The S&P 500 Is About To Get Crushed, Here’s What’s Breaking Out Instead | Jim Welsh

Key Concepts

• Advanced Decline (AD) Line: A running total of advancing versus declining stocks, used as a market breadth indicator.
• Secular Bear Market: A prolonged period of declining stock prices, typically lasting years.
• Russell 2000: An index representing small-cap stocks, often seen as a gauge of economic health.
• Macro Tides: Jim Welsh’s analytical service focusing on macroeconomic trends and market indicators.
• AI Concentration in S&P 500: The significant weighting of AI-related stocks within the S&P 500 index.
• Treasury Yields: The return an investor receives on U.S. government debt securities.
• Proprietary Major Trend Indicator: Jim Welsh’s custom indicator designed to identify long-term market trends.
• Wealth Effect: The phenomenon where increased wealth (e.g., rising asset prices) leads to increased consumer spending.

Market Outlook and Potential Correction

Jim Welsh anticipates a potential secular bear market driven by the escalating debt problem and the limitations of relying solely on the top 10% of earners to sustain economic growth. While acknowledging the current market resilience, evidenced by the AD line making new highs and the Russell 2000’s recent outperformance, he emphasizes that this doesn’t preclude a future correction. He believes a correction of 3-7% is likely in the near term, but a major correction requires a significant catalyst, such as a recession or a shock to the economy.

Today’s market activity (January 14th) – with the S&P and NASDAQ down 1%, but the Russell 2000, gold, and Bitcoin up – is viewed as potentially constructive, suggesting a rotation out of large-cap stocks and into other asset classes. He notes that 800 more stocks were up than down, indicating underlying strength despite the broad market decline. The concentration of the S&P 500 in AI stocks (47% comprised of the top 41) makes it vulnerable to sector-specific weakness.

Technical Analysis and Indicators

Welsh heavily relies on technical analysis, particularly the Advanced Decline (AD) line, to gauge market health. He explains that the AD line is a running total of advancing versus declining stocks and has historically been a reliable indicator of intermediate and long-term market tops. He also utilizes a proprietary “Major Trend Indicator” which, like the AD line, has been signaling resilience in the market.

He highlights past instances where divergences between the AD line and price action foreshadowed market declines (e.g., 2021, 2022 tariffs). Currently, both indicators suggest the market has the capacity to absorb selling pressure. He emphasizes the importance of looking for deterioration in these indicators as a warning sign.

Economic Fundamentals and Risks

Despite the positive technical signals, Welsh acknowledges underlying economic vulnerabilities. He points to the high levels of US debt, rising interest expense, and the looming challenges of Social Security and Medicare funding. He believes the fiscal situation is “not good” and “getting worse.”

He identifies several potential risks:

• Treasury Yields: A potential rise in yields, particularly if the Supreme Court reverses tax policies leading to increased government supply of bonds.
• Dollar Strength: A breakout above 102 could coincide with higher Treasury yields.
• Geopolitical Events: While acknowledging their headline risk, he prioritizes fundamental economic analysis.
• Fed Policy: He believes the Fed is unlikely to raise rates further, but political pressure from the Trump administration to cut rates could jeopardize the Fed’s independence and potentially lead to inflation.

Housing Market Analysis

Welsh discusses the housing market, noting that mortgage rates have fallen to their lowest level since 2022. However, he cautions that significant affordability issues remain. Research from Reef Insight suggests mortgage rates would need to fall to 3.68% and housing prices to decline by 29% to restore affordability. He also points to research indicating there isn’t a significant housing shortage, and that increased supply, coupled with potential economic slowdowns, could lead to price declines. He notes that a large percentage of homeowners have significant equity, mitigating the risk of widespread forced sales.

Wealth Effect and Consumer Spending

Welsh questions the sustainability of relying on the wealth effect – the idea that rising asset prices will continue to drive consumer spending. He notes that the top 10% of earners already account for nearly 50% of spending, and their ability to sustain this level of spending is limited. He also points out that the bottom 30-50% of the population is already under significant financial stress and cannot pick up the slack if the top earners reduce their spending.

Changing American Living Standards

Welsh expresses concern about the declining American dream, particularly for younger generations. He notes that a college degree no longer guarantees a well-paying job, and that the manufacturing sector has diminished. He cites surveys showing that younger people have less faith in capitalism and the prospect of upward mobility. He believes the unaffordability of housing and rising costs of living are contributing to this trend.

Notable Quotes

• “People don't sell because the market's expensive. That's the reality.” – Jim Welsh, emphasizing that market declines require a specific catalyst.
• “When this rally is over, I think we're going to see a secular bare market take hold. One of the reasons is going to be the debt problem.” – Jim Welsh, outlining his long-term market outlook.
• “You have money not leaving the market. That's when the market has problems, not when it leaves one area and then moves into another.” – Jim Welsh, explaining why the current rotation is not necessarily a bearish signal.

Data and Statistics

• S&P 500 AI Concentration: 47% of the S&P 500 is comprised of the top 41 AI-related stocks.
• Russell 2000 Performance: Russell 2000 up 7/10 of a percent on January 14th, while S&P 500 was down 1%.
• US Debt to GDP: Currently at levels historically associated with slower economic growth.
• Interest Expense on Credit Card Debt: $250 billion in the past year.
• Zillow Data: 53% of US markets saw housing prices fall an average of 9.7% in the last month.
• Homeowner Equity: Only 4% of homes have a loan amount exceeding the current market value.

Synthesis/Conclusion

Jim Welsh presents a nuanced view of the market, acknowledging current resilience while highlighting underlying economic vulnerabilities. He emphasizes the importance of technical analysis, particularly the AD line and his proprietary Major Trend Indicator, but also recognizes the need to monitor fundamental economic factors. He anticipates a potential secular bear market driven by the debt problem and the limitations of relying on the top earners to sustain economic growth. While not predicting an immediate crash, he advises caution and suggests investors should be prepared for a correction and a potential shift in market leadership. His analysis underscores the importance of diversification and a long-term perspective.