FSO Editorials

The Conference Board and The Flattening Yield Curve from their Leading Economic Indicators

by Bob Bronson, Bronson Capital Markets Research. August 2, 2005

...four variations of their economic indicators that turn their non-leading indicators into leading indicators that are therefore all coincident with the stock market, along with Economic Cycle Research Institute's Weekly Leading Index, still show that the extension of the stock market's rally is not economically justified.

Considering the Supercycle fundamental overvaluation of the stock market (134-year charts available on request), declining growth rates in corporate earnings (chart available on request), the negative political cycle (see discussed below), the peak in the national index of new home prices [SEE] ( updated chart available upon request), and the weakening technical condition (see discussion below), our forecasting model still concludes that the stock market is in the final stage of a classic Bull Trap [SEE] This is all very reminiscent of early 1973 (we were there), which led to the second and most devastating downleg in that Supercycle Bear Market.

Bob Bronson
Bronson Capital Markets Research


click to enlarge

The Weakening Technical Conditions

Some of the many weakening technical aspects of the stock market are the negative divergences in: price oscillators; new high-lows; trading volume, especially advancing-declining volume; implied volatility patterns; and inverse index fund cash flows. All of these confirm the very bearish expanding triangle, or megaphone, chart pattern in all of the broad-based stock market indexes. And contrary to the misinformation aggressively put out by the bullishly-biased financial media and TV talking heads, who confuse NASDAQ and high-tech volatility with relative strength, relative weakness in these and other leadership sectors and industries has recently re-emerged, confirming prior negative divergences. Also, the current extremely bullish consensus opinion, especially among unsophisticated investors, is a very bearish contrarian indicator. (Charts supporting of all of these points are available on request.)

Pick Your Poison

Everybody knows short-term interest rates will keep rising with the Fed raising the Fed Funds rate for the tenth consecutive time, up another 25 basis points to 3.25%, in just another seven trading days -- so:

(a) if long term rates continue to fall, the yield curve, a coincident indicator to the stock market -- since it is a leading indicator of the economy -- will further narrow, which is immediately bearish for the stock market, as well as bearish for the economy over the following two quarters or so; but

(b)if long term rates rise, which is also an (inverse) coincident indicator to the stock market -- since it is an (inverse) leading indicator of the economy -- that is also immediately bearish for the stock market, as well as bearish for the economy over the following two quarters or so.

The Political Cycle Is Bearish

Nine out of past ten recessions started either in Presidential election years, or during the post-election years. Three started during election years:

(1) Jan 80-to-Jul 80, started at the beginning of Carter's fourth and final year
(2) Apr 60-to-Feb 61, started early in Eisenhower's eighth and final year
(3) Nov 48-to-Oct 49, started in Truman's fourth year in office

And the stock market rose in two of these three cases, which ranged from +21% in 1980 to -6% in 1960, with a median gain of 4% in 1948.

The other six recessions started during the post-election years:

(4) Mar 01-to-Nov 01, started early in Bush's first year
(5) Jul 81-to-Nov 82, started in the middle of Reagan's first year
(6) Nov 73-to-Mar 75, started at the end of Nixon's fifth year
(7) Dec 69-to-Nov 70, started at the end of Nixon's first year
(8) Aug 57-to-Apr 58, started after the midpoint of Eisenhower's fifth year
(9) Jul 53-to-Jun 54, started at the middle of Eisenhower's first year

And the stock market declined in five of these six cases, ranging from +2% in 1953 to -13%% in 1973, with a median decline of 7%.

So the past ten recessions have exhibited 9:1 odds of occurring during the first two Presidential-term years, which now would be concentrated on 2005 since there was no recession in 2004. Note that the odds of nine heads or tails, out of ten coin tosses, is less than 1% due to mere chance.

A recession starting in 2005, Bush's fifth year in office, would be similar to the recession that started late in Nixon's fifth year, 1973, for Supercycle Bear Market and economic reasons beyond the scope of this commentary.

But the strongest statistical Presidential parallels for Bush having a second recession starting in his fifth year, 2005, are other war-time Presidents, like Franklin Roosevelt and Eisenhower, who each had recessions start during both their first and fifth years in office. And Eisenhower even had three recessions during his two terms in office, the third and last which primarily occurred during his eighth and final year in office.

But the bearish implication for 2005 is double the above -7% average, when consideration is made of the stock market performance during the second post-election year, or fifth year in office, for previous two-term Presidents.

Since business cycles have been categorized from 1854, there have been ten two-term Presidents, five of whom who had recessions start during their second post-election year, or their fifth year in office: Lincoln, Grant, Franklin Roosevelt, Eisenhower, and Nixon (also a war-time President). The last four of those five – we don't have figures for Lincoln's war-ending 1865, when the economy started a 32-month recession - each experienced stock market declines, which averaged a whopping ~15%, with a median decline of -11%.

So why would Bush's fifth year in 2005 be different? Certainly not because it's a year ending in five.

Debunking The Myth Of Years Ending In Five

The years ending in 5 have not had a recession since 1945, which was also an up year for the stock market because of Nagasaki and Hiroshima caused Japan to surrender, which was unequivocally and immediately bullish for the US stock market. (Do you expect the terrorists to surrender this year?)

Secular periods of stock market under-performance and over-performance, as we quantify in BAAC Supercycle Bull and Bear Market Periods, have lasted equally long throughout US stock market history. (And this 50-50 share existed in the period before 1871, the date from which we normally make reference.) But four of the five years ending in 5 since 1945 have occurred disproportionately during two Supercycle Bull Market Periods (i.e., 1955 and 1965; and 1985 and 1995), during which 86% of the calendar years have been up, as is characteristic of that secular trend.

The one Supercycle Bear Market Period exception was 1975, the calendar year following the near the 1974 year-end low of that six-year Supercycle Bear Market, during which the average stock and average equity mutual fund declined 75%. Clearly, the past several years are not similar to that period setup for a rebound, especially since the stock market was at a several year high at year-end 2004.

Years ending in 5, since 1945 and before, have had several times the odds of occurring in strong compared to weak secular market periods, like the current Supercycle Bear Market Period that started in the late 1990s.

Also, contrary to popular myth, not all years ending in 5 have experienced stock market gains. In particular, 1865 declined 8.5% and 1875 declined 4.1%. In fact, along with the modest gains in 1835, 1845 and 1855, those five consecutive years ending in 5 did not experience any aggregate market gain. Further, years ending in 8 and 9 have similar track records to years ending in 5, with all three of them up 12 out of their 14 occurrences since the 1860s.

Since there is no theoretic reason for the stock market to always be up during years ending in 5, or even to be up more than the average calendar year, chalk up the myth to pure numerology, or the obsession with random number patterns. And besides, this calendar year has been significantly underperforming the useless no-headed instead or wrong-headed myth.

© 2005 Bob Bronson
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Bob Bronson
Bronson Capital Markets Research
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