The following is based on our May 19, 2023 Smart Macro podcast, Large Cluster of Hindenburg Omens as LEIs See Further Decline, with Financial Sense Wealth Management CIO Chris Puplava.
Summary: Leading economic indicators (LEIs) are still pointing to a likely recession in the US. You wouldn't know it by the behavior of the stock market, however, given the massive bull run in tech stocks so far this year. Unfortunately, the majority of companies making up the broad market indices are getting left behind with the current level of concentration into high-priced technology stocks not a healthy sign for the current rally. As such, we now see a cluster of 'Hindenburg Omen' sell signals popping up across the major averages, similar to what occurred in late 2021. Overall, given the data reviewed below, we believe this aligns with a cautious/defensive posture on the outlook for equities.
Chris, when we spoke with you a couple of weeks back, you had mentioned how the 'Sell in May, go away' negative seasonal pattern for the stock market has a much higher occurrence when the leading economic indicators are turning down, which is what we're seeing now. However, when you look at the stock market, we just broke out to a new year-to-date high above 4200 on the S&P 500. Even with the decline in leading economic indicators and a lot of the bearishness out there on the economy, it appears that there is quite a bit of positive sentiment flowing into the tech sector—in particular, Nvidia, Google/Alphabet, Microsoft, you name it, all up pretty strongly—with a lot of the developments in artificial intelligence and generative AI. So, given what we discussed a couple of weeks back, and the leading economic indicators continuing to decline, has your view or assessment of the markets changed since?
Not at all. The LEIs are still pointing down. In fact, we recently just got the Conference Board's LEI for April, which has now declined for the 13th consecutive month (shown below). Based on the wide range of data they track, they believe the economy is going to contract this quarter and are forecasting a recession to start in the middle of this year. I think the concern is, when you look at the S&P 500, it's powering higher and the tech stocks look like they're doing well, everything looks good. But the question I have to keep asking myself, what has changed in terms of the outlook? We still see the Fed raising rates or keeping rates at current levels, which is putting pressure on the economy, the Fed is still shrinking its balance sheet and pulling liquidity out of the markets, and the economy continues to slow. So, all of the major headwinds are still present and, I believe, will continue to put pressure on corporate profit margins and the broader market in general.
Could the Conference Board LEI be giving a false signal about recession or are there other models flashing warning signs for the economic outlook?
It's not just the Conference Board, but even official data provided by various regional Federal Reserves are flashing high odds of a recession. For example, both the New York Fed and the Cleveland Fed have their own recession models estimating the odds of recession within the next 12 months (shown below). And the readings that we are seeing from their models are north of 68%. Now to give you an idea of 2020, when we were obviously in recession, they got up to about a 40% chance. Even in the Great Financial Crisis, the deepest recession we have had since the Great Depression, their odds only got to around 45%. And right now we're at 68%. So, extremely elevated relative to prior readings where recessions occurred, and I think you would have to bury your head in the sand to not think the odds of recession are high.
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So, there's a number of things that are lining up for further weakness, even though, again, tech stocks are rallying pretty strongly and moving higher while the broader market is not participating. What are some of the other things that you're looking at under the hood that line up with this idea that we could be looking at an important turning point?
I track a wide range of technical buy and sell signals on the major averages and, just recently, we've now seen a cluster of what traders and technicians refer to as Hindenburg Omens (shown below), which you can either think of as potential sell signals or red flags for a market peak. But essentially, the Hindenburg Omen signals when the market is going through an identity crisis where you have a high number of new 52-week highs as well as a high number of new 52-week lows. That's not a healthy market. And, in general, that tends to portend weak returns going forward. So, looking at some of the major indices, we have sell signals now appearing for the Russell 2000 small cap index, the S&P 500, and the NASDAQ Composite. This is potentially a bad sign for the market, in my opinion.
Looking at the bigger picture, when we continue to see returns dominated by a small handful of tech stocks and the stock market averages reflecting little concern over economic risks, I have to ask myself what has changed? And when I do that, nothing has changed. Interest rates—that is, borrowing costs—are still at elevated levels, which is exerting pressure on the economy and wider financial system; financial liquidity is still being withdrawn by the Fed as they continue to implement quantitative tightening by shrinking their balance sheet; the 'walk' on commercial banks has not ended and people continue to pull money from banks, which means banks have to either liquidate their securities holdings to meet deposit outflows or use maturing loans to do that; and banks are continuing to tighten up on lending. So, all together, these are not the kinds of things you see during a strong economic expansion to propel stocks higher. The one bright spot recently has been a recovery in housing activity but, again, unless interest rates materially fall from current levels, I think this is just a short-term recovery. And if the Conference Board and Federal Reserve models for recession—not to mention, Bloomberg's recession model as well, who we've spoken with on our show (see Bloomberg Chief US Economist Anna Wong Discusses Increasing Signs of Recession)—are correct about the outlook, we should expect to see more job losses in the months ahead. So, again, at this juncture, I'm still cautious on the outlook for the economy and the stock market and believe a defensive posture is the most prudent course.
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