As mentioned in our last blog post, there are numerous inter-market relationships that are pointing to an increased risk of a mid-cycle correction. As a result, we have made some adjustments to our models. First, we slightly decreased equity exposure and increased the fixed income exposure during our last re-balance. More recently, we sold a few positions that were moving against us. Given our concerns about a mid-cycle correction, most of these second sells were not re-invested.
If you have worked with us for a while, you have likely heard us state that we do not predict what will happen in the stock market. Instead, we analyze the market and let the data guide us. While there is no single dataset that is definitive, Chart 1 offers one visual to help illustrate our current concern.
Chart 1 – Data Source Optuma & TD Ameritrade
The top portion of Chart 1 is what is referred to as the “Advance Decline Line”. In essence, it shows us the overall trend of the stocks on the New York Stock Exchange. If the line is pointing up, more stocks are advancing than declining. Likewise, if the AD Line is pointing down, more stocks are declining rather than advancing. On this chart, we’ve added a red trendline on the recent peaks of the AD Line. You can see that this trend is pointing down.
The bottom portion of the chart is the S&P 500; the 500 largest stocks in the United States as measured by Standard & Poors. We’ve drawn a red trendline on this line over the same duration as the trendline in the top portion of the chart. This trendline is pointing up, indicating a positive trend.
If these two trendlines were both pointing in the same direction, one would confirm the other. In this case, since the AD Line is pointing down while the S&P 500’s trendline points up, it is referred to as a “negative divergence”. While negative divergences do not always resolve in a negative manner, we offer this chart as a simple way of highlighting our short-term concerns.
From a longer-term perspective, we remain concerned about inflation.
One of the drivers of our inflationary concerns is the fact that the Federal Reserve continues to add monetary stimulus into the economy while Congress and the President continue to add fiscal stimulus into the economy. Chart 2 tells us that all this stimulus might not be necessary.
Chart 2 – Data Source: St. Louis Federal Reserve (FRED), Total Non-farm Job Openings
This second chart is sourced directly from the St. Louis Federal Reserve’s FRED (Federal Reserve Economic Data). One downside to this chart is that it only goes back to December 2000. However, in the last 21 years there has never been as many non-farm job openings as there are right now. As a result, in order to attract candidates, employers are raising their starting pay. While this is good news for the new employees, it can easily cascade. Initially, employers will try to absorb the higher cost of these higher employee wages. However, eventually, they will be forced to raise their prices. You have likely already seen this happening. This is one reason why we are concerned that the recent inflationary trend is not “transitory” but could be a bit more stubborn than the Federal Reserve has been suggesting. A healthy economy will have some inflation. But too much inflation is generally not good for either the economy or the stock market.
In our next post, we will discuss the Federal Reserve’s plan to “taper” their asset purchase program as this is another one of our main concerns that could also lead to stock market volatility.