Where Are Stock Prices Headed?

The stock market has, for the most part, moved sideways this year. The big question is whether stocks are going to eventually break out to the upside and advance to new all-time highs or break down below the lows of earlier this year. There is obviously no way to know with absolute certainty what is going to happen, however, we can look at the weight of the evidence to evaluate market risk.

There are two things that I analyze when trying to determine whether the market is experiencing a minor correction within a longer-term bull market or something more ominous, like a bear market. I like to first look at the economy from a macro level, meaning where are we in the business cycle. Then, I evaluate what is going on in the global equity markets.

Let’s first talk about the business cycle. The stock market trades based upon where the economy is going, not where it is at presently. The economy is, for the most part, cyclical. Normally as the economy grows, inflation rises, and the Fed raises interest rates to control inflation. The raising of interest rates slows the economy, which results in declining corporate profits and thus falling stock prices.

Where are we now in the business cycle? We have been in one of the longest recovery/expansionary periods in history. The last recession coincided with the last bear market that ended early 2009. During the current period of recovery/expansion (2009 to present), the Fed had reduced rates and provided liquidity through what has been termed Quantitative Easing. This injection of liquidity into the markets has been unprecedented from a historical perspective and has helped to keep the bull market alive. However, now the Fed is raising interest rates after a prolonged period of easy money. Therefore, from a business cycle perspective, if we are not entering a bear market now, we are probably getting close.

Now let’s look at the global equity markets to see what they are suggesting about the current period of stock market weakness.

International markets peaked before ours and are all mostly in bear market territory, short-term market breadth has improved however longer-term market breadth is extremely negative, risk-off assets are substantially outperforming risk-on assets, long-term stock market index trendlines have been violated to the downside, and market-leading stocks (such as the FAANG stocks) have been getting hammered. This market decline has all the hallmarks of a bear market, except that the yield curve has not inverted yet.

The bottom line is that the weight of the evidence continues to suggest that stock market risk is extremely elevated. If you are in or near retirment, you can't afford to lose a substantial portion of your retirement savings. Now is the time to reevaluate the strategy you are using and the amount of risk you are taking.

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