Weekly Note - December 9, 2020

Current MRI Conditions and Near-Term Outlook

Resilience is increasing in stock markets around the world. The growing resilience represents a broad shift in the long-term trend of the market.  This shift does not mean that stock market prices will only go up.  Instead, it means that recoveries from declines that do occur will rebound quickly to prior price levels. 

The market resilience index that indicates the long-term cycle of resilience – the Macro MRI - is shifting to the upleg of its cycle for many stock markets around the world.  The Macro MRI for the DJIA, for example, is shifting to the upleg of its cycle and doing so at a low level – the 30th percentile of levels since 1918.  All else equal, the Macro MRI moving higher from a low level is supportive of stock prices moving higher for several quarters. 

The Exceptional Macro MRI, which appears only infrequently and foreshadows a stronger positive Macro trend is present for many stock indexes as well.  For the twelve major stock indexes I monitor closely (e.g., DJIA, NASDAQ, US large company, US small company, emerging market, China, UK, Europe, Japan) all but two have positive Macro MRI and/or Exceptional Macro MRI present at this time.  The exceptions are Japan stocks and NASDAQ, which lack both. 

However, the Micro MRI (indicating the shortest cycle of resilience) for many indexes have been positive for a few weeks and have moved quickly to the upper ends of their normal cycles.  For the DJIA, last Friday the Micro MRI was moving higher but was at the 73rd percentile of levels since 1918. Given this high level, it is likely to move to the downleg of its cycle over the next few weeks, which would in other conditions produce price declines that we would try to avoid.  But a key point for all the stock indexes in this condition is that the resilience from the Exceptional Macro and Macro MRI typically provide ample resilience to compensate for any lack of short-term (Micro) resilience. 

Based on the MRI conditions for DJIA, the algorithms conclude that stock prices may not change much or may move higher over the next few weeks.  Declines that do occur will be recovered quickly (unless there is extremely negative news). 

These conditions are most consistent with strong market performance lasting for several quarters.  I subjectively place a 60% probability of this happening. 


High Valuations Are Likely to Get Higher

High current stock valuations could be a headwind to further price increases.  While the MRI-based investment approach does not directly consider valuation, it does measure what investors in general are perceiving as attractive investments considering a wide range of variables, including interest rates, future earnings and current valuations.  At the moment, the MRI suggest that investors in general are not highly concerned about valuation levels.  As stock prices increase, valuation measures will likely edge higher. 

See this blog post for comments about current stock valuations (it is a revised section from the “Weekly Note - November 11, 2020” blog post): https://marketresilience.blogspot.com/2020/12/research-note-stock-market-valuations.html

The 40% Chance of Vulnerability and Deep Declines in Early 2021

It is possible that this period of resilience could be cut short, for valuation or other reasons.  If it is cut short, overall market resilience could weaken as early as mid-January. I mention this timeframe because of the downleg of the Micro cycle occurring over that time – deterioration of the long-term trend is more likely to occur during this time.  At the moment, I would place a 40% chance of deep declines occurring, and this level is still high enough to be concerned with. 

If deterioration does occur over the next several weeks, I believe it will be accurately indicated by the end of the Exceptional Macro MRI.  If this does occur, I will not hesitate to suggest raising Box #2 Cash levels outside of the regular Friday trading discipline.