In a recent report, we argued that the current bull market is more of a business cycle than a political cycle. The volume of “hate mail” in response to this heresy suggests we are on the right track.
We based our opinion on sector thrust, a rare signal which has identified almost every cyclical bottom since 1926. The latest was confirmed in April 2016, well ahead of the November election. This suggests, despite shrill voices, that politics is not the main driver of the current market rally. The so-called “Trump bump” is probably an ordinary earnings-cycle expansion.
The chart below shows sector-thrust signals relative to the earnings cycle since 1940. Interestingly, corporate earnings are not the only reason for market bottoms. Some important bottoms have coincided with earnings troughs, but others haven’t.
There are six prior cases in which the indicator matched bottoms in the earnings cycle. The minimum rally in these cases was 25% following the December 1998 signal. A comparable run-up from April 2016 targets SPX 2570 – a minimum 9% upside from here, if the pattern holds.
Today’s valuations are rich by historic standards, so the potential for further gain is arguably limited. But the market is a complex system driven by price, earnings, and a host of other factors including interest rates, animal spirits, and yes, politics.
Deciding which factor will dominate is tricky business. Lofty valuations, however, are less daunting near the beginning of earnings-cycle expansions. The current upswing is less than a year old. Our sector-thrust model suggests a 4-year-cycle bottom in January 2016, so a classic top is not likely until mid-2018 or later.
Market forecasting is never easy. Behavioral models, however, do add value. Political analysis is undoubtedly important. But make sure it jibes with the message of the market. With earnings season dead ahead, let’s temper our fascination with politics and entertain the possibility of an ordinary business-cycle expansion.