2018 is a difficult year to predict because of a potential divergence between the stock market’s cycle and the underlying economic cycle.
The U.S. stock market appears to be nearing the top of the bull market that began in 2009. Evidence for this comes from two sources: Elliott Wave and George Lindsay’s Counts from the Middle Section. The latter model projected a top by the end of last year. Although the top did not happen, the model nevertheless serves as evidence that the top could occur soon. However, it is likely that before the ultimate top, there will be a drop of 7-10% followed by a rally to at least a marginal new high.
My long-term Elliott Wave count allows for the bull market to run higher from its current levels as shown on the chart below.
I consider the NASDAQ-100 (NDX) to be in Primary Wave V of the 2009 bull market. Primary Wave I was a 98% rally from March 2009 – April 2010. After the Primary Wave II correction during April – July 2010, an extended Primary III took place during July 2010 – Dec 2015, in which the largest subwaves had the magnitude of primary waves. After that, Primary IV was the correction during Jan – Feb 2016. Primary Wave V began from the Feb 2016 low and is still underway.
If Primary Wave V has a magnitude equal to Primary Wave I on a percentage basis, the target for the ultimate bull market top would be 7,700 on the NDX.
While it is well known that the stock market often tops out before the economy does, in the last 100 years, there has never been an instance in which a bull market ended amid economic acceleration beyond the levels previously seen in the expansion cycle. Typically, bull markets end when the rate of economic growth levels out or starts to slow down.
In order for the bull market to continue beyond the first half of 2018, we will have to see economic growth stronger than the norms of the last nine years. It is possible that the tax reform recently passed by Congress could serve as the catalyst for stronger economic growth. Going forward, for the bull market to continue, the average annualized rate of GDP growth would need to be at least 3%.
Regarding the job market, I think that, with the current socioeconomic environment taken into account, the economy is near full-employment. I reference the “current socioeconomic environment” because there are some constraints on employment at this time in history which are more significant in the current economic cycle than they were in the expansions of the 1980s, 1990s, or mid-2000s.
The biggest issue I see regarding employment is that the depth of technical knowledge required by many employers today due to automation of labor (including many job positions not traditionally considered tech-savvy) is difficult to firmly attain through the current educational systems.
That said, it is possible that with lower corporate income tax rates, business executives may decide that instead of putting the heaviest workloads possible on a few employees with extensive technical knowledge, it would be worthwhile to hire more employees and train them on tasks to enable more division of labor. This could enhance the sustainability of the business’s operations, and also provide more opportunities for experienced employees to contribute to business expansion.
The official unemployment rate (U3) is 4.1% (as of Dec 2017). The lows of the previous three economic expansions were 4.4% (Dec. 2006), 3.8% (Mar. 2000) and 5.0% (Mar. 1989). The broader, U6 unemployment rate, which includes part-time workers who need full-time work and people only marginally attached to the labor force due to economic reasons, stands at 8.1% (Dec 2017), vs. previous cycle lows of 7.9% (Dec. 2006) and 6.9% (Dec. 2000). U6 was not tracked prior to 1994.
Economics is not a precise science; thus, comparable numbers, occurring at different times in history, probably do not tell the same story about the underlying situation. Ordinarily, with an unemployment rate as low as it is today, there would not be much room for job creation to outpace population growth. To find a U3 rate lower than the 2000 low (which we are getting close to), you would have to look all the way back to 1969. Although the U6 rate in 2000 was about 1% lower than it is today, there were many cases of companies “over-hiring” in 2000 in response to the dot-com boom, leading to unsustainable job positions and new hires with questionable competence or reputations.
However, due to circumstances described earlier, I think that there is potential for the unemployment rate to fall further without overheating the job market, and that such a decline would be necessary in order for the bull market in stocks to continue throughout 2018.
Another factor to consider, when assessing the bull market’s continuance in 2018, is the state of public sentiment regarding the stock market and economy. In this area, I am seeing very conflicting signals.
Prior to 2017, public sentiment about the stock market had a definitively negative bias. Although a lot of negativity came from political conservatives who were critical of the Obama administration and the Federal Reserve, there were also people who did not see their own financial situation to be improving and were suspicious of the stock market’s rise. Political progressives, who supported the Obama administration’s policies, were generally not focusing their attention on the stock market.
The big question now is whether overall public sentiment started to turn in 2017. I was surprised by the number of politically conservative commentators who suddenly began speaking positively about the economy and the stock market in 2017, despite the lack of major legislative accomplishments by Trump and the Republican-controlled Congress. Perhaps I should have expected this enthusiasm, given the highly partisan nature of basically everything these days, but in 2009, after Obama took office, progressives were more subdued in their talk of economic and market recovery, opting to praise the social aspect of Obama’s politics while sometimes expressing concern about the rate of economic progress.
Could it be that the stock market’s rise in 2017 was in part due to individual investors, who previously avoided the stock market for political reasons, finally entering the market again? If so, is this a sign of a bullish bubble forming, that would signal a top in the near future?
I would be highly cautious about making claims that the current state of public sentiment signifies the late stages of a bull market. If the economy were to accelerate over the next couple years, there would be room for more investors who previously stayed out of the stock market due to financial difficulties to reenter the market as their financial situation improves. Furthermore, while sentiment among political conservatives has started to turn, sentiment among progressives is extremely negative.
However, it is hard to tell how much of the negative sentiment among progressives is directed specifically toward the economy or the stock market. The mainstream news media, which often has a discernible negative bias in its reporting on the Trump administration, seems willing to report economic and market statistics without casting a negative shadow over them. Much of the progressives’ angst over the country’s situation carries heavy social overtones, and they seem to be staying out of the fray when it comes to macroeconomic debate. The key question, which is very difficult to answer, is the extent to which these progressives are willing to invest their money in stocks despite the direction they think the country is headed socially.
With all things considered, I am going to refrain from making any definitive predictions about the stock market’s long term direction until we see how the economic backdrop develops over the next couple months, and whether the market makes any erratic moves to the downside in the near future. Given the precarious cyclical situation of the stock market right now from a technical analysis standpoint, I would probably conclude that the bull market has ended if we were to see a drop with accelerating downside after falling 10% from the highs.
Aside from that scenario, it is likely that the bull market will continue until we get a 7-10% drop followed by a rally to at least a marginal new high.
Employment statistics in this post are from Portal Seven (http://portalseven.com/employment/)