If the market falls

New highs next?

Subject:	Is the correction over at the August lows or not?
Last updated:	25.12.2015

H1	The rally from the low on Septemper 29 is the beginning of a new move to new highs.
H2	A new leg down will start soon.

Evidence	H1	H2	Comments
E1 - NYHL is showing some strength.	+	+	There is not enough strength to invalidate H2.
E2 - Short term macro indicators look ready to bounce.	+	+	This does not invalidate any of the hypothesis.
E3 - TRIN 13dma has shown some weakness  on the latest rally.	+	+	Anything can happen given the TRIN at these levels.
E4 - Everybody seems to be bearish, expecting a bigger correction, me included. (Jeffrey Saut said it after discussing with many fund managers).	+	-0.50
E5 - The November rally has been an opportunity for participants to exit massively from US equity funds.	-0.50	+	A first month of massive redemptions seems to have followed previous bigger corrections.
E6 - Indicators of breadth have been very weak. For example 22d adv. It has gotten oversold only on the consolidation in December.	-0.25	+	This could be just a measure of the extreme bearishness.
E7 - Valuation looks high. Profits are at extremes and they could start to fall, especially if the slowdown in the % yoy rate of GDP continues.	-0.50	+	This looks like a strong argument against new highs but valuation is always hard to time.
E8 - The LT trend has been higher and has not been broken. The correction can be enough (12-13%) in an ongoing secular bull.	+	-0.25	Another leg down would break the rising trend but not decisively.
E9 - The Fed has started to hike rates.	+	+	The hike could bring some turbulence but in previous hiking cycles,  equities have been higher after some time from the first hike.
Total:	-1.25	-0.75

Conclusion:

H2 is winning.  A new leg down will start soon. This conclusion neglects the signal given by the generalized bearishness, but this could be ok because weak sentiment is sometimes leading and, also, if the new leg down is short, the bearishness could be exacerbated, producing a very good buying opportunity. The main evidence that made H2 a winner are the massive exits from mutual funds and valuation. Are they reliable enough? I think so. Note that classical indicators (like breadth, momentum are not useful - they will only signal an entry point)

Falling Retail Sales and Falling Inflation

The series for Real Retail Sales shows a visible drop in the rate of growth, the kind that can be associated with a peaking business cycle, while Core CPI is resuming its downward trend, something that could suggest longer term structural weakness or just that the business cycle peak is farther away into the future.

Since the QE does not end until September given a $10bn tapering pace, the stock market seems to have enough time to complete another bull leg with 1900 - 1950 or even 2000 as possible target.

Weakness becomes visible

The big plunge in the New Orders Index comes as a a surprise, but weakness was expected.

The NFP report confirmed the slowdown with a visible fall in the number of average weekly hours worked for January. This is a leading indicator, so if it does not bounce back soon enough, the headline NFP number should continue to be on the weaker side.

GDP, Durable Goods and the Correction

Good Q4 GDP report with the consumption of Durable Goods still at respectable levels of growth but slowing down. In fact the annual rate of growth for December is significantly lower than the quarterly average. The behavior during the previous expansion suggests rates of growth will slowdown further.

Meanwhile, the stock market seems to have started an intermediate term correction (7-10%). The tapering is finally weighing in. Longer term support is at 1700 SPX:

Retail Sales, CPI and the Taper

Real retail sales kept growing at a good pace in Q4, while the available data on Durable Goods (October and November) suggests a slight slowdown but still a healthy pace. No wonder y/y growth in GDP is accelerating.

Meanwhile the slowdown in Core CPI has stopped but no clear turn to the upside is visible yet.

With economic activity still strong and CPI seemingly stabilizing, the Fed can still find excuses to continue tapering.

Employment - further slowdown expected

Further slowdown expected for the pace of growth in employment.