The Summer Stock Market Rally Is Over

Our August 10, 2010 Call

For the purpose of providing market timing advice, the following report, which is now fully fleshed out and independently edited, was originally sent to our private email list Tuesday, August 10, the day after the stock market made its summer rally high at SPX 1129.

Our August 10, 2010 Call: The Summer Stock Market Rally Is Over

Our work shows the 5.5-week, 11.6% advance (so far) from the Jul 1 S&P 500 (SPX) index’s intraday low of 1011 up to yesterday’s intraday high at 1129, which was near the lower end of the normal retracement range of between one-half and two-thirds of the preceding 17.1% decline from the Apr 26 SPX high at 1220 down to its Jul 1 intraday low at 1011, will now likely be followed by a much larger decline, probably much closer to 30%, if not more.

More below about the possible subdivision variation of the usual 12345 Growth Cycle decline pattern incorporating the previous downleg (#1 in the chart below) and following downlegs (#3 and #5, not illustrated), plus some fundamental reasons for what we expect will eventually become a decline of Supercycle magnitude. See the history and characterization of the severity (magnitude and duration) of declines in our table of the 33 Most Severe Declines since 1895 and our Decline Severity Profile/Drawdown Grid - both exhibits are near the bottom of this report.

The Economic Recovery Has Ended Since GDP Peaked During The Past Three Months

Everybody knows the latest revised annualized real GDP quarterly data shows rapid growth deceleration from Q4’s +5.6% to Q1’s +3.7% to Q2’s + 2.4% - why no reference to “less good” “red shoots”? - but few are currently aware that: (a) Q2’s +2.4% was overstated because of a huge miss in nondurable goods inventories:, and likely lower net foreign trade, which will cause a larger downward revision to be reported on Aug 27.

Macroeconomic Advisers has reported that their monthly GDP estimate declined in both May and June and similar, but independent, work by Maria Simos ( shows the first decline in actual GDP dollars was during June. These actually dollar monthly declines in GDP follow, as they usually cyclically do, a peak in the monthly annualized growth rate of about 9.2% in November and in the three-month (rolling) annualized growth rate peak of about 5.6% in January.

Thus, even with GDP increasing in July, when all the GDP revisions are made, we expect that the so-called economic recovery ended during the past three months, especially when measured on a per capita basis – that is adjusted (divided by) for the labor force or population. This is consistent with the probable May peaks in Conference Board’s (CB) monthly coincident economic index (CEI) – discussed further below – and in the growth rate of Industrial production – May for monthly data and June for year-over-year (YoY) data, which has been the strongest area of the economy.

Yesterday’s probable high in summer rally stock market also probably reflects the peak in investor optimism during the earnings reporting season, where important measures of the YoY growth rate of four-quarter (rolling) corporate earnings have clearly peaked: as reported GAAP earnings per share (EPS) and operating earnings, by both bottom-up and top-down analysts. In fact, Standard and Poor’s is already starting to reducing their EPS consensus estimates from the perpetually over optimistic bottom-up (individual company) analysts for five of the next six quarters.

All of these peaks are consistent with our work on the (core) business cycle portion of GDP, which technically is real, domestic, private sector, final demand, per capita GDP (first chart below) and with our forecasting model of the onset, and probable consequence, of what is now popularly called the “double dip” (second chart below).

(Note that in this vein, the Fed today announced easing-like actions an effort to offset the reductions in their tripled balance sheet from the natural runoff of the mortgages they’ve purchased. But, importantly, this follows their warnings in recent weeks about the slowdown in the economic recovery, which have been unheeded by the “irrationally complacent” stock market – so far. More about this bearish investor mass mood further below.)

In other words, The Great Recession has predictably turned into what could be now called The Great Stall: which we expect to turn into what might be called The Great Double-Dip, as calendar-quarter reported GDP growth will probably turn negative by year-end, absolutely stunning permabulls and new bulls alike.

Revised GDP Data Shows The Core (Private-Sector) Business Cycle Declined 7.7% During The Seven-Quarter Great Recession And Has Since Only Retraced 18%

Coincident Economic Indicators Also Confirm The End Of The Economic Recovery

Notice in the two charts below that the CB’s CEI, whose four components track the U.S. economy on a monthly basis, retraced less than 30% of its recessionary decline before stalling out in May, with one component declining June – consistent with the June monthly decline in GDP referenced before.

This is essentially coincident with the stock market’s Apr 26 high and follow-on decline in May and June. This lack of meaningful lead time by the stock market, similar to late 2007, and as we’ve explained in more detail previously, is characteristic of Supercycle Bear Market Periods.

These peaking/topping out data is also accompanied by the May peak in the CB’s Leading Economic Index (LEI) (illustrated in the second chart below), partially due to the stock market not leading the business cycle, and the peaks and turns negative during the second half of this year.

All of this simultaneity is fully consistent with our forecast of an imminent onset of the first of the after-shock, double double-dip recessions, investor realization of which will probably end the ongoing Supercycle Bear Market, while the second one will likely end (following a October, 2014 low) the whole, ultimately deflationary economic Supercycle Bear Market Winter Period containing it and the two previous recessions.(See the characteristics and history of Supercycle Economic Seasons in the table further below.)

In fact, significant parts of the U.S. economy have been in continuous, double-dip recessions for the past 10 years, which we were the first to forecast. See “Bob Bronson was forecasting the first of a devastating trio of upcoming recessions, Are You Prepared for the First of Three Perfect Storms... ” on page 6 and the charts on page 44 of: As Forecasted – A 12-Year Retrospective

For example, these sectors continuously in recession for the past 10 years include: employment, the most important of the four components of the business cycle; the auto industry, the biggest component of durable goods in the production component; and in the income component, what could be called “organic” income, or real, per capita, disposable (after-tax) personal income, which excludes (government) transfer payments.

Both Economically-Leading Initial Unemployment Claims and Economically-Coincident Payroll Data Continue to Be Bearish

Note in the table and chart below the predictably poor performance of initial unemployment claims, about which we have warned for several months. It’s a leading indicator for the all-important employment aspect of the economy, and one-fourth of the National Bureau of Economic Research’s formulation of the business cycle, as well as a leading indicator for the whole economy, and thus a coincident indicator for the stock market, since initial unemployment claims and the stock market are each one of the 10 leading economic indicators tracked by the Conference Board. This important weekly indicator of the economy confirms the Apr 26 top in the stock market (see the red dotted curvilinear best-fit line in the chart below), as well as the coming, huge second downleg of the Supercycle decline that we expect.

Business Cycle-Leading Initial Unemployment Claims

Even a casual examination of the chart below makes clear in hindsight the deterioration in all-important initial unemployment claims, which is very bearish for the stock market. The data and comments adjoining the chart explain how we used the calculus of motion to “see” that coming weakness months in advance. The same goes for the payroll data in the second chart below.

Business Cycle-Coincident Nonfarm Employment (Payrolls)

Some bullish commentators have tried to argue that the once-in-a-decade influx and outflow of census Workers from the U.S. Household Employment Survey has confounded what they had hoped would be a better trend for private sector payrolls.

But well-known market strategist David Rosenberg recently wrote that when “…we adjusted the Household employment numbers by netting out the federal government segment from the Payroll survey, the results are the same. Excluding non-postal government workers, Household employment fell 446K in May, 80k in June and by 11k in July. That is a total loss of 537k and again, history shows that when the household employment is down three months in a row, we are already in recession or about to head into one 98% of the time. What is playing a key role in dragging these numbers lower is not the reversal of the Census hirings as much as the steady declines we are seeing in self-employment — the ‘entrepreneurial’ part of the jobs picture. The number of job losses here has exceeded 130,000 in just the past three months and, at 9.64 million, the level is down to the lowest it has been since November 1987.” So more detailed analysis of the employment situation shows it is even worse that the headline reports.

Here are some more keen observations of the weak employment data:

Home Sales Prices Will Continue To Decline And This Is Bearish

A continuing housing recession – with some seven million houses seriously delinquent or in some state of foreclosure no recovery is underway whatsoever – which we were also the first to forecast with our call 10 years ago for The Great American Home Equity Bust (see pages 6 and 38 in As Forecasted – A 12-Year Retrospective ), and the resumption of the Supercycle Bear Market in the stock market are the primary causes, as a result of their combined negative wealth effect that depresses consumer spending and thus (lagging) business spending, of the next predictable phase of after-shock, double double-dip recessions, which we were the first to forecast more than a year ago further refining our “Triple Perfect Storms” forecast in 2006.

As demonstrated in previous reports, the stock market is typically more of a coincident, rather than a leading, economic indicator during Supercycle Bear Market Periods, and during such secular periods, Supercycle Bear Markets – again see the Decline Severity Profile/Drawdown Grid further below – follow cyclical bull markets like the latest, 14-month, 83% advance that ended on Apr 26. This context of bearish secular influence on the stock market is similar to economic slowdowns, or more exactly business-cycle corrections, during what is now called the New Normal of a secularly weak economic period (what we fundamentally and technically quantify as an ultimately deflationary Supercycle Bear Market Period, or Winter), typically turning into recessions, and otherwise normal recessions into severe ones, as we are anticipating again currently with our after-shock, double double-dip recessions call and working model.

Our working model for the most likely sub-cycle trends of the Supercycle Bear Market’s price-time geometry suggests either a much more typical five subdivision pattern, or even a rare cascade- or waterfall-shaped three subdivision pattern. When the June stock market lows at the SPX level 1011 are decisively broken and if a Mass-Correlation, Hyper-Volatility, Illiquidity Event, or MCHVIE (pronounced “mac-vee”), does not then develop, then that decline will likely be eventually followed by another countertrend rally, bigger in magnitude and longer in duration than the recent one, which, in turn, will likely be followed by a third and final downleg (a fifth subdivision Growth Cycle trend), hopefully ending with a sufficient selling climax to make the final Supercycle Bear Market low.

A sufficient selling climax did not occur with the lows that we fully anticipated in Oct ’02 and Mar ’09, which we accordingly concluded were very unlikely to be the end of the Supercycle Bear Market. It’s even fundamentally and technically clearer now that they weren’t the ultimately final lows.

But there is some compelling, emerging evidence that the coming downleg could be severe enough, with another – the third, and possibly final – decline cumulatively greater than 50% and with a MCHVIE selling climax, to end what will then be a 10.7-year Supercycle Bear Market underway since Mar 24, 2000. If this occurs, it would pre-empt a usually intervening, large countertrend rally (the #4 cycle trend in a classical down-up-down-up-down Growth Cycle pattern decline).

Among such evidence are the already unusually high (mass) correlations between various asset classes (with stocks and commodities and inversely with bonds and the U.S. dollar) and between equity sectors and industries caused by the proliferation of ETFs and high-frequency trading.

Furthermore, there was a shot-across-the-bow warning of impending liquidity problems (e.g., no trading bids for many of the most important large-cap stocks) from the “flash crash” that occurred on May 6. And don’t think the circuit breakers, trading curbs and/or halts will prevent a MCHVIE - they likely will aggravate the need for an adequate, final market-clearing selling climax.

Then there’s probably worsening in the already unusually divisive socio-political turmoil leading up to the Nov 2 mid-term Congressional election, probably requiring a market selling climax, if not a market collapse, as a galvanizing solution of legislative gridlock.

An imminent warning of any such MCHVIE will necessarily be signaled by the severity of the negative momentum that will occur when various implied volatility metrics (VIX, VXO, VXN, etc.) make significant new highs above 50 in the next 60 days.

Corporate Earnings Are Not Nearly As Impressive As The Accompanying Hype Implies

Meanwhile don’t be caught up with TV talking heads bombastically proclaiming that “powerful” Q2 corporate earnings reports argue that a bull market is still underway and that it has simply paused before it resumes its momentum to much higher highs. The aggregate 43% YoY EPS gains are mainly due to both the extraordinarily easy comparisons, as explained in our warning report just before the Apr 26 stock market high:, and continuing aggressive cost-cutting by companies, rather than by any significant top-line (revenue) growth.

In fact, when adjusted for the zero singularity of extraordinary write-offs a year ago (see the chart below), non-organic M&A (merger and acquisition) growth that is generally not repeatable, and non-operational, favorable currency-translation profits from foreign operations, the latest earnings reports are not that impressive at all. Of course, such extraordinary cost-cutting is an increasingly less effective way to get higher growth rates, and it has nearly reached its limit.

More importantly, even qualitatively unadjusted as suggested above, corporate earnings are not exhibiting powerful momentum as has been recently proclaimed by TV talking head permabulls and new bulls. According to S&P, only is the 43% EPS YoY (as reported on a GAAP basis) comparison down two-thirds from their previous Q1 YoY comparison of 132%, but the current quarter’s (Q3) YoY comparison will likely be almost 75% lower to 12%, and similarly down more almost 65% to only 4% in Q4’s YoY comparison. Not only is that sharply declining momentum, rather than powerful momentum, we expect these consensus-reflecting expectations are too optimistic since they do not factor in any double-dip.

Supercycle Bear Market: Two Common Stock Markets and Two “Irrational” Mass Moods

As we have demonstrated before – see pages 22-23 in As Forecasted – A 12-Year Retrospective – the five Supercycle Bear Markets since 1881 have each exhibited two booms and busts, consistent with theoretically-grounded mass mood logic, which forms down-up-down ABC Growth Cycle patterns.

The next two charts bifurcate the stock market by the two main exchanges on which about 8,000 of the largest U.S. common stocks are traded, thus largely illustratively isolating the “irrational exuberance” that was reflected mainly in the 1995-2000 boom and 2000-2002 bust of the technology-laden and financial-services-lite Nasdaq Composite index and the “irrational complacency” reflected mainly in the 1995-2007 boom and 2007-2010(?) bust of the financial-services-laden and technology-lite NYSE Composite index.

Both permabull and new bull TV talking heads, who never saw the financial crisis, or what is now called The Great Recession, in advance, or even contemporaneously identified when it got started, have been bombastically pounding the table while proclaiming there will be no economic “double dip.” Never mind that there is no official ( or even industry-accepted definition of what an economic double dip is – recession, depression or otherwise.* None of most recognized economists, investment strategists, or portfolio managers have an effective long-term or even short-term business-cycle model anyway, while our work shows that double-dip recessions are an important hallmark of the four previous Supercycle Bear Market Periods (two deflationary double dips and two inflationary double dips) that have occurred during the past 130 years.

Even more important, we have previously pointed out – and forecasted well in advance in the present instance – that the worst back-to-back recessions in the two previous deflationary economic Supercycle Bear Market Periods (Winters) since 1881 have been both double dips, and together they were considered depressions. In fact, each of those two Winters, 1929-1949 and 1881-1896, experienced two double-dip recessions, not just one. This is one of the main reasons why we forecasted “…Triple Perfect Storms…” more than three years ago - before the last recession and financial crisis started – and why we have subsequently refined them further with our after-shock, double double-dip recessions call and working model.

More evidence of this extraordinary mass mood of “irrational complacency” is the denial over the past several months of emerging bearish economic news, with the ridiculous rationalization that, because a financial Armageddon was avoided, even if only narrowly, none of the follow-on bad news is new and/or relevant, especially since the stock market rallied 83%. Such stupid, circular logic abounds at major market tops.

Or institutional investors, especially Private Equity Funds (aka as LBOs hoping that a resumption of significant M&A activity and/or IPOs, (like General Motors going public) will stimulate individual investors to return en mass to speculate, or even invest, in equities in order to classically bail them out of their currently fundamentally over-valued (relative to New Normal slow growth - at best - economic conditions), over-owned (too popular), and overbought (technically over extended) portfolio positions. In a maturing Supercycle Bear Market Period, especially a deflationary Winter, this try-to-get-rich quick, musical chairs game won’t return.

This is in addition to the fact that the Investment Company Institute reports that their (liquidity) cash ratio for U.S. equity portfolio managers recently hit an all-time historic double-bottom low. Obviously, these institutional investors, who drive stock market prices, are not yet concerned about a double-dip causing a stock bear market, although the last time that they were this complacent, in Sep ‘07, the SPX subsequently declined a whopping 58%!

The NBER suggests that the business-cycle contraction of 1980-82, was two separate recessions, rather than a double dip one, because the 12-month “expansion” between them made new highs. However, that view is not shared by probably the most important member of their business cycle Dating Committee, with whom I’ve discussed this issue. Not only did that supposed second recession (Jul ’81 to Nov ‘82) make a lower low than the first recession (Jan ’80 to Jul 80), like a megaphone, or widening wedge, in technical chart analysis (see that pattern in the Conference Board Coincident Economic Index chart above), but that narrow consideration lacks imagination and even common sense. A robust definition of a (combined) double-dip recession needs to not only consider the magnitude, but also the duration of the back-to-back contractions. Not only is it easy to imagine that an extended duration in the immediate follow-on contraction is more important than if it only double bottoms, or even less, rather than making a lower low than the first one.

Japan’s economy for the 20 years since 1990 is a most relevant example for consideration of such broader severity (magnitude times duration) business-cycle geometries. We’ve little doubt that whether this incipient, second U.S. business-cycle contraction makes a lower low than the first one or not, investors will end up evaluating what is occurring to be double-dip in spite of the NBER’s lack of guidance.

Although several commentators have recently opined that the delay in the NBER declaring the month that they think the (first) recession ended (i.e., Jun 2009) is evidence of their belief in a potential double dip, don’t count on such guesswork since the revised GDP data the NBER were rightfully waiting was only made available 11 days ago. Their announcing their traditionally irrevocable determination for the end of the recession provides some political expediency for cheerleading, even if the NBER dating decision itself does not, so don’t be fooled by any short term stock market rally, or extension of one - like the otherwise ended summer rally - that may follow that announcement.

Supercycle Fundamental Valuations Never Reached Mean-Reverting Extremes

Then there is the question of stock market valuation. Below is the update of our charts of 140-year corporate EPS and the Supercycle mean-reverting stock market P/E, which shows that, for a simple example, Microsoft with a trailing P/E of 12, is not a buying opportunity, but is instead indicative of where the whole stock market is headed. And the stock market will then predictably overshoot on the downside, as illustrated in the chart below of P/E mean reversion.

Our other Supercycle fundamental valuation indicators, such as net book value and Tobin’s Q ratio (enterprise replacement cost), dividend yield and the stock-market-to-GDP ratio, have extremely similar patterns of over-valuation on a long-term analytical basis.

Predictably Declining Supercycle Period Interest Rates Are Forecasting Further Economic Weakness, Not Stock Market Undervaluation

One reason for expecting the stock market’s long term P/E (36-month exponentially smoothed) to overshoot on the downside below 10 (illustrated in the above chart) is the declining trend in interest rates, which a companion lead to the K-cycle declining trend in price inflation which we were first to forecast at the beginning of the Supercycle Winter.

Periodically thereafter we were more specific, for example, forecasting the 10-year T-note yield to reach 2.0% after they started their descent from their Jun ’07 intraday peak at 5.31% to their Dec ‘08 intraday lows at 2.04%. See the Dec 7 mark on the chart in the Supercycle Economic Season table below. After that when they bounced back up double topping with their Jul ’09 intraday peak at 4.01% and started declining four months ago, we reiterated that we expected at least the 2.0% level to be reached again, if not broken significantly especially as the after-shock, double double-dip recessions play out.

Interest rates, or the (inflation) price of credit (debt), are the all-important leading indicator in deflationary economic Supercycle Winters for timing the stock market, understanding the phases of the business cycle and forewarning of the four seasons of general price reflation (Spring), inflation (Summer), disinflation (Autumn) and deflation (Winter). See the double charts below of the past 140 years of K-cycle, Supercycle mean-reverting inflation x-axis (time-synchronized) with 210 years of K-cycle, Supercycle mean-reverting interest rates, reflected in past more than five decades by the now widely-recognized “benchmark”10-year Treasury Note yield.

Most Important: Don’t Confuse The Market P/E With Net Present Value

One of the biggest mistakes made by institutional investors, who drive stock market prices, is confusing the stock market P/E with NPV (the Net Present Value of interest-rate discounted cash flows) as we have explained in several articles during the past several years: Declining interest rates do not, either empirically or theoretically, indicate more attractive stock market prices during half of the about 16-year Supercycle Seasons: deflationary economic Winters (like now) and reflationary economic Springs (probably starting near Oct, 2014 and likely lasting through 2030 or so).

The consensus of institutional investors have been continuingly surprised by lower interest rates, which has wrong-headedly caused them – naively and/or biasedly - to expect a higher stock market P/E and thus higher stock market prices. Their reluctant, but inevitable capitulation is has been, and we fully expect to continue to be, a primary driver of the selling pressure necessary to cause the major stock market decline that is underway, and which we now expect to accelerate.

1. We have documented our discussions with others over many years who have used the terms K-Cycle, K-Wave or Kondratieff Wave, with Season(s), and the like. Our decades long publishing record clearly establishes that we were the first to use these terms with Season(s), as well as the first to quantify them economically or otherwise fundamentally (Kondratieff and Schumpeter did not) or even technically. Most importantly, we were also the first to forecast their applicability to the secular period dating variously from the late 1990’s through March 2000, depending on the metric under consideration. As Forecasted – A 12-Year Retrospective We more than welcome further inquires.

2. The terms “more“ and “less” refer to the combination of cyclical frequency and severity (duration times magnitude) – see SMECT: A Forecasting Model That Integrates Multiple Business and Stock Market Cycles Since 1896

3. The terms ““bull” and “bear” refer to the over- and under-performance in Supercycle (secular) trends of excess total return compared to the risk-free return and other asset classes

4. P/E includes quantification of investor mood (animal spirits) – see our earnings-capitalization stock-market valuation model: Quantifying and Forecasting an Equity Risk Factor

5. See our severity (magnitude and duration) quantification of the 33 most severe bear markets since 1895: Exhibit E in #2 above.

About the Author

Bronson Capital Markets Research
Bob [at] bronsons [dot] com ()