Looking at the big picture possibilities for US equities, treasury yields, & NGDP

The purpose of the following post is to pull back the lens to better think about the possible secular set ups for US equity indices, US government bond yields, & nominal GDP.  By taking the big picture into view and ignoring the daily noise, the hope is that we can more accurately contextualize the present shorter term trends.  Keep in mind, the analysis of the big picture is used to help determine whether or not the present is a good risk taking environment and shouldn't be used for short term positioning.  

Long term charts for US equity indices support a continued bias toward risk-taking.

• The chart above applies a standard 50 period relative strength index (RSI) on the quarterly price of the DJIA along with major trendlines to identify secular trend changes.
• The three green arrows on the chart mark a time when price first made a new multi-decade high after the RSI 50 quarterly moving average began sloping upwards.  By combining a new decade high along with a 50 period quarterly RSI moving average, we are better able to determine whether or not it is more likely that the breakout will morph into a long term secular uptrend.
• Interestingly enough, this method would have warned that the price behavior in 1973 & 2007 could represent a false breakout.  In each case, equity index prices needed more time to consolidate before beginning a new secular uptrend.  
• As for the current ongoing price behavior (starting somewhere in 2013-2016), it more closely resembles the early 1950s & the beginning of the 1980s.  It goes without saying that both of those major breakout periods precede secular bullish advances that lasted for multiple decades.
• Moreover, the RSI 50 moving average rolled over well before the previous major tops and violations of the secular uptrend lines (shown above).

• Whereas the quarterly DJIA chart is meant to capture potential secular shifts (decade or more), the above SPY price history uses a simple 10-month vs 20-month moving average crossover to confirm cyclical price trends.
• As monthly moving averages smooth out daily volatility, a positive cross should signal that a bullish stance is warranted whereas a negative cross is a warning to become more defensive. 
• At the start of 1995 a bullish cross fired and lasted until the very end of 2000.  This proved to be the last leg of the secular bull as shown in the first RSI chart.
• What followed was 13 years of price consolidation in US equities that featured two violent bear markets and the Global Financial Crisis. 
• Although a bullish crossover in 2009 marked the end of the big equity cyclical bear, equity indices still remained in a secular sideways corrective phase.
• The 2015-2016 risk-off phase forced investors guiding by this barometer to become defensive.  Critically, despite a very tumultuous first seven month of 2016 which rightly forced the Fed to pause, the first bullish cross within the context of the latest secular upswing occurred.  Therefore, today's intra-year price action can be described as being part of a cyclical uptrend in a possibly still very young secular bull market.

• To lend support to this thesis, the Value Line Geometric Index is incorporated to determine the market's breadth.  This tracks the median move for stocks within the NYSE on an equally weighted basis regardless of market cap size.  By treating each stock's movement equally, this index provides insight as to how many stocks are participating in the prevailing trend.
• From 1998 to 2017, the median stock movement was flat.  In other words, this marked a roughly 20 year period of zero price appreciation which is to be expected in a secular sideways consolidation.  
• Much like the first two aforementioned price charts, the Value Line Geometric Index currently supports the bullish big picture as it has finally broken above the 1998 & 2007 highs.  Should things change where the index falls back into the consolidation zone, it would then be prudent to question the current advance from this perspective.  With that said, the ongoing bullish stance will remain in place as long as the index remains above those previous cyclical highs.

• After considering the secular & cyclical price action, the relative strength of the IEF vs VIX is provided as a way of identifying the potential end to intra-year corrections/ negative extremes.  The idea being that investor will take aggressively defensive stances during acute market corrections which will cause the VIX to spike relative to the treasury bond ETF.  Seeing as both the VIX and treasury bonds have a tendency to rally during risk-off periods, when the VIX outperforms treasuries it suggests that market participants are seeking a great deal of protection.
• Importantly, this reading should only be used as a guide to help provide context to the severity and end of corrective phases.  As shown above, there have been three corrections since the GFC (2011 Eurozone Crisis, 2015-2016 China scare plus Brexit risk off phase, & this year's 7-8 month pause).
• This measure suggests that the current price action can be described as a pause in an ongoing cyclical upswing within a new secular bull market.  It is understandable that equities have consolidated for much of this year as a way of working off an overly bullish parabolic price movement that blew off at the end of January 2018.

Treasury yields, nominal GDP growth, and tight credit spreads all corroborate the optimistic story being told by US equity indices. 

The January post from earlier this year, Are the signals that usually precede cyclical downturns present today?, showed how treasury yields along with NGDP growth both tend to top out and enter downtrends months before major cyclical tops are made in US equities.  High yield bond spreads also have a tendency to widen significantly months before equities hit their final cyclical highs.  As aggregate domestic nominal spending and income growth starts to decelerate (NGDP), asset managers bid up the price of safe treasury securities relative to riskier corporate bonds.  This causes the price of the former to rise and the latter to decline which manifests itself in widening credit spreads.  The conclusion of the January 2018 post was that the price high from earlier this year was unlikely to market a significant top.  US indices have since gone on to make new all-time highs.  Are US treasury yields, NGDP growth, and credit spreads providing us with red flags as of today?

The answer is no.  The 10-year treasury yield just closed at its highs level on a monthly closing basis since 2013 while US nominal GDP growth has reached new cyclical highs following the GFC.  Credit spreads remain very tight as well.  None of this is consistent with cyclical equity market tops.  Until these leading indicators turn, positioning for more upside (potentially much more) is warranted under today's conditions.  Critically, should equities actually be in a secular bull run, treasury yields may follow higher after completing their own three decade downtrend.  That remains to be seen, but that possibility shouldn't be ignored.

Conclusion:

Given the analysis above, today's price action in US equity indices can be described as follows: new-highs after an intra-year pause that worked off overly bullish sentiment in the context of an ongoing cyclical upswing in a what could be a newly confirmed secular bull market.  This stance is supported by cyclically strong US NGDP growth, rising treasury bond yields, and tight credit spreads.  In essence, renewed economic optimism has lifted growth & inflation expectations, treasury yields, and equity prices.

Should this change, this writer would suspect that:

• NGDP growth has topped out and has entered a downtrend,
• treasury yields are declining through important support levels as growth & inflation expectations fall,
• credit spreads have started to wide significantly,
• market breadth has begun to deteriorate (Value Line Geometric Index is no longer making new highs)
• a bearish monthly moving average crossover has triggered,
• the quarterly 50 period RSI moving average has rolled over and is sloping downwards.*

As of today none of this has occurred.  The philosophy of this blog has been to react to price and economic trends and not to anticipate them.  When the above list turns negative, this writer will seek to take a defensive stance by raising stops on profitable position, immediately exiting small losing ones, and paring back on risk in general.  For now, a bias toward risk-taking is supported by the big picture view in equities, treasuries, and strengthening US nominal GDP growth.


*Even if the present secular breakout holds, there will be cyclical movements along the way.  Therefore, defensiveness on a cyclical basis would be prudent should the first five red flags listed above fire even if the RSI 50 quarterly moving average remains positive.  The different being that such a correction would be viewed as a cyclical bear market within a secular bull.

**For thoughts on EM vs DM equities please see last month's post.  In short, as long as the above bullish environment remains intact, if the USD tops out EM risk assets should start to work again and likely outperform their DM counterparts.  That remains to be seen given that the dollar has yet to even make a 3-month low and is therefore still in an intra-year uptrend.

***Here are a few brief notes on the Fed's current policy rate cycle.  As long as the Fed does not tighten more than what is being priced in by the markets and today's optimistic conditions continue to hold, then it feels much more likely that the Fed will keep doing as they have been.  Although this writer would prefer that the Fed not be in too much of a rush in order to allowing NGDP growth to press higher (run the economy hot) after a decade of anemic economic performance and below target inflation, it doesn't seem overly probable that the Fed will pause yet.