Is the Market Stuck?

Economy and stock market’s fundamentals are strong right now.

Year-over-year earnings growth is currently at 20%. It looks like the final year-over-year earnings growth for 2018 will probably be somewhere closer to 15%.

The yield curve is still positive (Yield curve is bearish for the market once it becomes inverted).

Inflation growth is still muted.

No recession. Leading economic indicators continue to improve and trend higher.

So why isn’t the stock market stuck?

 

Just because the stock market doesn’t go up for a few months despite improving fundamentals doesn’t mean the bull market is over. It is perfectly normal for the stock market to swing sideways despite strong fundamentals.

In fact, the longer the stock market swings sideways in the face of improving fundamentals, the fiercer the eventual breakout will be on the upside.

Fundamentals represent the market’s long term “fair value”. If the stock market keeps swinging sideways while the fundamentals improve, the market’s “fair value” is going to trail higher and diverge from the stock market’s price. The longer this continues, the bigger the gap between “fair value” and the stock market’s price. Eventually the price will snap back and reconnect with “fair value” by rallying.

Here’s a look at the S&P 500’s chart in 1994. The stock market moved sideways for 1 year while the fundamentals continued to improve. The longer the sideways consolidation, the fiercer the upside breakout. The stock market soared in 1995.

 

 

The following charts demonstrate that it’s perfectly normal for the S&P 500 to make a “small correction” while the fundamentals are improving (which is what’s happening right now).

We can use the year-over-year change in Industrial Production to demonstrate medium term “improving/deteriorating” fundamentals. Notice how it is improving right now.

Industrial Production improved in 1994 and 1996-1997. There were multiple 10%+ “small corrections” along the way despite the improving and strong fundamentals.

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