Is the stock market setting up for a crash? Some market pundits see areas of concern for equities, ranging from the length of this bull market (at over six years), to falling commodity prices, to technical issues with the number of companies taking part in the market’s advance. These worries are leading many to call for a significant market top in the coming months.
However, according to Chris Puplava, Chief Investment Officer at PFS Group, it’s still not time to hit the sell button yet.
Here are some of the reasons he gave why in a recent interview with Financial Sense Newshour:
Limited Recession Risk: A slowdown in the US economy and the increasing risk of recession are very important to monitor when it comes to forecasting major market turning points. Though stocks can clearly become unhinged from economic fundamentals, when the world's largest economy is stable and not showing signs of a severe contraction, conditions are generally supportive for an improving stock market.
When asked about the likelihood of recession, Chris pointed to his often-cited recession probability model (see below - recessions in red), which incorporates a large array of leading economic data and has been very helpful at identifying prior market tops. Currently, it is reading close to a 12% probability of recession in the next 3-6 months. Once it gets over 20%, the economy and stock market are more likely to experience a large decline.
Low Risk of Financial Crisis: Major market peaks and corrections are often associated with increasing signs of stress in the financial system. Though a currency crisis or banking collapse can often take investors by surprise, it is possible to monitor the overall health of the financial system and track whether changes are improving or getting worse. Chris cites one indicator in particular, the Bloomberg US Financial Conditions Index (FCI), which will drop into negative territory prior to major peaks and bear markets as financial conditions begin to deteriorate. As seen below, the FCI went into negative territory as the bull market peaked in 2000 and 2007 and remained there until after the bear market had runs its course.
Source: Bloomberg
Oil Spikes: While many pundits are pointing to declining commodity prices as a sign of dangerous deflation, Chris reminds people that it is oil spiking higher—and not crashing lower—that creates greater problems for the US economy and equity market. 100% increases in the price of oil—so called "oil shocks"—like in 1990, 1999, and 2008, put a massive amount of strain on businesses and consumers. Today is just the opposite. What’s more is the fact that oil prices normally collapse at the end—and not the beginning—of a recession.
Source: Bloomberg
Given the above, Chris says he doesn’t see “a bear market caused by recession…financial crisis…or oil shock. Those conditions which pretty much explain every bear market in the past are not present in the current case.”
Moving on to technical factors, in a recent interview with Richard Dickson of Lowry Research—one of the oldest technical advisory firms on Wall Street—Richard forecasted a possible market peak in 4 to 6 months based on the number of stocks that have already broken down into their own bear markets.
But Chris believes that there is more to this story than meets the eye:
“When technicians look at the deterioration of market breadth—whether it is the advance-decline line or 52-week new lows—what you have to do is qualify those numbers based on which sectors are in trouble and which ones are not.”
When Chris looks at the stocks currently making new lows, it is not the ones that are normally associated with an elevated risk of market turmoil:
“98% of the stocks this week that hit new lows were concentrated in three sectors: energy, materials, and industrials. Energy alone explained 60% of the number of stocks making new lows.”
Conversely, sectors like financials and technology are among those making 52 week highs, which reinforces the idea that the American consumer and economy is much stronger than many people think. Given this context, Chris is not concerned that we are heading to a bull market top, and at this point he does not share the same concerns that Lowry’s does, when you look more closely at the makeup of the data.
After the interview, Chris noted that if Dickson's forecast for a bull market peak later this year or early next turns out correct, then we should expect to see a widespread deterioration in economic data moving forward, which will also lead to a spike in the probability of recession, a breakdown in the Financial Conditions Index as well as other financial stress measures, and, at the very least, a reversal in leading sectors of the market. Right now, none of those things are present and the weight of the evidence is still in favor of equities, he said.
Eventually that will change, but it doesn't appear that time is now or in the near future.
Listen to this full interview with Chris Puplava, Chief Investment Officer at PFS Group, by clicking here. For a complete archive of our broadcasts and podcast interviews on finance, economics, and the market, visit our Newshour page here or iTunes page here. Subscribe to our weekly premium podcast by clicking here.
