The breakout
The S&P 500 (SP500) is in breakout mode. After about two weeks of a narrow range, the S&P500 has been breaking out to new all-time highs over the last two days.
The breakout could continue. However, this is likely the last hurrah for the bull market, as I will explain in this article, before the recessionary bear market commences, and the bubble burst on the Index level.
Specifically, the US economy is likely already in a recession, as the current data shows. However, the S&P500 is still pushing higher and ignoring the economic data, led by very few mega-cap stocks, which actually take turns in spiking.
As I already explained, the current stock market dynamic is full of “smokes and mirrors” or distractions, which mask the real activity – which a selling in advance of the recessionary bear market.
Investors who get caught in the euphoria associated with the major tops could repeat the same mistake that investors made in 20000 and 2008 – see that paper gains evaporate and possibly turn into realized losses.
The recession
First, let’s look at the most recent data, which actually shows that the US economy could already be in a recession.
- Initial claims for unemployment
Here is the chart of the 4-week average initial claims for unemployment. This is used as one of the leading indicators by the Conference Board, which calls the turns in the business cycle. This is a leading indicator because it’s released weekly, and shows the actual number of people that apply for unemployment benefits – these are people who just lost their jobs.
Usually, when the weekly initial claims for unemployment increase 20-30% above the cyclical low point, the US economy is entering a recession. For the current cycle, that is the 240-260K level. We are currently right at the bottom of that recessionary range. The chart below shows that initial claims have been in an uptrend since May 4th,which signals that the economy has been deteriorating over the last 2 months, and it’s right at the recessionary level.
- The continuous claims for unemployment insurance
But the chart above also shows that we had the similar spikes in the initial claims in January 2022 and July/August 2023, and in both cases, the initial claims fell back to the low levels at around 200K – the recession was avoided, and it was a false signal.
The continuous claims for unemployment explain the situation – this datapoint counts the “number of unemployed and currently receiving unemployment benefits who filed for unemployment benefits at least two weeks ago.” In other words, it indicates how long it takes to find a new job.
In January 2022, the continuous claims were falling as the labor demand increased following the covid reopening – obviously this was not a recession, thus the initial claims decreased. In summer of 2023, the initial claims spiked, but the continuous claims were very low, meaning the unemployed people were able to quickly find a new job – thus this was not a recession either.
Now, the initial claims are spiking, but also the continuous claims are spiking at an already high level, as the chart below shows. Thus, the people are losing their jobs, and staying unemployed for much longer. This is recessionary.
We know that the manufacturing sector has been in contraction for a long time. However, as long as the service sector continues to grow, the US economy remains insulated from a recession – given that services account for 70% of US GDP.
The ISM Services PMI just dropped to 48.8, well below expectations, and in a contraction (sub-50). Here is the long-term chart of ISM Services PMI – it only goes below 50 if the US economy is in a recession, 2000, 2008, 2020, no false signals here. We are sub 50 now, as of June data release.
The chart below also shows that ISM Services PMI number has been in a downtrend, and it was bordering the 50 level for some-time now, actually dropping below 50 in April 2023 – so we have been bordering a recession since December 2022.
However, the Conference Board is using the ISM Service new orders as the leading indicator, and the ISM Services new orders just collapsed to 47.3, that’s deep drop in the recessionary territory, based on historical evidence.
So, these are the facts, and not an opinion. Taken together, 1) initial claims are spiking, 2) the continuous claims are spiking, 3) the ISM services is in contraction, and 4) the ISM services new orders are collapsing. Historically, this happens in a recession.
What’s moving the stock market?
While S&P 500 (SPY) is up by 16% YTD, the Russell 2000 (IWM) is flat at 0% YTD. Thus, nobody is really betting on a strong economy and cyclical stock like the small-caps.
Investors are chasing few mega-caps, related to the Gen AI bubble, and possibly to the weight loss drugs. Given the relative importance of these few stocks, the broad index such as the S&P500 is rising. This is actually consistent with the recessionary scenario, the cyclical stocks are underperforming, while the bubble rages in few stocks based on industry-specific factors (non-systematic).
The recent range in the S&P500 around the 5500 level has been achieved by selling certain mega-cap stocks on some days, like Nvidia (NVDA), but heavily buying the other ones, like Amazon (AMZN) or Apple (AAPL). The net effect was no change in the Index level.
The recent breakout has been led primarily by Tesla (TSLA), which is up by 21% over the last 5 days. And every day, the Tesla move was supported by a different mega-cap stock. So, that’s the game. The breakout is not based on the fundamentals, it’s based on speculation in the mega caps.
Implications. When does it all end?
The economic slowdown or a recession has to be eventually reflected in the corporate earnings. Particularly, consumer-based mega caps like Meta (META), Alphabet (GOOGL), Amazon and Apple will have to lower their guidance, and acknowledge a slowing economy, which is likely to burst the bubble.
This is exactly what happened in March of 2000, when Yahoo missed the earnings, which burst the dot-com bubble. Will it happen during the current earnings season, or the next earnings season in September, it remains to be seen. Companies can manage their earnings over a short period, and delay the inevitable.
The current breakout in S&P 500 is an opportunity to sell. The S&P 500 is overvalued with the PE ratio over 24, facing a recessionary bear market, and we could be in a recession already.
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