In the past I have argued that signs of an impending bear market were not present based on leading economic data, lack of financial stress, and corporate profit levels. Recently, however, financial stress measures have started to move in a troubling direction.
Here is a chart of the S&P 500 (shown in blue) with four different measures of financial stress provided by various Federal Reserve regional banks. As you can see, financial market stress started to bottom over the course of last year and has now moved higher. This typically happens prior to market selloffs and, if all four measures make a sustained move into positive territory (above the x-axis), also raises the possibility of a much deeper bear market.
Another measure I’ve cited in the past for evidence against an impending bear market is corporate profits. Here’s one of the timeliest measures I’ve seen since it tends to fall off a cliff before an economic recession and helps provide confirmation that we’ve seen a major peak in the stock market. So far, this hasn’t happened. However, with pressures now coming from a stronger dollar, weakening global demand and the recent hit to the energy sector, this will be something we’ll need to watch closely moving ahead.
To balance out some of the negatives, leading economic indicators are still showing growth for the U.S. and don’t indicate that the world’s largest economy is about to enter a recession. Many believe the U.S. cannot decouple from the rest of the world and will eventually get dragged down. As always, this is a question of timing and, so far, we aren’t seeing a stalling or reversal in leading economic data to suggest this is happening.
Bottom line: financial risks have risen from their lows and may put pressure on U.S. stocks ahead; keep a close eye on corporate profits and U.S. leading economic data for broader deterioration.