Leading indicator suggests heightened risk of bear market
By Rob IsbittsPublished: Apr 20, 2016 12:54 p.m. ET
Every time I try to argue against the current stock-market environment of being something other than a gradual transition from bull to bear market, I come up empty. The latest evidence that this is a time for defense more than offense is this long-term look at the Economic Cycle and Research Institute (ECRI) Index. You may not have heard of it, but you should familiarize yourself with their work. Their mission is to forecast turning points in economic growth and inflation.
ECRI's weekly indicator has been more reliable than most I have seen, and their record of predicting recessions shortly ahead of their onset is strong. Just as importantly, it is typically a slow-moving indicator, as opposed to the many short-term trading tools highlighted in MarketWatch and other financial media.
The ECRI Index is part of my firm's weekly Investment Climate Indicator, which assesses the probability of the next 10% move in the S&P 500 being up vs. down. We analyze a variety of factors we believe are influential indicators of the health of the investment markets. No indicator is perfect, nor can it be used in isolation. But it certainly helps to have this and other so-called "leading indicators" of the market's potential direction.
Naturally, the reading of this and other indexes in chart form is a subjective task, but I do notice something that adds to the bearish case I have laid out in MarketWatch the last several months. After all, in the chart above — which runs from the start of 1996 through the current time — the shaded areas are the last two U.S. recessions. In both cases, the ECRI Index started to turn down in earnest not long before the S&P 500 did.
I have written about the gradual deterioration of the market, which I have observed since the second half of 2014. The S&P 500 has not suffered as much as the market as a whole due to its increased concentration of "momentum" stocks. This is typical of late bull-market periods, and so it is my feeling that the S&P 500 is merely the last straw to break the bull's back.
This brings us to the recent pattern of the ECRI Index. It is currently in a mild downturn, not unlike that which preceded the dot-com bubble burst in 2000. But it has now failed to rise for nine straight weeks (eight down, one flat). And while this may just indicate that the economy and stock market are ripe for yet another dip than a follow through to a true bear market, it "bears" watching.
The ECRI peaked near the end of 1999 and again in May of 2007. If you are familiar with market history, you know that those were good times to get defensive, especially if you are in or near retirement. It is environments like these that prompted me to create long/short strategies for dividend investors several years ago.
The ECRI is currently trapped in a tight zone around its highest level ever, except for the 2007 financial-crisis bubble. The headline stock-market indexes (S&P 500, Dow, Nasdaq) are similarly situated. So while a declining ECRI in the next few months could be the death knell for ardent bulls, it could also be a rare fake out.
As an investment strategist and investment manager, I must cover as many possible angles as I can. For you, the question is do you ignore this growing threat to your wealth, or strategize for the possibility that ECRI is telling us it's a great time for defensive approaches to equity portfolios?
Posted by: Paul <ur12bfriend@gmail.com>
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