The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
NEW YORK (
) -- In each of the past two years the stock market began a slide in the spring, a phenomenon often referred to by the old adage "sell in May and go away," which lasted well into the summer months. Are stocks poised to repeat the pattern this year? We have identified 10 indicators to watch closely in the coming weeks that may warn of an impending slide.
What to Watch
In both 2010 and 2011 an early run-up in the stock market, similar to this year, pushed stocks up about 10% for the year by mid-April. On April 23, 2010 and April 29, 2011, the
made peaks followed by 16%-to-19% losses that were not recouped for more than five months. While late April is still four weeks away, judging by what indicators seemed to precede the declines in 2010 and 2011, we have identified 10 indicators to watch over the next four weeks.
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The 10 indicators include:
Fed stimulus -- In each of the past two years, Federal Reserve stimulus programs known as QE1 and QE2 came to an end in the spring or summer and stocks began to slide until the next program was announced. The current program known as Operation Twist was announced on Sept. 12 and is scheduled to conclude at the end of June. The stock market may again begin to slide until another program such as QE3, the scope of which was recently hinted at by the Fed, is announced.Chart 1: Another Fed Stimulus Program Ending SoonS&P 500 Index and Fed Stimulus Programs Source: LPL Financial, Bloomberg dataShaded areas represent Fed programs from the date of announcement until termination
Economic surprises -- The Citigroup Economic Surprise Index, shown in the chart below, measures how economic data in the U.S. fared compared to economists' expectations. A rising line indicates that the data is consistently exceeding expectations. A falling line suggests expectations have become too high. The index moved to what has historically marked the peaks in optimism about a month or two before the peaks in the stock market in 2010 and 2011. This year, it appears the index may have already started to retreat from a peak since early February; if this index again leads by two months the slide may soon begin.Chart 2: Economic SurprisesCitigroup Economic Surprise Index The Citigroup Economic Surprise Index is an unmanaged index, which cannot be invested into directly. Past performance is no guarantee of future results.
Consumer confidence -- In 2010 and 2011, early in the year the daily tracking of consumer confidence measured by Rasmussen (shown in Chart 2 above) rose to highs last seen on Sept. 5, 2008, just before the stock market collapse as the financial crisis erupted. The peak in optimism gave way to a selloff as buying faded. Investor net purchases of domestic equity mutual funds began to plunge and turned sharply negative in the following months. This measure of confidence is once again close to the highs seen in early 2010 and 2011; we will be watching for a turn lower in the index that would indicate the start of an erosion of confidence.
Earnings revisions -- The first couple of weeks of the first quarter earnings season (April 2010 and April 2011) drove earnings estimates higher in both 2010 and 2011. Earnings estimates for S&P 500 companies over the next year rose a greater-than-average 3-5% over the first couple of weeks of reports. But as the second half of the earnings season got underway in May 2010 and May 2011, guidance disappointed analysts and investors as the pace of upward revisions declined sharply. This year, we will be watching to see how much earnings expectations rise as the initial reports come in and if they begin to taper off sharply.
Yield curve -- In general, the greater the difference, or spread, between the yield on the 2-year and the 10-year U.S. Treasury notes, the more growth the market is pricing into the economy (see chart 2 above). This yield spread, sometimes called the yield curve because of how steep or flat it looks when the yield for each maturity is plotted on a chart, peaked in February of both years at 2.9%. Then the curve started to flatten, suggesting a gradually increasing concern about the economy. This year the market is pricing a more modest outlook for growth, but we will be watching to see if the recent slight decline in the spread (currently about 190 basis points) begins to decline.
Oil prices -- In 2010 and 2011, oil prices rose about $15 to $20 from around the start of February, two months before the stock market began to decline. This year oil prices have climbed back to the levels around $105 to $110 that they reached in April of last year. However, they have risen only about $10 since around the start of February 2012. A further surge in oil prices would make this indicator more worrisome.
The LPL Financial Current Conditions Index -- In 2010 and 2011, our index of 10 real-time economic and market conditions peaked around the 240-to-250 level in April and began to fall by over 50 points. This year, the CCI recently reached 249 and has started to weaken and currently stands at 232.
The VIX -- In each of the past two years the VIX, an options-based measure of the forecast for volatility in the stock market, fell to a relatively low 15 in April. This suggested investors may have become complacent and risked being surprised by a negative event or data. This year, the VIX has recently declined once again to 15 in the past two weeks.
Initial jobless claims -- It was evident that initial filings for unemployment benefits had halted their improvement by early April 2010, and beginning in early April 2011, they deteriorated sharply. So far, in 2012 initial jobless claims continue to improve at a solid pace, but it may yet be too early, and so we will be watching for any weakening as April gets under way.
Inflation expectations -- The University of Michigan consumer survey reflected a rise in inflation expectations in March and April of the past two years. In fact, in 2011, the one-year inflation outlook rose to 4.6% in both March and April. This year, inflation expectations have also jumped higher so far in March, reaching 4%.
While this list may seem incomplete, it is notable that many of the most widely watched indicators of economic activity such as manufacturing (the Institute for Supply Management Purchasing Managers Index known as the PMI or the ISM), job growth, and retail sales, among others, did not deteriorate
of the market decline, but
along with it
. It is not that they are not important; it is just that they did not serve as useful warnings of the slide to come, while the above indicators did.
So far, about half of the 10 indicators point to a repeat of the spring slide this year, while the other half do not. We will continue to monitor these closely in the coming weeks.
While it is possible we will experience another spring slide this year, there are factors that may mitigate the decline short of the 16% to 19% seen in the past two years.
Looking back, in 2010 the negative environment that helped fuel the decline included the end of the Fed's QE1 stimulus program, the uncertainty around the impact of the Dodd-Frank legislation, the eurozone debt problems and bailouts, central bank rate hikes, and the end of the homebuyer tax credit. In 2011, the negatives included the end of the Fed's QE2 stimulus program, the Japan earthquake and nuclear disaster that disrupted global supply chains and pulled Japan into a recession, the Arab Spring erupted pushing up oil prices, the budget debacle and related downgrade of U.S. Treasuries, rising inflation, central bank rate hikes and the eurozone debt problems coming to a head.
Looking ahead, the negatives we face in 2012 already include the end of the Fed's Operation Twist stimulus program, rising oil prices, China's slowdown, the European recession, the election uncertainty and anticipation of the 2013 budget bombshell of tax hikes and spending cuts. However, there are some positives this year that may help offset some of the negatives making for a potential decline that may be less steep than those of the past two years.
First, central banks are now cutting rather than hiking rates, which should help to temper global recession fears evident during the past two years' spring slides.
Second, housing is showing signs of improvement as both new and existing home sales are rising at about a 10% pace.
Third, while energy prices are up this year (same as last year) food prices are decelerating, which helps to explain why consumer sentiment is going up in the face of higher gasoline prices.
Finally, auto production schedules are robust for the next quarter and likely to support manufacturing activity, which had fallen in May through July of the past two years and contributed to the market decline.
Given this year's double-digit gains and the possibility of another spring slide for the stock market, investors may want to watch these indicators closely for signs of a pullback despite the current upward momentum in the stock market and solid economic growth.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.
Jeffrey is Chief Market Strategist and Executive Vice President at LPL Financial.