Fundamental Analysis & Indicators To Predict Stock Market Direction

Fundamental Analysis  & Indicators/Indexes help us to understand the drivers of financial markets, and in particular the likely direction of the stock and bond markets that we are all invested in.

The fundamentals below are predominantly linked to the US economy and stock market as most global stock market funds are 70% to 75% US weighted.

I have listed these fundamentals in a general order of importance in terms of checking to see if we are heading for a downturn or a recession. I track these fundamentals for signs of strength or weakness to help make decisions on which assets to be invested in. Ultimately, we are only really concerned If we see a weakening across the board of these fundamentals. This is when I would think about selling equities/stocks and re-allocating to bonds and other capital preservation assets.

Before we launch into the main FA Indicators I track it's worth mentioning a free resource that real students of FA will know and use which covers most FA indicators... click here for Ed Yardeni's excellent list of free charts.

Unemployment

Top of the checklist is unemployment. You can't have a recession without the unemployment figures trending up in a meaningful way. For a deeper dive into unemployment metrics... click here.

The most widely watched measure of unemployment is the US 'Total nonfarm payroll'. 

Click the link below and switch the Total nonfarm payroll chart below to 'Percent Change from a year ago' and look for drops below the zero line. Only during these periods do we see the grey recession bars along with their associated falls in the stock market: -

• All Employees, Total Nonfarm (Fed Reserve chart) (Note: Click the "Edit graph" button on the Fed page and switch the charts to 'Percentage change from a year ago' in order to see a clear relationship between sub-zero readings and recessions.)

Initial Jobless Claims (an Unemployment Leading Indicator)

"Initial Jobless Claims" are more of a 'leading indicator for unemployment in the US. From a macro-economic view point, seeing rising "Initial Jobless Claims" rise along with a steepening (un-inverting) yield curve is a very accurate predictor of recessions and therefore declines in global equities. The grey shaded area's below are recessions which materialise when the black 'yield curve' line and the amber 'Initial Claims' line rise from a low point below the horizontal 'zero' line. This signal is 100% accurate going back to the 1960's...

Click here for "Initial Unemployment Claims" from Yardeni.com

Leading Indicators & Risk-On/Risk-Off

Leading indicators for the stock market give us a better idea 'ahead of time' where the stock market might be heading. Hence, leading indicators are tracked quite high up in this list of fundamentals.

Yardeni Research provides a great chart of the main leading indicator indexes which blend a number of the best leading indicators into an index: -

The Index of Leading Economic Indicators (LEI) has been a bad indicator of a recession in the current cycle. It peaked in 2021 and has been falling ever since. The red dotted line is the S&P 500 has ascended to record highs, but, it did drop about 20% in 2022. Unlike the LEI, the Index of Coincident Economic Indicators has been the best leading indicator tracking the SP500 to new all time highs. However, as you can see from the graph above, there is a lag between the LEI turning down and the SP500 doing the same. The divergence you can see between the SP500 and the LEI may be down to the AI mania bubble and liquidity injections by central banks which reversed the 2022 crash. We shall see if this divergence eventually plays out in 2025 ...

Risk-on/Risk-off & Sentiment

For the most part the stock market has 2 modes... 'risk-on' with bullish sentiment and behaviours from both consumers and investors and 'risk-off' with bearish sentiment and behaviours. One of the best indicators for risk-off consumer sentiment is when XLP (Consumer Staples ... i.e. defensive = risk-off) start to out perform the broad SP500 Index. As can be seen in the chart below the rise and fall of the SP500 is very well correlated with the rise and fall of XLP/SPY. The green line is the 50 week MA...

Another great indicator for risk-off consumer sentiment is when government bonds (TLT ... i.e. defensive = risk-off) outperforms the broad SP500 Index. As can be seen in the monthly chart below of the SP500 the 2008 GFC is accompanied by TLT/SPY trading below the ten monthly MA line when the price action crosses below the MA. The dotted vertical lines below show when this signal triggered without a 'yield-curve' inversion/un-inversion. The solid redline followed by the red box is when this signal triggered WITH a 'yield-curve' inversion/un-inversion. As can be seen, if history repeats here then we are heading into a financial crisis is 2025...

Recession Risk & Financial Distress Indicators

One of the most followed recession charts of the FRED database (Fed Reserve US Central bank) website is the 'Smoothed U.S. Recession Probabilities'. You can see the accuracy of this chart going way back to the 1970's

• Smoothed U.S. Recession Probabilities (Fed Reserve chart)

Note: Recessions start AFTER the stock market tops and the end AFTER the stock market bottoms.

The MacroMicro home page has a recession probability percentage for the global economy and the US economy.

For a deep dive into recession risk and financial distress <<< CLICK HERE (new tab) >>>

US Financial Conditions Index

The Chicago Fed index tracks a range of financial conditions to provide a measure of the overall health of economic conditions centred around credit, risk and leverage. The visual chart protruding above the flat zero line is a strong signal that the markets are in distress and indeed we see this happening during covid and the GFC 2008...

• National Financial Conditions Index (NFCI)

US Credit Tightness

Related to the above we have the the following measure of Credit tightness by banks in the US which correlates very well with the inset of recessions as can be seen below..

• Net Percentage of Domestic Banks Tightening Standards for Commercial and Industrial Loans to Large and Middle-Market Firms

The 10 year / 3 month yield curve

The market keeps a close watch on the 10year/2year Us Treasury yield curve but the 10year/3month correlates very accurately with the beginning of major downturns in stock markets when the yield curve inversion starts to come back up from a deep yield curve inversion as seen by the red shaded area below...

The ten year minus two year US Bond "Yield Curve" is widely watched as it it quite nicely negatively correlated with the direction of the SP500... 

The same chart on a longer term basis shows the un-inversion of the yield curve ushering in significant market declines. Also shown is the Fed Reserve central bank rate to see how closely that correlates with the beginning of stock market declines.(Red shaded area 2001 "Dot Com" crash and 2008 "GFC" crash...)

The Conference Board growth rate dipping below -4 or -5 has either been an excellent recession predictor, but even when there was no recession in 2022 there was a bear market in stocks so heading back down after not surfacing above zero could spell headwinds ahead... 

Stock Market Valuation

Financial Investment professionals spend their whole careers either creating/generating valuations for various asset class markets, or investing/trading from those markets. Not surprisingly then, this is probably the most often quoted fundamental indicator when assessing the timing of investing capital into the stock market...

For a deep dive <<< CLICK HERE >>>

The start of 2025 was a good case study for top end stock market valuations which typically lead to poor returns. Whether that happens in 2025 remains to be seen, but investment decisions should be made on probability and when the probability is lower returns then that should factor into investment decisions and allocation.

The current SP500 PE ratio is the standard stock market valuation model, but for longer term investors the Shiller CAPE ratio has become a gold standard for market valuation and the returns based on history are not looking great for our 2025 case study... 

Global Demand & Earnings

Purchasing Managers Indices - The Official Measure of Global Demand

Purchasing Managers Indices (PMI) are a measure of purchases made by businesses and is a leading measure of economic strength. A PMI above 50 signals expansion and when below 50 its signals contraction. The image below shows the European and US PMIs to the end of 2019. As you can see the Great Financial Crisis 2008 (GFC) would have been a good time to consider the tactical use of bond funds as ‘flights to safety’ to preserve capital. Or, even basic ‘shorting’ of the market by selling out into cash and waiting for the bottom that inevitably comes and turns up again. For example the US and Eurozone composite PMI’s below show strong levels of confidence returning halfway through 2009… a good time to get back into the markets.

PMI (Purchasing Manager) indexes show current economic demand. This turns down when the stock market is about to do the same. So, once again, we need to be concerned about the US with globally 'diversified' funds so heavily invested in them. US manufacturing leads the stock market. If it goes down then US equities tend to follow and global equity markets behind the US markets.

AN ECONOMIC CYCLE LEADING INDICATOR - DURABLE GOODS

The 'durable goods' sub-sector is the sub-sector that is the most sensitive to The economic cycle. We can see declines leading into the last three major recessions: -

• Durable Goods (US) (Fed Reserve chart)

Capacity Utilisation & Industrial Production & GDP

These 2 metrics should be monitored monthly on the 'Percentage change from a year ago' scale. Drops and holding pattern below zero is a warning sign the economy and stock market may go into decline, regardless of there being a recession or not.

Related to the PMI's above the Capacity Utilisation has a long track record in the US so we can trace this measure of demand going way back. We can see this demand measure drop off in the last 3 major financial crises along with a drop off in GDP... (Note: Click the "Edit graph" button on the Fed page and switch the charts to 'Percentage change from a year ago' in order to see a clear relationship between sub-zero readings and recessions...)

• Capacity Utilization & GDP (Fed Reserve chart)

Industrial Production... how much are factories producing... logically is a function of demand so if production is waning, it's a sign that demand is waning. they is key stock market metric to consider: -

• Industrial Production (Fed Reserve chart)

For a deep dive on Global Demand  <<< CLICK HERE >>>

US Stock Market Earnings

The Earnings per share and Forward earnings measures correlate very well with downturns/recessions often preceding the official recession (grey bars below). Other earnings charts also show important relationships between earnings and the economy.

US Dollar Strength and US Dollar Supply

The dollar as the worlds global reserve currency is the most important currency to track. It's the most influential in terms of the global economy. A strong dollar is not necessarily good news for global stock markets. Both the SP500 and global funds tend to move in the opposite direction to the almighty US dollar. If the stock market rallies into a strengthening dollar it could be a sign of a 'bull trap' with sellers cashing in at the top creating headwinds for the SP500 and therefore our global stock market funds.

For a deep dive <<< CLICK HERE >>>

Money Supply 

Money Supply into the economy is a measure of the commercial bank money creation along side central bank money creation. In short when M2 increases, inflation tends to increase also although there can be a lag of more than a year before the inflationary affects of an increase M2 is seen. 

• Real M2 Money Stock (Fed Reserve chart) (Note: Click the "Edit graph" button on the Fed page and switch the charts to 'Percentage change from a year ago' in order to see a clear relationship between sub-zero readings and recessions.)

Are The Global Markets & FUndamental Stock Market Indicators Showing Strength? 

As we know, The US SP500 is our main focus as it will be where most standard funds are invested, but if there is weakness in the global markets and economy then it could start to affect the US so it's something to keep an eye on as part of our fundamental analysis for the overall health of out global stock market fund we are invested in.

Global Blue Chips & Markets

The Global Dow is a 150-stock index of corporations from around the world, created by Dow Jones & Company. Only the largest blue-chip stocks are included in the index. The market cap-weighted global funds that our pensions and investments will be invested in are effectively contained this index so its another clue as to where our global funds are heading...

THE KOSPI
The South Korean stock market (KOSPI) closely reflects the fortunes of the global economy. Everything is represented in the index from autos and shipping to microchips. The KOSPI peaked back in May 2021! That's getting on for 3.5 years and has recently taken a anothe turn down. This backs up the claim that the global economy is slowing as demand contonues to decline... 

 LONG TERM MARKET BREADTH

When the percentage of stocks in the US SP500 above their 150 day MA, is 10 or lower this represents the best time to re-enter a market at the point of maximum pain (or pessimism). Be greedy when others are fearful...

A slightly longer term version of the chart above shows percentage of stocks above their 200 Day MA. If this chart reading hits 20%, the market is extremely oversold. If its at or below 10% then all bets are off and its a case of waiting for the chart to start heading back up before re-entering the that market. 

As can be seen in the GFC 2008/9 the bottom of the chart can maintain a 'ranging' sideways pattern for quite some time. What is likely at the point of max pain is the central banks step in and start printing money again and implementing Quantitative Easing. This is a major green signal and is effectively the only reason we did not see an even worse GFC in 2008 and potentially even more catastrophic fallout from Covid.

DIVERGENCE: Looks for long term divergence on the weekly chart between the percentage of stocks above their 200 day MA...

Long Term Advance Decline Line

Advance Decline lines of stocks moving higher or lower in 2007 was in decline (and also even though its hard to see in the chart below). The Sep 2007 lower high in the ADL was a divergent lower high from the higher high achieved by the SP500 at that same point in time on the black sp500 line… 

… this is not what we are seeing today… (but if we start seeing the lower highs on the ADL then then that should ring loud alarm bells… 

Long Term New Highs vs New Lows

You can see a pretty strong relationship for new highs new lows and the long term direction of the stock market...

INFLATION, Oil/Enrgy & Yields (Leading Indicators)

One of the main signals of a decline in stocks is a rise in inflation. At the time of writing on 2024/25, we need to keep a close eye on the US CPI inflation. After the Covid inflation spike we are seeing the CPI follow an eerily similar path to the 1970 reflation scenario which saw inflation come back even harder. If we start to see inflation trend up from this point, that would be a huge warning sign for stocks...

For a deep dive <<< CLICK HERE >>>

If Energy is outperforming the SP500, it's a Warning Sign

Outperformance of energy stocks against the SP500 Index is highly correlated with the SP500 heading down as shown below. Energy Stocks (XLE) against (divided by) SP500 is shown in the top chart below and the SP500 directly below it. When XLE is outperforming the SP500, its a bearish signal for the stock market...

The same chart below shows the 2008 financial crisis showing energy stocks outperforming the SP500 whilst the SP500 crashed.

OIL PRICE SHOCKS ARE HARBINGERS OF DOOM

2022 saw the price of oil rocket to a gain in price as bad as the Oil shocks of the 70's and the Dot com bubble. It has already surpassed the GFC shock on 2007. Seems like a pretty accurate messenger telling us that bad things are around the corner.

THE PLAIN OLD CPI - AN EVEN BETTER HARBINGER OF DOOM

Recession have coincided with recessions (the grey shaded areas on the grid below) for the last 50 years...

Cash Yield vs Yield from Stocks

One investment rule from Warren Buffets Investing bible ... "The Intelligent Investor" by Benjamin Graham, is to allocate more to Cash when the yield on cash exceeds that of stocks which are shown below on the highlighted lines on the chart. 

These lows on the 'spread' (difference) in cash yields correspond pretty well with market tops of some form as can be seen on the second chart below.