For the past few months, we have noted in our Leading Indicator Watch publications that financial market inputs to our leading indicators were running far ahead of actual hard economic data. The same is true for survey data vs real economic data. While we have seen some modest improvement in economic data like industrial production, sentiment surveys like consumer confidence and the small business NFIB surveys are positively euphoric. Whenever soft data runs so far ahead of hard data, it is a sign investors have got ahead of themselves and normally it leads to markets trading sideways to down.
On the left chart, you can see the difference between soft versus hard data is at the highest levels recorded. We have extracted a signal, as you can see from the chart on the right. The market has not always gone down, but it is worth noting that, when previous signals have activated, eg in 2003 the market declined for the next ten months, it peaked in 2007, it had the “Flash Crash” in May 2010, it traded sideways and then fell 20% in 2011. We’re not forecasting a crash, but investors should beware that given euphoric sentiment surveys, the good news is arguably priced in. The economy has a lot to deliver for stock prices to be justified. (Click on image to enlarge.)