From a long-term investment standpoint, the stock market remains obscenely overvalued, with the most historically reliable measures we identify presently consistent with zero 10- to 12-year Standard & Poor's 500 nominal total returns and negative expected real returns on both horizons.
From a cyclical standpoint, I continue to expect that the completion of the current market cycle will likely take the S&P 500 down by 40% to 55% from present levels, an outcome that would not be an outlier or worst-case scenario but instead a rather run-of-the-mill cycle completion from present valuations.
If you are an historically informed investor who is optimistic enough to reject the idea that the financial markets are forever doomed to extreme valuations and dismal long-term returns, you should be rooting for this cycle to be completed. If you are a passive investor, you should at least align your current exposure with your investment horizon and your tolerance for cyclical risk, which we expect to be similar to what we anticipated in 2000-2002 and 2007-2009. For more data and detail on these views, see The Next Big Short: The Third Crest of a Rolling Tsunami and Rarefied Air: Valuations and Subsequent Market Returns.
From an economic standpoint, recall that economic deterioration typically follows a well-defined sequence, with weakness in what I call the “order surplus” (new orders + backlogs - inventories) followed by deterioration in industrial production (which retreated again last month) and by real retail sales (which have declined for two consecutive months), then real personal income (which is the next measure to watch here) and typically followed only then by weakness in employment indicators. Nothing in recent weeks has changed our assessment of an imminent likelihood of recession, though as I’ve regularly noted, the immediacy of that expectation would be deferred if our measures of market internals improve significantly. Though employment is a lagging indicator, we would still watch for an increase in weekly unemployment claims above roughly 330,000, a decline in aggregate weekly hours over a three-month period and an increase in the unemployment rate to about 5.3% or higher to confirm the actual start of a recession.
From a near-term standpoint, given a well-defined top formation extending back to 2014, and a strenuously overbought advance that has now carried the market to the arc of that formation, my sense is that the preceding paragraphs would be most satisfying if I were to say that all evidence supports expectations of an immediate collapse and that crash risk is our most pressing concern (as it was just a few weeks ago).
Frankly, that outcome would still serve us best. But like last week, our near-term outlook actually remains fairly neutral. That near-term outlook would shift to a hard-negative view at about the 1975 level on the S&P 500, which is where the full weight of market action would pile to the downside again. I also continue to view the 1820 level as a potential crash threshold.
