The Economy Will Deteriorate Over The Next Half Year. What This Means For Stocks?

The economy (macro) is set to deteriorate

Our new Macro Investing Index is described as:

As we’ve demonstrated repeatedly here at Bull Markets, leading economic indicators are also long-term leading indicators for the stock market because the stock market and the economy move in the same direction in the long term. This is how you know if the stock market’s decline is a correction, or the start of a much bigger bear market (e.g. a 30%+ decline).

  1. A 10-20% decline without significant macro deterioration = a correction. The economy is the dog, and the stock market is the tail. Sooner or later, the dog is going to wag the tail.
  2. A 10-20% decline with significant macro deterioration = the start of a much bigger decline, possibly 30%+

(Click on image to enlarge)

And herein lies the problem right now.

Macro deterioration happens all the time. It is a normal part of bull markets. HOWEVER, when “long term risk” is high (i.e. the economy approaches “as good as it gets”), AND macro starts to deteriorate, it tends to cross the line in the sand at which macro cannot return, and the stock market is doomed to be in a bear market.

Long Term Risk is “high”

This is our Long Term Risk Index. You can see that it is quite high right now

(Click on image to enlarge)

“Line in the sand”

For our Macro Investing Model, 0.5 = the line in the sand. Once the Macro Investing Index falls to 0.5, there is no return, and it becomes long term bearish.

In layman’s terms:

Question: If the market makes a e.g. 15% correction, and then retraces 50-61.8%, how do you know to use that opportunity to sell (in the event that is the one leg up before a much more serious decline/start of a bear market), vs. holding your long position thinking that it is the beginning towards a test of the news?

Answer: look for macro deterioration. Specifically, look for the Macro Investing Index to fall to 0.5. That’s when you know “oh shit, this is the start of a much bigger decline”.

  1. Right now, long term risk is high, and macro is starting to deteriorate.
  2. Looking at how the economic data is shaping up right now, it seems that macro will slowly deteriorate over the next 3 months, and then deteriorate more rapidly after that.
  3. However, macro has not yet crossed the line in the sand, although I think it will do so in Q2 2019.

The recent deterioration in macro (the economy) is something I highlighted back in September 2018, but only recently have had the time to model this. This has not been a long term concern throughout this entire bull market until now, because Long Term Risk has only become high in 2018.

What seperates the current decline from the January-February 2018 correction? In January-February 2018, macro did not deteriorate at all. This time, macro started to deteriorate 1 month before the correction began (in September 2018). That makes the current correction more dangerous than the January-February 2018 correction.

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