Are Stocks at a Peak?

A slightly pessimistic tone has developed in the markets. The geopolitical risks involving potential clashes with North Korea and Venezuela seem to have influenced markets. We also have words of caution from well-known investors about near-term market declines. Jeff Gundlach, a well-respected bond manager, has said that those holding risky bonds should start heading for the exits; he mentioned high-yield bonds and emerging market bonds. Others have echoed his comments.

This is a good time for us to assess the stock market’s ability to rebound from geopolitical shocks, its maturity, and how this bull market might proceed from here.

In a letter to clients a few weeks ago, I recommended reducing the equity exposure of their portfolios to 80% from 100% by July 28. Our research indicated that the stock market was losing resilience, and a shift in allocation was appropriate at that time.

While our portfolios became more defensive, many of our indicators suggest that the market will be able to rebound from any near-term declines that may be caused by moderate shocks. The long-term trend of the stock market is still positive. Near-term vulnerability will be replaced by higher resilience in a few weeks.

Of course, the magnitude of a geopolitical event is important ― a sizable nuclear conflict may overwhelm any inherent market resilience. Nonetheless, the market is still relatively resilient and should be able to recover quickly from market declines that fall short of that unthinkable event.

Regarding the cautious tone from well-known investors, we do not see the typical signs of the stock market reaching a peak and then experiencing protracted declines. Again, the longer-term positive trend in the DJIA is still intact.  

What History Tells Us About Market Declines

Our research on the last 100 years of stock market price movements indicates that protracted market declines are typically foreshadowed by a weakening of our proprietary Macro Resilience Index. Weakening resilience suggests greater vulnerability, and then some catalyst occurs to initiate the protracted decline. The progression from resilience to vulnerability to decline typically takes place over a period of a few quarters, giving advanced notice to reduce exposure to the stock market. This is generally true for the prominent declines of 1929, the 1970s, 2000, and 2008.  We are not yet in that type of environment.

However, the sharp decline of 1987 stands out as unusual. This decline was not foreshadowed by a smooth reduction in our long-term resilience measure. If we are indeed coming to a major decline while our long-term trend measure is still positive, it would be generally similar to 1987. Let’s take a closer look at what led up to the sharp 20% decline in August and September of 1987, exactly 30 years ago.

                                                                                                                                               

Our measure of the long-term trend (the Macro MRI) did shift to a vulnerable reading in November of 1986, almost a year prior to the decline, but it switched back to positive in May of 1987. And it made these changes after a long upward trend – almost 3 years after a decline in the Macro MRI and the stock market in late 1983 and early 1984. The Macro MRI had moved to a high level that placed it at the upper extreme of the range it has traversed over market cycles since 1918.

Today, the Macro MRI is positive, steady, and well short of its historic extremes.  Furthermore, it is moving higher in a recovery from the phantom bear market we experienced in 2015/6 ― just over a year ago.  In short, measures suggest this market is simply less mature and less extreme than the situation in 1987.

Let’s take a look at how prices actually moved in 1987 compared to today. The chart below shows the DJIA in 1987 with recent price movement as an overlay. These series start August 9^th of 1984 and 2014. 

The first thing that catches one’s eye is that the periods of strong upward movements and declines line up fairly well. Based on the apparent synchronization of peaks and troughs, one might conclude that we are on the precipice of a major decline.

However, as mentioned earlier, the level of maturity of the bull market is quite different. We estimate that our current level of maturity (corresponding to the current price level shown by the green triangle) is where it was in June of 1986 (white white), well over a year before the big decline.  We define maturity as the level of our Macro MRI, which can be thought of an indicator of investor euphoria. 

The chart above focused on price patterns, not actual returns. The chart below shows the same price movements in terms of returns.

The returns since the beginning of the chart for each time period are quite different. From August 9, 1984 to the top of the market in 1987, the DJIA rose 113%. Over the period from August 9, 2014 to August 9, 2017, it has risen 32%. The difference is big.

This information does not suggest there is no risk at this time. Thirty-two percent in today’s environment may somehow be equivalent to 113% in the 1980s environment of rapidly decreasing interest rates.  Historically, the best course of action has been to respond to the dynamics of the market as they present themselves at the time rather than to focus on repeating overall price patterns.  Our view could change in a matter of weeks should the underlying dynamics change. 

Near-term Outlook

I believe we will have a few weeks of soft prices and perhaps moderate declines. When those pass, we can expect a continuation of high resilience for stock prices.

Other Markets

Emerging market bonds, as Jeff Gundlach suggests, appear to be at an inflection point. This asset has been resilient for several quarters but is quickly shifting to being vulnerable. There is still short-term resilience, but that is likely to fade in a few weeks. Historically, this asset has not decline dramatically during the early stages of vulnerable periods.  

The SPGSCI (commodity index) is generally resilient. It has been borderline with a potential shift to vulnerable, but the shift has not taken place. Short-term resilience is developing.

Stock Market: Continued Resilience

We are approaching what appears to be a minor inflection point in the US stock market. The shortest price cycle – the Micro Market Resilience Index – is approaching a historically high level for the DJIA.

That said, my work indicates it is too soon call the end of this bull market for large US stocks. The conventional wisdom is that this bull market started in early 2009 and that it is already one of the oldest since WWII ( http://fortune.com/2017/03/09/stock-market-bull-market-longest/). The 8+ years of upward price movement places it as the second longest in the post war period.

However, my work indicates that the 2009 bull market ended in late 2014 to early 2015 (https://marketresilience.blogspot.com/2016/08/week-of-8222016-market-resilience-index.html). There was a clear bear market in terms of various resilience measures in 2015/16 but prices didn’t decline in the absence of resilience. I suspect that very low interest rates and a global effort to combat deflation were enough “good news” to prevent stock market prices from finding equilibrium at a level more consistent with their resilience levels.

Instead, the market trough was muted and the Phantom Bear Market of 2015/16 came and went and no one noticed.

Thus, the current bull market began in roughly March/April of 2016. The long term trend (Macro MRI) began moving higher at that time, well before the US presidential election in November 2016. The current bull market is therefore just over a year old. Market behavior (as measured by the various MRI) over the last year fits the image of a new bull market: very strong resilience in the first approximately twelve months, with moderate strength continuing for another few quarters.

I do not expect large price declines as we come upon the inevitable end of the positive short-term trend (of the Micro MRI). At this time, it does not appear that the declines will be like those of 2008, which dramatically marked the end of a bull market.

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Our publications use price-based algorithms to determine the "resilience" of major markets, and our model portfolios are designed to rotate among markets by favoring the resilient markets and avoiding the vulnerable. Resilience describes a market's mood and relates to general investor enthusiasm. Resilience is seen in a market's ability to recover quickly from negative news and events. Changes in resilience over time are rhythmic and we seek to identify inflection points; these are appropriate times for shifting assets among markets.

Today's Drop and Uncertainty in Washington

The news today seemed to drive the market.  Concerns about the Trump presidency and his agenda being derailed were common topics in the press.  The Focused 15 Investing approach is based on systematic assessments of the market’s resilience, not on forecasts of a particular outcome of current events.  That said, in the past, I have indicated when I believe the market will recover quickly from bad news or simply move higher.  Three recent prominent events are interesting because they occurred at the naturally occurring low points of the Micro Market Resilience Index (MRI).  They are the Brexit referendum in June 2016, the US presidential election in November 2016, and today’s recent sell-off being associated in the press with the Trump/Comey events. 

The following chart shows the DJIA, the Macro and Micro MRI, and the timing of these events.  One can see that these events correspond to low points in the Micro MRI.  The current level is at about the 12^th percentile of the weekly levels since 1918.  Eighty-eight percent of the weeks since that time have had higher levels. 

  

                                                                                                                                             

This chart is interesting because it shows how the slope of the Macro determines how prices will move on the down-leg of the Micro MRI cycle.  When the Macro slope is clearly negative, as it was in September 2015 and February 2016, the price declines were pronounced.  When the Micro had similar down legs and the slope of the Macro was positive, the price declines were less dramatic as seen in May 2016, September 2016, and January 2017.  

This pattern is what we expect from the market when viewed through the MRI lens.  Thus, I expect the market to recover from the recent events, consistent with the positive sloping Macro MRI and the higher Micro MRI levels.   

The chart also shows that the Macro MRI is at a relatively high level.  The top of this cycle may be moving into a mid-term time frame, perhaps later this year.  

The Market Will Hold On to Gains

The US stock market (as measured by the DJ Industrial Avg.) will most likely hold on to the gains of the last few days. Last week, I wrote in a letter to clients that the market is likely to move sharply higher. This appears to be taking place. The mood of the market is shifting to a more resilient stance, and this is likely to last for several more weeks.

With all due respect to France and the French vote, the rebound we are seeing is tied more to rhythmic changes in market resilience than to the French election. The outcome of the French vote may be a catalyst, but the conditions were in place for a catalyst to have a positive effect.

As of last Friday (April 21, 2017), the shorter-term resilience level was notably low. Last week’s level, as measured by our Micro Market Resilience Index (MRI), was lower than 93% of the weeks since 1918. Assuming simply a reversion to the mean, one could expect Micro resilience to start moving higher.  

As the Micro MRI turns positive, it will join the currently positive long-term resilience trend, which we measure with the Macro MRI. The Macro MRI measures resilience trends lasting many quarters. The current Macro trend is positive and has been since mid-2016, even as we move through multiple Micro cycles. The positive combination of Micro and Macro MRI suggests that the market will hold on and even add to recent gains over the next several weeks. Higher resilience often leads to higher prices. 

It is appropriate to remain fully invested in stocks. 

A February Trump Dip?

US large cap stocks will continue to be only somewhat resilient over the next few weeks. Stock prices will be choppy and may, as I mentioned in a prior comment, experience abrupt declines within a longer-term trend of higher resilience and likely higher prices. Longer-term investors may not be able to take advantage of any declines, while investors willing to trade frequently may be able to benefit from the short-term market moves.

The most interesting upcoming dynamic right now appears to be in the bond markets. I expect the resilience of the 30-year Treasury bond future (US1) to decline more dramatically in the next few weeks. With less resilience, prices are likely to move lower. The same is likely to be true for the 10-year Treasury bond future (TY1).

Trump Rally – Not Accurate

The recent stock market rally has been called a Trump Rally. However, based on the shifts in market resilience that I measure, this is not accurate. We are still experiencing trends in major markets established before the US presidential election. The Market Resilience Index (MRI) ratings are completely systematic and don’t assess political events directly. The MRI ratings anticipated a rally before the election, when many were expecting a Clinton victory.

For the most part, prices are moving in line with their levels of resilience. US large cap stocks are continuing a trend toward higher resilience that began in early 2016. The price movements since then have been consistent with a rhythmic shift of resilience on an upward trend. In addition, the market does not appear overly euphoric.

A shift in resilience that began in late September 2016 favoring inflation-linked bonds over nominal bonds (globally) is continuing. Price movements since then have been consistent with the rhythmic shifts expected of the higher relative resilience of inflation-linked bonds.

The 30y Treasury bond reached peak resilience in early July 2016. The 10y Treasury bond reached peak resilience in late August 2016. The price movements since those times have been consistent with the rhythmic decreasing levels of resilience for both markets.

It is not appropriate to link the rally directly to Trump, and it is not appropriate to link the current choppy stock market to him either. Had Clinton been elected, we would be experiencing a similar pattern. The magnitudes might have been different between the two, but the timing would have been similar.

Therefore… Not a Trump Dip

Based on market resilience, the stock market is more vulnerable now and will react more harshly to negative news than it would have 6 or 8 weeks ago. If the market drops over the next four to six weeks, and it appears to be correlated with something Trump does or says, be skeptical — it is not a Trump dip or a market verdict on the news of the day. When the market rebounds a few weeks later, be skeptical of pundits who say that some course has been corrected.

Of course, the market will sell off on calamitous events like earthquakes, some political events, surprise actions by the Fed, and other shocks. However, movement that is often attributed to news events is more a function of changing market resilience than the news itself.

January 2017: A Minor Inflection Point

Please see the links above and to the right for information on the MRI ratings and Focused 15 Investing.  

US large cap industrial stocks shifted this week to somewhat resilient, a market resilience index (MRI) rating of 2 on a scale of 0 to 3, with 3 being most resilient. Risk assets in general have been resilient (MRI rating of 3) since before the November election and this represents a minor inflection point. The decrease in resilience may result in temporarily lower prices for these assets, but the declines are unlikely to last long enough to for investors to trade them. Price could well be higher several weeks from now.

While these comments are specific to US large cap industrial stocks, other major stock markets are in a similar circumstance with respect to resilience. These comments also apply to US transportation stocks, Japan stocks, and Europe stocks.

Other markets are still rated highly resilient (MRI rating of 3). These include NASDAQ, UK stocks, US small cap stocks, and emerging market stocks. These markets are more resilient but may be affected by the choppiness of the markets mentioned above.

Yields on the US 10 year bond have been resilient (MRI rating of 3) for the last several weeks. The rating dropped to 2 this week — also a minor inflection point. The mid- and longer-term measures of resilience for the 10y yield are still positive. Yields may decline over the next six to twelve weeks, but the trend toward higher yields appears intact at this time.

Bond prices are correspondingly more resilient over the short term.  However, the longer-term trend toward lower bond prices appears intact.

Gold is somewhat vulnerable. It moved last week to a MRI rating of 1, up from 0. There may be some recovery in Gold prices, but the mid-term outlook continues to be weak.

Beginning, Middle, or End of Rally?

Based on prices as of December 9, 2016; views effective December 19, 2016

The most recent rally began (using our methodology) on November 7, one day before the election. Our report was published November 1, at a time when many thought that Clinton would surely win the Electoral College tally. I believe we would be having a rally now if Clinton had won. The Focused 15 Investing approach emphasizes anticipating the direction and timing of market moves based on market resilience. We do not try to anticipate magnitude, except to suggest that moves will be either small (and maybe not worth trying to catch) or large. The magnitude of this rally has been large, but we don’t know what it would have been if the election had a different outcome.

We are just over one month into this rally, and the question is: Are we closer to its beginning, its middle, or its end? 

Let’s first look at the magnitude of the returns. The chart below shows the price moves of the DJIA since 2000. The recent pop in prices is seen at the far right. It looks large compared to what has happened since 2000, but not completely unprecedented. There was a roughly 10% increase in prices from November 4^th through December 9^th. 

Yes, prices have increased dramatically over the last month, and they are at an all-time high, but those reasons alone are not sufficient cause to take money out of the stock market. The chart below is also for the DJIA and covers the same time period. However, it is on a log scale, which means that a move up or down of a given length (visually on the chart) equals the same percentage point shift regardless of the starting point of the move. This has the effect of reducing the apparent size of the recent run up compared to prior price movements. The recent shift is dramatic, but not unusual in percentage point terms. 

As prices move higher, greater price moves are needed to achieve the same percentage point move. This is why Focused 15 Investing publications favor using a log scale over multi-year periods.

Thus, the recent price movement is not unusual in percentage terms. Prices being at an all time high should also be ruled out as a reason to get out of the market. Economic growth continues (even if the rate is slow) and inflation boosts price levels over time. These forces have been present for decades and continue to push market price levels higher. 

Focus on Resilience

At the moment, the US stock market is resilient and likely to remain so for the foreseeable future. It is rated 2 out of a possible 3. This means that two of the three Market Resilience Indexes (MRI) are positive. While the next 4 to 5 weeks may not be like the last (returning about 10% on the DJIA), resilience is sufficient to limit the likelihood of a deep and/or protracted decline over the next several weeks.

After the first of the year, we may see larger declines that could alarm some market observers. It appears, however, that any decline will be short-lived given the strength of current resilience. The Focused 15 Investing model portfolios may become more defensive just prior to that time, but for now, the model portfolios are fully invested. Our assessment for January will take place at the end of December.

As my regular readers know, we invest on the basis of market resilience – not forecasting future events. When negative events happen in a resilient market, losses may occur, but they tend to be recovered quickly. Negative events happening in a vulnerable market tend to result in longer-lasting declines, which may induce panic selling leading to greater losses. For now, the US stock market appears to be resilient and able to recover from negative news and events. Stay invested for now. 

Bonds

The US 10y Bond continues to be vulnerable to declines. Going forward (over the next roughly 6 weeks), declines are likely to be less severe than the recent drop. However, this is now an inherently vulnerable market and should be avoided. Focused 15 Investing model portfolios have little or no exposure to US 10y bonds. The US 30y is also vulnerable overall but is now developing some resilience, at least over the short term. 

Commodities

Oil and copper have been resilient for several weeks, and this condition is likely to continue for at least a few more weeks. Gold has been vulnerable since October 7, 2016, and this condition is likely to continue for several weeks.

Currencies

The Dollar (DXY) shifted from vulnerable to resilient on December 12^th.  Strength in the dollar could undercut the rally in US stocks; the greater resilience of the dollar could be foreshadowing an erosion of resilience in the US stock market. 

2015/6 Phantom Bear Market

Recent market action reinforces my view that in March 2016 we bounced off the trough of a phantom bear market that took place largely in 2015. It was clear that resilience levels experienced a bear market. However, probably because of monetary policies, US stock prices did not.

The bounce after the phantom market trough was anemic. During this period, we had rally-like MRI levels but not rally-like price behavior. I described those months in a commentary as a mid-2016 malaise. 

The dramatic returns over the last month may simply be the market catching up to roughly where it might have been based on its own inherent resilience, regardless of whether Trump or Clinton won.

Somewhere Between the Beginning and Middle

It could be that we are in a bull market that is almost a year old. Based on 100 years of market history, we can see that bull markets don’t live indefinitely, but they can last several years. If we indeed experienced a phantom bear market, we are now in the early years of a new bull market. Given the phantom bear market and the mid-2016 malaise, this bull market could be shorter than usual. We will only know for sure after the fact, and as long as the current MRI ratings register “resilient,” we would invest that way.

Presidents and Market Impact; Remain Dispassionate

Of course, who the president is and what they accomplish does have an impact on economic growth and stock market performance. Also, markets anticipate possible events well into the future. Perhaps the pro-business policies of a Trump administration will boost corporate earnings.

Nevertheless, it is important to be dispassionate about politics. If resilience levels change, we will change portfolio exposures regardless of views we might hold about current political circumstances.

Jeff Hansen

For more information about Focused 15 Investing and the performance of the approach, please see the website Home Page tab above.  

Trump Rally or Catch-up Rally?

Based on prices as of November 11, 2016; views effective November 21, 2016

The press has been talking about a Trump stock market rally. Trump’s election roughly coincided with the beginning of sharp increase in stock prices over the last week. Is this really a Trump rally? Or was Trump’s victory associated with a move that would have taken place anyway?

According to the Market Resilience Indexes (MRI) developed by Focused 15 Investing, the stock market’s inherent resilience started to move higher a week before the election, as published on Nov 1. The markets moved up, as anticipated, beginning Monday, Nov 7, the day before the election. Monday’s price move coincided with polls suggesting Clinton was ahead. The rally continued through the rest of the week after Trump won the necessary electoral votes. It has been a catch-up rally.

The appropriate way to think of the last couple of months is that prices were abnormally depressed prior to the election. On the 7^th, the depression began to ease.

Recent Malaise

Over the last few months, the bounce off the March trough of the phantom bear market has been weak. We had rally-like MRI levels and behavior… but not rally-like price behavior. In past commentaries, I described the last few months as a malaise and an anemic rally. This weakness may have been the result of some or all of these factors:

1. The fact that the phantom bear market did not produce price declines in the US, and there was no capitulation, which meant there was no real bear market and therefore no reason to rally
2. The fear that our last remaining monetary tools were not boosting growth
3. The global markets were struggling to come to terms with the massive decline in oil prices and what that meant for global growth (and its subcomponent, struggling to assess the impact of the Saudis’ focus on market share rather than price)
4. Concern about US election uncertainty

Last week’s move caught the market up to roughly where it should have been based on its own inherent resilience, regardless of whether Trump or Clinton won. The catalyst was a natural inflection point in market resilience. It does not appear to be a market verdict on the US election.

A possible qualitative rationale is that both candidates would likely increase spending on infrastructure, taking heed of suggestions by economists and the central banks. The prospect of moving forward on spending and infrastructure programs and having the election behind us may have been a relief.

If we accept that we have had a catch-up rally, we gain some perspective on the near-term future. Going forward, the current situation suggests that prices still have an upside. The Micro MRIs, those with a 6 to 12 week horizon, for most equity markets are still clearly positive and are likely to be for several weeks. Thus, we are still early in the rising trend. Continued exposure to the US stock market is appropriate.

How About a Price Reversal?

After a period of strong returns, the market sometimes experiences losses. The Dow Jones industrial average was up about 5% election week. This return is abnormally high for a one-week time period. The idea of a reversal suggests that the market has moved too far and overshot the “appropriate” price level. Prices may fall back to where they started, or even further.

We evaluated over 100 years of market history for the DJIA and almost that for the S&P, plus the full histories of the TOPIX (Japanese Stocks) and Russell 2000 to determine the circumstances when price reversals typically occur. It turns out that some markets do experience price reversals that can be predicted systematically. However, the current situation does not appear to be one of the classic situations where a price reversal typically occurs.

Price declines can certainly happen over the next few weeks, but they are likely to be mild and/or short-lived. Further increases in resilience should ultimately lead to stronger support for stock prices. The best strategy at this time is to hold tight. Accordingly, the Focused 15 Investing portfolios have had relatively high allocations to their stock ETFs prior to the election, and this will continue.

Bond yields (10y) continue to have positive Micro and Exceptional Macro MRI ratings — suggesting higher rates. However, the Macro for the 10y bond is still stubbornly negative, suggesting that a longer-term trend for higher rates has not started. Short term, however, markets will fear rising rates. 

Election Week Update

The philosophy of Focused 15 Investing is to make bets based on the resilience of the markets rather than on the outcome of future events. Resilience is easier to measure and evaluate systematically than varied future events. This week’s presidential election is a prime example of how that philosophy can play out. Many investment strategists expected the markets to decline after a Trump victory (and to rise after a Clinton victory). My work suggested markets would trend higher regardless of the winner. On November 2, I wrote:

For the week of November 7, US stocks have a resilience rating of 2, up from 1 the prior week. This higher rating is because the Micro Market Resilience Index MRI has turned positive and is now gaining strength. This is an important shift and could lead to higher prices, barring strongly negative news or events. 

The effective date for this rating is 11/7/2016. The US presidential election will be held the following day. Resilience will be higher that week regardless of which candidate wins. Some observers will say that the markets are rendering a verdict on the winner, but my statistics suggest that it is simply the beginning of a normal short cyclical move providing support for higher prices.

Since the market’s close last Friday, the Dow Jones Industrial Average is up about 4%. I believe that I would be saying essentially the same thing if Clinton had won. The magnitude might be more or less, but I believe it would still be positive.

Looking forward, the market may decline and give back some of these gains. However, the positive trend is likely to continue. Many of the major stock markets around the world are experiencing greater resilience, not just the US markets. This also would have taken place in the short term, even if Clinton had won.

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Overview of market resilience ratings for stock, bond and commodity markets for the next few weeks. #marketResilienceIndexes #marketOutlook #InvestmentResearch 

Week of 11/7/2016 - Market Resilience Index Ratings

Week of 11/7/2016 – Market Resilience Index Ratings

Both the US stock and bond markets have been through a period of heightened vulnerability over the last several weeks. For the week of November 7, US stocks have a resilience rating of 2, up from 1 the prior week. This higher rating is because the Micro Market Resilience Index MRI has turned positive and is now gaining strength. This is an important shift and could lead to higher prices, barring strongly negative news or events.

The effective date for this rating is 11/7/2016. The US presidential election will be held the following day. Resilience will be higher that week regardless of which candidate wins. Some observers will say that the markets are rendering a verdict on the winner, but my statistics suggest that it is simply the beginning of a normal short cyclical move providing support for higher prices. Of the 5000+ weeks since 1919, 87% had a higher Micro Resilience level than last week’s level, which means it is currently near the lower extreme. Since the Micro MRI is particularly rhythmic in its movement up and down, it is a good bet that it will move higher over the next several weeks and provide support for prices.

Should the stock market decline after the election, possibly in reaction to the winner, the decline is likely to be short-lived. There will likely be a rebound, and "market concerns" will seem to pass quickly. Coincidentally, the level of the Micro MRI now is very similar to its level at the time of the Brexit vote. After Brexit, there was a decline in the US stock market and then a meaningful recovery.

In an earlier market (link) overview, I mentioned that the period of March 2015 through January 2016 was a bear market in terms of MRI levels, but one that failed to produce large-scale declines, panic or capitulation. As 2016 has progressed, the resilience measures indicate that we are rebounding off the bottom of our phantom bear market. However, that rebound is not as strong as is typically the case just after bear markets that are expressed as major price declines. This mid-term malaise is detectable in the US stock market’s MRI levels and is evident by the current lack of the Exceptional Macro MRI. In a typical rebound, the Exceptional Macro MRI persists for several quarters. In this one, it lasted just a few months.

The anemic rebound may be a reflection of concerns about global growth, US election uncertainty, and conflicts in the Middle East. Thus, while we can expect higher stock market resilience (which supports higher prices) through the end of the year, the New Year could bring a change in the overall character of the market.

Global Stocks

The European stock market has a rating of 1, unchanged from last week. Out of the major equity markets, this one shows most stress. Its positive Exceptional Macro Resilience MRI has failed to result in a positive Macro MRI, which would be expected over the next few weeks.

The Japanese and Chinese (Shanghai Composite) stock markets are beginning to show more resilience, with ratings of 2. Emerging Market stocks continue to be resilient (rating 3).

The global stock as a whole appears more resilient. The rating of the MSCI World stock market index is 2. I believe that rating will increase to 3 over the next few weeks.

I analyzed the relative resilience between Contrarian mutual funds (funds that buy low quality company stocks) and Quality Growth stock mutual funds. Over recent months, the low quality stocks have been favored over high quality stocks. It appears that this will continue for the next several weeks, and may even be more pronounced.

Commodities

Commodities in general continue to be resilient, with the exception of Gold. Its resilience is deteriorating. Gold has declined in price recently and there may be a temporary stabilization of Gold prices. Mid- and longer-term, however, it appears that its resilience will be weak. It is currently rated 1.

Crude Oil is currently rated 3, the highest resilience rating. I expect it to drop to 2 in the next few weeks. Price increases may not occur or may be more muted at that time. At the moment, the Macro and Exceptional Macro MRIs are positive and strongly so.

Bonds

Resilience in bond markets in general is deteriorating. For example, the US High Yield bonds market is rated 2, down from 3 the prior week.

Finally, global inflation-linked bonds are more resilient than global bonds. This reflects heightened inflation concerns. Based on the MRI ratings, I expect inflation-linked bonds to continue to be favored for the next several quarters. Of course, a shift toward higher inflation has been expected for some time, and there have been several false starts over the last three years.

Week of 10/17/2016 - Market Resilience Index Ratings

Week of 10/17/2016 – Market Resilience Index Ratings

Both the US stock and bond markets have been through a period of heightened vulnerability over the last several weeks.  As expected, bonds (as measured by TY1) moved to a higher rating this week.

The tables below show the Market Resilience Index Ratings for both US 10y bonds and US stocks. The first table and chart focus on US 10y bonds (TY1). The ratings have indicated low resilience (meaning moderate vulnerability) for the last several weeks.

Trade Date	8/12/2016	8/19/2016	8/26/2016	9/2/2016	9/9/2016	9/16/2016	9/23/2016	9/30/2016	10/7/2016	10/14/2016
Bond Market Rating (TY1)	2	2	2	1	1	1	1	1	1*	2

                * Likely to move to a rating of 2 over next few weeks.

The recent price movements have not been large, but there is some indication that prices have moved according to the resilience measures.  The screenshot below shows the price of TY1 along with two vertical lines. The first line (white) shows when the rating dropped to 2 from 3, effective 7/14/2016. This indicates that high resilience had peaked. One can see that the prices peaked just before that date. The second vertical line (red) shows when the rating dropped to 1 from 2, effective 9/2/2016. One can see that prices softened after that time. The minimum rating is 0, so there was still some resilience for bond prices. The current reading, effective this Friday 10/14/2016, indicates stronger support for bond prices.   Thus, bond prices are likely to stabilize over the next few weeks and could even move higher.

US stocks, as measured by the Dow Jones Industrial Average, currently have a rating of 1 and may soon move to a rating of 2.  While an upgrade has not happened yet, I expect it to take place within a few weeks. Of the 5000+ weeks since 1919, 84% of them have had Micro MRI levels higher than the current reading.  This suggests that we are closer to the beginning of a strengthening of prices than to additional price declines because of a lack of resilience. However, the resilience reading is still low so there may be some near term declines.  

Between now and that shift, we may have some price dips that represent global stresses, but the duration of the dips is likely to be short given that we see some modest level of resilience in a number of equity markets globally.  These stock markets are rated 2 (moderately resilient) or 3 (resilient) for this week: MSCI World, DJ Transports, NASDAQ, Russell 2000, UK Stocks, Emerging Market stocks. These observations suggest that, barring major negative news or events, US stock prices can reach new highs over the next month or so.

Commodities have the highest resilience of the major asset classes right now.

The S&P Goldman Sachs Commodity Index represents a basket of commodities with a high weighting in crude oil. Crude oil (not shown in graphic) continues to have a rating of 3. Please note that crude is a volatile asset and can differ meaningfully week to week from the MRI ratings. Over long periods of time, however, the ratings result in profitable trades.

Gold has a rating of 2, moderately resilient. There may be near-term price softness, but the Macro and Exceptional Macro MRI continue to be positive, and prices are likely to be more resilient mid-to-longer term.

There are changes this week for currencies. The GBPUSD has a new rating of 1, which means there is even less support for the GBP. It has already fallen in response to Brexit concerns. The recent shift in vulnerability suggests that value may continue to weaken; buying GBP right now is likely to be premature.

The dollar index (DXY) has moved to 1 from 0, meaning that it now has some resilience, although it is still at a very low level.

Overview of market resilience ratings for stock, bond and commodity markets. #marketResilienceIndexes #marketOutlook #InvestmentResearch 

Week of 10/10/2016 - Market Resilience Index Ratings

Week of 10/10/2016 – Market Resilience Index Ratings

Both the US stock and bond markets have been through a period of slightly heightened vulnerability over the last several weeks. Over the next few weeks, I expect both markets to be able to support higher prices, with bonds likely to move higher sooner.

This note is a follow-up to the post for the week of 9/19/2016. The table below shows the Market Resilience Index Ratings for both US 10y bonds and US stocks and adds the three most recent weeks. The ratings have indicated low resilience (meaning moderate vulnerability). Compared to earlier periods, the recent price movements have not been great, but there is some indication that prices have been affected by the vulnerability. The first table and chart focus on US 10y bond (I analyze the bond futures TY1 in this case). 

Trade Date	8/5/2016	8/12/2016	8/19/2016	8/26/2016	9/2/2016	9/9/2016	9/16/2016	9/23/2016	9/30/2016	10/7/2016
Bond Market Rating (TY1)	2	2	2	2	1	1	1	1	1	1*

                * Likely to move to a rating of 2 over next few weeks.

The screen shot below shows the price to TY1 and two vertical lines. The first line (white) shows when the rating shifted to 2 from 3, effective 7/14/2016. This indicates that high resilience had peaked. One can see that the prices peaked just before that date. The second vertical line (red) shows when the rating shifted to 1 from 2, effective 9/2/2016. One can see that prices softened after that time. The minimum rating is 0, so the was still some resilience for bond prices. An important point is that from this point forward, it appears that the rating will increase. Bond prices are likely to stabilize over the next few weeks and could even move higher.

US stocks, as measured by the Dow Jones Industrial Average, currently have a rating of 1 and may soon move to a rating of 2.

Trade Date	8/5/2016	8/12/2016	8/19/2016	8/26/2016	9/2/2016	9/9/2016	9/16/2016	9/23/2016	9/30/2016	10/7/2016
DJ Industrial Average	3	3	3	2	2	2	1	1	1	1*

              * Likely to move to a rating of 2 over next few weeks.

The chart below shows the recent rating shifts for the DJIA. The green line shows the shift to 2 from 3, effective 8/16/2016, an indication that resilience had peaked. This was a good marker of the recent price action. The yellow line shows the rating shift to 1 from 2, effective 9/16/2016. This appears to be a less meaningful shift in terms of price action.

A key point is that prices have not declined meaningfully during this period of increased vulnerability, and there are signs (finer signals than described here) that the period of vulnerability will dissipate over the next few weeks.

Going forward, I do expect an upgrading of the resilience of the DJIA. While it has not happened yet,  I expect it to take place within a few weeks. Between now and that shift, we may have some price dips that represent global stresses, but the duration of the dips is likely to be short given that we see some modest level of resilience in a number of equity markets globally. 

These stock markets are rated 2 (moderately resilient) or 3 (resilient) for this week: MSCI World, DJ Transports, NASDAQ, Russell 2000, UK Stocks, Europe Stocks, Emerging Market stocks.

In total, these observations suggest that, barring major negative news or events, US stock prices can reach new highs over the next month or so.

Commodities have the highest resilience of the major asset classes right now.

The S&P Goldman Sachs Commodity Index represents a basket of commodities, with a high weighting in crude oil. Crude oil (not shown in graphic) continues to have a rating of 3. Please note that crude is a volatile asset and can differ meaningfully week to week from the MRI ratings. Over long periods of time, however, the ratings result in profitable trades.

Gold has a rating of 2, moderately resilient. There may be near-term price softness, but the Macro and Exceptional Macro MRI continue to be positive, and prices are likely to be resilient mid-to-longer term.

While much of the world is seeing growing resilience, the situation for Japan-based investors is different. The USDJPY spot rate is vulnerable to lower values, which means a stronger yen. This puts downward pressure on the returns from non-yen investments, such as sovereign bonds excluding Japan (WGBIxJ) and on the earnings of Japan’s export sensitive stocks (TPX). Both of these have new ratings of 0 this week.

The yen is likely to see additional strength. Historically, a strengthening yen has been an indicator of global economic and financial stress. Higher bond prices in the US are also an indicator of stress. These are warning signs and would challenge the resilience we are seeing in the seven stock market indexes mentioned above.

The DJIA's current rating of 1 (moderate vulnerability) is consistent with the signs of stress found in the strengthening yen and potentially higher bond prices. On balance, however, given the signs of resilience most major equity markets, I believe the stock markets will avoid major declines like those we saw in the summer of 2015 and early 2016, even if the upcoming US election and other political issues may test what resilience is found in these stock markets.