With the bull market 10 years old and the economic cycle about to reach 10 years, the big question is how much longer can it go? To answer this question we will take a closer look at our Five Forecasters for late-cycle warnings. Historically, these indicators—which are summarized in our Recession Watch Dashboard—have collectively signaled a transition to the latter stages of the economic cycle and an increased potential of an oncoming recession and bear market.
In our two weekly commentaries (due out later today), we will examine market breadth, valuations, the yield curve, and leading indicators. That leaves one more indicator—how the economy is doing, which we will look at here.
Earnings are the most fundamental driver of the stock market and should be a part of any recession or bear market watch checklist in our opinion. The Institute for Supply Management (ISM) Manufacturing Index has historically been a good earnings indicator, with a six-month lead time. For example, the peak in the ISM that occurred in late 2014 indicated an ensuing slowdown in profits. Since purchasing managers are on the front line when it comes to the manufacturing supply chain, and the ISM surveys future plans, they can provide signals of economic turning points ahead. With the majority of S&P 500 Index profits tied to manufacturing–and even though manufacturing is a relatively small portion of the U.S. economy measured by gross domestic product–demand for manufactured goods has been a timely barometer for all types of economic activity in recent decades.
As our LPL Chart of the Day shows, manufacturing has been slowing, but it is important to note that it is still above the critical level of 50, which suggests economic expansion. “Yes, manufacturing has been slowing, which has impacted earnings growth recently,” explained LPL Senior Market Strategist Ryan Detrick. “But don’t forget manufacturing is still expanding and we’ve found it can take up to four years after manufacturing peaks before a recession starts, suggesting there is still ample time for a second half recovery in both manufacturing and earnings.”
For more information on why it takes so long for recessions to start after manufacturing peaks, please read ISM and Recessions.
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