Research.LeutholdGroup

The Boom/Bust Indicator, a weekly ratio of industrial-commodity prices to initial unemployment claims, has had a near-vertical rebound to old highs in the last several weeks. This index usually peaks out many months in advance of a business cycle peak (although not in 2007, when it provided no warning of the pain to come).

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If the market’s manic rebound succeeds in assuaging consumers’ recently shaken confidence, we can certainly see a scenario in which the economy and corporate profits firm up after their current slowdown… although that is not our bet.

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Read this week's Major Trend.

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The Intrinsic Value category remains a drag on the MTI but is well below cycle extremes seen in January 2018 and again in September. The Momentum category, however, continues to nudge the MTI higher for the third consecutive week.

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One of our long-term momentum models improved last week, while the Dow Bond Oscillator—as good of a mechanical monetary indicator as we’ve encountered—pushed further into positive territory.

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Within the Economic work, the big development was a bullish flip in our Dow Bond Oscillator (DBO), which crossed above the zero threshold by the thinnest of margins. Subjectively, however, we are troubled that government yields across the maturity spectrum have been holding near recent lows in the face of equities’ powerful rally.

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Valuations seem to ignore indications that an earnings recession has begun, let alone the possibility that S&P 500 GAAP Earnings Per Share for 2018 could represent not just a short-term peak, but perhaps a cyclical peak as well.

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Read this week's Major Trend.

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All of the domestic and global quantitative Chart Scores in the Momentum category are now positive and both the Advance/Decline and High/Low figures leave no doubt as to the breadth behind the market’s 10-week rally.

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The MTI’s stubbornness during the current rally confirms our overall sense that cyclical risks facing U.S. equities remain high. That said, we have great respect for the action of the market itself—enough so that we’ve allowed net equity exposure in our tactical funds to drift upward.

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Momentum category gain was driven by strength in breadth measures, selected trend models, and most of the Chart Scores.

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The Attitudinal category, which tends to vary inversely with the Momentum work, turned negative for the first time since mid-October, suggesting growing investor conviction that the rally will continue.

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Read this week's Major Trend.

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From a Momentum perspective, chart work has improved across the board but much of the longer-term trend work has remained in neutral or bear territory. These measures are, by definition, late at turning points, and we strongly prefer that the “anticipatory” tools within the MTI drive most of the swings.

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The Attitudinal category remains solidly bullish, suggesting there are significant investor doubts surrounding the rally. The market has also absorbed the past few days’ earnings torpedoes fairly well, another sign that expectations are still subdued.

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While growth rates in M1, M2, and MZM appear to have leveled off following their sharp declines over the prior 18 months, the annual rate of decline in the Adjusted Monetary Base (a good proxy for the Fed’s balance sheet) accelerated to almost 12% at year-end from just 3% six months earlier.

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The move off the late-December lows has been broad and powerful but not at all unusual for a countertrend move in a bear market. Since 1945, bear market rallies in the S&P 500 have lasted an average of six weeks and carried the index higher by an average of 10.8%.

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Read this week's Major Trend.

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The Attitudinal category’s net reading is the best (i.e., most pessimistic) since the week following the February 2016 correction low. While that’s an encouraging sign, there’s no mechanical threshold on this composite which would indicate a “safe” re-entry point.

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The lack of more meaningful MTI improvement in response to this month’s collapse suggests the bear has yet to fully express himself. But the swipes he’s taken so far have hit hard: Last week saw a nearly 150-point gain in the Intrinsic Value composite to its best level since April 2016.

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The median trailing P/E across the Leuthold 3000 universe has corrected more than 30% from January’s bull market peak (and all-time peak) of 25.1x to just 17.3x on Friday, while the median Normalized P/E ratio has shrunk more than 20% to 22.4x.

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More of our long-term trend-following measures deteriorated to "bear" status, but it isn't unusual for the market to stage a brief countertrend rally when this work becomes as decisively bearish as it is now.

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Read this week's Major Trend.

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The Economic/Interest Rates/Inflation category was not a big mover on the week, but its relative stability of late has masked a major shift within key indicator groupings. Leading inflation measures have faded sharply, with upgrades across the board in the commodity readings.

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While the improvement in the fundamental categories is encouraging, the weight of the evidence continues to support a cyclically defensive stance toward the stock market.

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A critical difference we’ve discussed repeatedly is that market overvaluation in the 1999/2000 episode was concentrated in roughly the top-50 Mega Caps, while current overvaluation—though arguably not as extreme—afflicts nearly the entire list of publicly-traded U.S. stocks.

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Although the Intrinsic Value category is now about 100 points above the worst levels recorded in early January, it is far too early to begin making a bullish valuation case for the stock market. Interestingly, some of the same pundits who warned “valuation is not a timing tool” on the way up are the ones trotting out these premature, value-based arguments—which are typically built on extremely-optimistic forecasts for 2019 operating EPS.

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Read this week's Major Trend.

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Momentum category collapsed to receive its first negative reading since early March 2016, while the Attitudinal category flipped to net positive ground for the first time in more than 2-1/2 years.

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We believe the catalyst for market weakness has been the decline in accommodation by the Fed and other central banks. While there has been a pullback in some of the leading inflation measures since June, the rate of global tightening has actually accelerated.

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The abrupt decline in the Momentum work reflects deterioration in most trend models, along with bearish flips in the Chart Scores for the Russell 2000, NYSE Financials, KBW Bank Index, and Securities Broker/Dealer Index (XBD). The NYSE Daily Advance/Decline Line provided only limited warning of the impending weakness.

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The weakening we’ve observed for several weeks in most internal stock market measures began to spread last week to the “externals,” i.e., the major market indexes like the DJIA and S&P 500. Still, we are amazed these indexes remain so close to their cycle highs in light of the extent of subsurface damage reflected in the daily and weekly breadth figures.

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Read this week's Major Trend.

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Since late August even the strongest of the market breadth measures—the NYSE Daily/Advance Decline Line—has failed to confirm highs in the DJIA and S&P 500, while the weakest—which measures 52-week highs and lows—has continued to erode.

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Swings within the five factor groups were muted, but the small loss in the Intrinsic Value work was enough to drop that category to a new negative extreme for the current bull market. The new low in this category counters the argument that U.S. stocks would “grow into” their valuations in 2018 thanks to the corporate tax cut and acceleration in GDP growth.

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High/Low Logic Index readings suggest a “fractured” stock market. Usually, though, a fractured stock market is also a narrow one, but the evidence on that score is mixed.

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Even the long-term trend model on the MSCI ACWI, which has been considerably weaker than the S&P 500 for several months, reverted to bull territory last week.

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Read this week's Major Trend.

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The Attitudinal category neared a new negative extreme for the rally off February lows, while the Intrinsic Value category reached a new extreme for the entire bull market. This combination of overvaluation and overconfidence will eventually be resolved with large market losses…

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Daily and weekly versions of all the advance/decline lines we track stood at cycle highs at week’s end, which—alongside the high in the Value Line Arithmetic Average—makes it hard to argue the market has narrowed significantly.

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