While the long-term remains uncertain, the rest of 2019 should be very positive
- Critical slowing down (CSD), a phenomenon observed as complex systems going through a transition, in the S&P 500
- A cycle shift to private sector confidence had increased the odds of a miscalculated move by public sector actors (i.e. governments)
- Price action suggested that new highs were elusive and markets could break down
As the leaves have turned orange, it seems likely the move is up:
- The continued presence of CSD in the S&P 500
- Private sector forces (e.g. consumer confidence, wage growth, technology innovation, the dominance of new platform businesses) appear sufficiently robust and have absorbed public sector event risk
- There are three instances since 2011 when the S&P 500 was signaling CSD and experienced significant range compression. In each case, dramatic price movement followed within 3 months
- Modeling macro data in my neural network Market Model, I wrote on August 24th that the S&P 500 was likely to gain ~7% over the next year. Since then, it is +7.7%. I wrote on October 14th that I now expected the index to rise ~11% over the next year. Since then, it is +3.4%
While event risk looms large for the long-term, a significant upward move in stocks through year-end should not come as a surprise. Full code and data are on my GitHub under post 65.
Critical Slowing Down in the S&P 500
As discussed here, rising correlation and increasing variance imply CSD. Both signals suggest the possibility of a phase transition in the S&P 500.
The presence of CSD is by itself not enough to confirm a major transition. Let’s move to cycles.
Private Sector Forces Remain Ascendant
I wrote here of a rhythmic cycle of confidence in the private sector relative to the public sector.
During this era, society as a whole has less confidence in public institutions, namely the government. One by one, government services and sponsored-monopolies are being replaced by solutions delivered to the supercomputers in your hands. The epitome of this cycle may have been the election of a complete outsider, the real estate and entertainment businessman, Donald Trump, to the most powerful office in the world. His election has propelled many other private sector moguls to contemplate politics, such as Howard Schultz, Mark Cuban, and Oprah Winfrey.Source: Complexity Everywhere Post (June 2, 2019)
I further mentioned that:
Unsurprisingly, the entrenched public sector is not taking well to this shift in confidence, and the greatest risk to society is from miscalculated public sector actions. Picture a trapped animal, lurching out in incoherent directions as it fights for survival.Source: Complexity Everywhere Post (June 2, 2019)
The list of event risks is growing:
- Mishandled trade negotiations
- Impeachment proceedings in DC
- Brexit uncertainty
- Instability in Hong Kong spreading across China
- Global spread of protests and unrest (Haiti, Ecuador, Chile and elsewhere)
- Nuclear power confrontation in South Asia, Korea or the Taiwan Strait
- Ongoing war across Middle Eastern hotspots
- Unchecked nationalism again taking root in Europe
- Degradation of post-WW2 multilateral institutions
- Growing (and rare) bipartisan consensus in DC to regulate Big Tech
- Abuse of technological innovations for control (e.g., facial recognition)
Equities, however, have mostly overlooked these risks.
CSD + Range Compression
There are three instances since 2011 when the S&P 500 was signaling critical slowing down AND experienced significant range compression. Movement outside of this compressed range can be a strong signal for a major transition.Moments When the S&P 500 Signaled Critical Slowing Down During a Period of Significant Range Compression
|S&P 500 Index||Direction Outside Compressed Range||EOM Price||1 mo. return||2 mo. return||3 mo. return|
A similar setup has occurred here at the end of October 2019.
Any opinions or forecasts contained herein reflect the personal and subjective judgments and assumptions of the author only. There can be no assurance that developments will transpire as forecasted and actual results will be different. The accuracy of data is not guaranteed but represents the author’s best judgment and can be derived from a variety of sources. The information is subject to change at any time without notice.