Wednesday, January 23, 2019

Stock market update

It's time for the annual stock market update. You can find the January 2018 update here and the 2017 update here.

The three charts immediately above this post show my main long term trend indicators. The Dow and the S&P 500 are both still below their 200 day moving aveages which have begun to decline. The New York Stock Exchange advance-decline line has moved back above its own 200 day moving average which is still rising.

This is a long term bearish configuration although the bearish implications are moderated by the strength in the NYSE advance-decline line. But I won't turn longer term bullish unless and until both the Dow and the S&P reestablish themselves above their 200 day moving averages.

One reason am inclined to the bearish side of the market is the configuration of Lindsay time periods which I have delineated in the top chart. Recall that in 2011 and again in 2016 the Dow and the S&P both dropped significantly below their 200 day moving averages. The main difference I see between those two episodes and the current situation is that the Lindsay 15 year time period was not in 2011 or 2016 calling for any bull market top. Nor did the Lindsay 12 year period project any imminent bear market low.

This time is different. As I first pointed out two years ago Lindsay's 15 year period projected from the 2002 bear market low forecast a bull market top for January 2018. A Lindsay basic advance ended then as well.

Despite these Lindsay indications I did not turn long term bearish on the subsequent fast, five day drop early this year for two reasons. First, bearish sentiment had built up to high levels very quickly during the drop. And brief drops are typical of bull market corrections, not the start of a bear market. Second, the three long term trend indicators above all held above rising moving averages during the January- February 2018 drop.

Looking ahead in February 2018 with Lindsay as a guide I saw two obvious possibilities, both consistent with Lindsay's basic advances and long term time periods.

The most bullish possibility was that another two year, basic advance had begun which would carry to February 2020. I knew that Lindsay's 15 year period sometimes (but rarely) extends to 17 years so this would project a bull market top for late 2019 or early 2020.

I should add that if the Dow and the S&P both reestablish themselves above their 200 day moving averages this bullish scenario for the rest of 2019 will become my Lindsay projection for the year.

The more likely possibility, however, was the development of what Lindsay called a "right shoulder", a long rally which follows the expiration of a 15 year period and the completion of a basic advance. This "right shoulder" typically lasts 4-8 months. It brings the market up close to or a bit above the top associated with the expiration of the 15 year period. Once the right shoulder is complete a bear market begins.

Right now I think this Lindsay right shoulder ended in September 2018. Basic declines and the 12 year period then project a bear market low for October 2019.

All that said, I doubt that this drop will carry the Dow or the S&P more than 30% down from their 2018 tops. And I also doubt that the economy will suffer much. There probably will be no recession. Why?

The Fed is now much more sensitive to economic threats conveyed by stock market drops than it has been at any time in its history. This is especially true now, a time when inflation and inflationary expectations both remain low. The Fed's big screw-up in 2008-09 will not be repeated for at least a generation.

Reinforcing this dovish Fed bias is the well-advertised hostility of President Trump to any Fed policy which threatens the economy even a little bit. The Fed may be nominally independent but is still influenced by political pressure.

Finally, while the Fed's balance sheet is currently shrinking, its previous expansion still  leaves a lot of room for inflation of asset prices. This is likely to be triggered by increasing optimism of investors and business resulting from a dovish turn in Fed policy.

As long as  the Fed maintains its current commitment to shrink its balance sheet and increase interest rates  a bear market low in October of this year is likely. But if in the interim the Fed makes a dovish U-turn the stock market is likely to respond with another leg up in the bull market which started in 2009.

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