With the S&P 500 now trading almost 10 percent above its 200-day moving average, the index appears vulnerable to a pullback of 5 percent or more at some point in the first quarter. The S&P 500 last traded this far above its 200-day moving average at the end of 2013, just before the index gave up more than 6 percent of its value in the back half of January 2014.
Four years ago, this correction amounted to little more than a blip, with the S&P 500 overcoming minor pullbacks in April and August and a 9.8 percent decline in the fall to post a 13.7 percent return in 2014.
Will history repeat itself?
The risk of a short-lived pullback of 5 percent or more—the S&P 500’s first swoon in more than 18 months—has increased, though timing moves of this magnitude is notoriously difficult. Moreover, the overall outlook for stocks remains sanguine.
Since 1937, the S&P 500 has suffered 12 bear markets, or pullbacks of more than 20 percent from closing high to low. Ten of these bear markets coincided with US recessions, including the severe selloffs that occurred during the 1973-75, 2000-02 and 2007-09 cycles. Investors must limit their losses during these periods if they want to outperform the market over the long haul.
At the same time, bear markets can create lucrative opportunities for nimble traders because specific stocks and industries tend to underperform during the selloff. Currencies, gold, bonds and crude oil can also make significant moves during these periods of upheaval.
That said, we see no evidence that the US is headed for recession, now or in the foreseeable future. To the contrary, the US economy, along with the EU, Japan and China, appears to be accelerating as part of a synchronized up-cycle.
The Conference Board’s index of Leading Economic Indicators (LEI) remains one of our favorite warning signals for the US economy and stock market. When the year-over-year change in the LEI slips below zero, the risk of a recession is elevated. This simple indicator has flashed red prior to all seven of the major downturns that have occurred since the 1960s.
Today, the LEI is up 5.5 percent year over year and has strengthened since mid-2016.
Trends in month-over-month changes in LEI can yield even more timely sell signals. Three negative sequential changes in LEI over a six-month period indicate that the US economy has entered a soft patch or a recession. This indicator warned of a rising risk of recession in the first half of 2016, but hasn’t posted a month-over-month decline since August 2016.
And there’s more.
Most market corrections of at least 10 percent involve narrowing market leadership. Whereas a relatively small number of large-capitalization stocks led the market higher in June and October 2017, this time the cumulative advance-decline line for equities traded on the New York Stock Exchange has reached new highs along with the S&P 500. Bottom Line: This rally has broad-based support.
With the bull market poised to enter its 10th year, this rally has likely entered its final stages. The recent upsurge in commodity prices and early signs of a pick-up in inflationary pressure could indicate that the bull market has entered its latter stages.
However, until market leadership narrows or our favorite forward-looking economic indicators exhibit signs of deterioration, we’re inclined to regard dips as opportunities on the long side.
We also expect rotation into cyclical, value groups to continue, favoring the energy and financial sectors, as reflected in recent alerts and articles for Capitalist Times Premium subscribers.
Elliott H. Gue is founder and chief editor of Capitalist Times and Energy & Income Advisor.