The SPDR Dow Jones Industrial Average ETF tracks a price weighted index of 30 large cap US stocks
The SPDR S&P 500 ETF tracks a market cap weighted index of US large and midcap stocks selected by the S&P Committee
The Powershares QQQ tracks a modified market cap weighted index of 100 NASDAQ listed stocks.
– Nearing the end of the current economic expansionary cycle
– Extreme optimism, complacency and greed are showing up
– However, sentiment indicators, price action and interest rate related metrics are not flashing red yet
– General equity market should continue to grind higher until the major indicators signal danger
With the US equity market climbing to new highs, we thought it would be a good time to review the strength of the bull market. From a cyclical economic point of view, we are nearing the end of the expansionary phase where it all started back in June 2009. The current economic expansion is the third longest in history at 98 months, which means a recessionary cycle is about to take over once the current expansionary cycle ends. Each expansionary cycle is met with some form of crisis that leads to a recession with the two most recent crisis resulting in a 50% wipe in the S&P 500. Expansionary cycles are defined as positive QoQ GDP growth while contractionary cycles are defined as negative QoQ GDP growth. The average expansionary cycle is about 60 months, and the longest economic expansion was 119 months during the 1990 decade while the second longest economic expansion lasted for 107 months during the 1960 decade.
Figure 1. Economic cycle – Current economic expansion is the third longest in history
The noteworthy part is the current 98 months of economic expansion has outlasted the previous cycle of 73 months where the Global Financial Crisis happened. History does not repeat but often rhymes. Hence, we are not calling the market to top out now with the economic cycle but emphasising the end of the expansion cycle is nearing.
Extreme greed and optimism are a great signal for late stage economic cycle, and the following indicators are suggesting it:
Figure 2. Equity VIX – hitting a low of 8.84, last seen in 2006 just before GFC blew up
Figure 3. Non-Commercial short contracts VIX Futures – hitting unprecedented high showing extreme greed and complacency
Figure 4. Treasury VIX – hitting a low of 4.00 in July 2017, surpassing the GFC low of 4.22 showing extreme complacency
Figure 5. Conference Board Consumer Confidence – exceeding pre-crisis highs
Figure 6. Umich Consumer Sentiment – exceeding pre-crisis highs
Figure 7. Bloomberg Consumer Comfort – exceeding pre-crisis highs
Figure 8. Unemployment rate – recent low of 4.4%, last seen in 2001
Figure 9. Unemployment claims – lowest since 1973
Figure 10. Margin Debt – at an all-time high of $550B, 44% above GFC peak
Figure 11. Global Junk Bond – more than doubled from GFC peak, currently at $2.5T
Source: Bloomberg, PSR
As the end of the expansionary cycle is in sight, we did a study to display some indicators to warn about the upcoming top in the US equity market. The indicators can be divided into four main categories, namely;
We believe the voluntary or involuntary spike in interest rate will ultimately be the cause for the next crisis with the consequence of global Quantitative Easing and the ongoing excessive debt binge the world has taken on due to the extended zero interest rate and negative interest rate policy around the world. Especially, when the debt level has already exceeded the pre-crisis level. It will be a similar replay of what happened during the subprime panic, but this time on a way bigger scale as the adjustment of the teaser interest rate resulted in the mass default of subprime holders and ultimately causing a carnage.