Staying the Course

A new feature is introduced this month: News and comments relevant to the most recent month are highlighted in bold. Otherwise, context and longer term prospectives will be in regular fonts.

Last month we advised not to get sidetracked by the spectacle of the military activities and lose sight of the major trend, which is revealed by our Diffusion Indexes. Since then, the S&P 500 rose to record highs.

We rely on the Sound Advice Diffusion Indexes (page 9) to identify business cycles because they have an accurate track record of predicting major stock market trends for the last 50+ years. They work by observing changes in the most sensitive leading and lagging economic indicators that lead to shifts in interest rates. During “Aggressive” signals over the last 50 years, the S&P 500 climbed an average of 31.5 percent. The market has undergone corrections but has never crashed. All market crashes have occurred during “Caution” signals. When the stock market was not crashing, the S&P 500 either meandered, climbed moderately, or declined in an extended bear market, recording an average decline of 0.6 percent.

The most recent signal change was in late 2022, when our Diffusion Index of Leading Indicators (page 8) recorded a zero reading which led to a new signal change from “Caution” to “Aggressive”. That signal was prescient as we began a new bull market.

As reliable as our Diffusion Indexes are, it is still prudent to keep an eye on the underlying indicators for any sudden changes that would reveal an oncoming adverse event or trend. One of the leading indicators used by our Diffusion Index of Leading Indicators is the “Initial Claims for Unemployment Insurance”. This is a reliable, timely leading indicator of economic activity and it does not get revised in future months, unlike many other indicators. Initial Claims have been steady this year through April, indicating that there was not significant economic deterioration during the month.

Our next signal will come from a 100 percent reading of our Diffusion Index of Lagging indicators, revealing that the economy is overheating and exerting a lasting upward pressure on inflation and short-term interest rates. From here, it would take a seismic increase in all of the underlying economic indicators contained in our Diffusion Index of Lagging Indicators to cause a 100 percent reading. Accordingly, the end of the current bull market is still not on the horizon.