Markets are commonly understood to be leading indicators of economic activity, despite the fact that most investment manager’s reports to their investors focus on how actual economic developments have caused market movements. Market prospects are not divined from economic developments; rather economic prospects are more likely to be divined from market developments.
A bear market, or at best a long sideways correction, has begun
US Interest Rates
Ever since quantitative easing came to an end twelve months ago, the market expectation for the date of the first increase in the Federal Reserve base interest rate has been six months into the future. This has reflected the Fed’s professed data-dependency, the market’s perpetual optimism that the US economy has always been about to accelerate but also the steady stream of slightly disappointing economic news. Until August’s market turmoil, the market, aided by strong hints from Janet Yellen, had priced in a first rate hike by now, but current expectations are once again for a hike in about six months’ time.
US High Yield Bonds
The US high yield market peaked in May 2014. The most damage over the ensuing eighteen months has been in the energy sector, where much of the financing of the investment in the US shale oil fields was from the high yield market. However yields have also been rising across the rest of the high yield market for those 18 months.
This reflects economic growth disappointing expectations over that period, and the fact that in order to meet analysts’ earnings per share expectations, companies have accelerated their share buybacks, and funded this through corporate debt issues. The high yield market has thus been signalling deteriorating creditworthiness amongst US companies, which is typically a leading indicator of an equity market top and economic downturn.
US Equities
Through 2015 the US equity fund sector has lost the momentum that had sustained its long bull move since March 2009. The S&P 500 gained over 200% in this period, but has since trading sideways and in August it broke the uptrends from both the 2009 and 2011 lows. This fading price momentum was also accompanied by deteriorating breadth as fewer and fewer stocks made new highs as market leadership became concentrated in a few key technology and biotechnology names, and market volumes disappointed.
These internal market signals, are very typical leading indicators of a developing market top, and the August breakdown below 2,080 was a market statement that the bull market since 2009 was complete and a bear market, or at best a long sideways correction, had begun.
In addition the daily market action of the last two years suggested a market that was valuation-driven as long as QE was still on the table, rather than a market led by stronger corporate performance. The market tended to rise on weak economic data, since it implied an easier monetary policy for longer, and tended to fall on strong economic data, implying a nearer, tighter monetary policy.
