Our working hypothesis is that the only constant factor in the stock market is human emotion, and that these emotions are imprinted in the market’s historical record as repetitive patterns. Searching for, and analyzing these patterns informs us on the probability of future market outcomes. In this article, we present two of these patterns and speculate on what they might imply about the future of the stock market.
Two important repetitive patterns that influence — or at least, correlate with — emotions are the unemployment rate and the 10-year minus the 2-year Treasury rate differential. As the chart below demonstrates, the rate differential inverts (goes negative) months before the S&P 500 (SPX) makes a top. At the moment, the differential is still positive at +0.43 and if the slope is maintained, the differential will turn negative near the end of this year, or early in 2019. That means, the SPX would not top-out until later in 2019 or 2020 (chart below).
The unemployment rate, while dropping steadily during bull markets, tends to start rising months ahead of the SPX making a top. The following two charts demonstrate this for the market tops of 2000 and 2007.
The unemployment rate dropping, and the rate differential maintaining a positive value, supports our view that we are in a late-stage bull market that is going through a much-needed correction and that we are still likely to see new highs. The bull market is only resting, it’s not dead yet.
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