In August, the University of Michigan’s Consumer Sentiment Index dropped to the lowest level in nearly three years. Trade wars and recent weakening in the economic data are leading to greater uncertainty among survey participants, notes Jim Stack, editor of InvesTech Research.

Yet, the Consumer Confidence Index from the Conference Board remains more resilient as a strong labor market has kept optimism about the economy high in this broader survey. If the Consumer Confidence level falls below its January 2019 low, it would likely confirm major economic trouble ahead.

The ISM Manufacturing Index has entered contraction territory for the first time since 2016, a signal that usually precedes recessions or prolonged economic slowdowns.

Trade and soft global economic conditions are clearly having an adverse impact on the measure, with new orders declining as well. The weakness in manufacturing is a global phenomenon — approximately 70% of countries have manufacturing PMIs in contraction.

With manufacturing already in pre-recession territory, a failure of this index to bounce back above 50 would be an ominous warning sign for future economic growth.

One of our technical indicators is signaling a high degree of danger, as the bearish “Distribution” component  of our Negative Leadership Composite shows increasing downside leadership. Risky markets are often marked by an internal disconnect as downside leadership increases despite (apparent) market resilience.

The Dow Jones Transportation Average (DJTA) and the Russell 2000 Index are continuing to negatively diverge from the Dow Jones Industrial Average (DJIA). As noted in previous issues, divergences in these key secondary indexes are often symptomatic of a developing market top.

Both the DJTA and the Russell 2000 Index have tested their May correction lows several times in recent weeks (red dashed lines), and a decisive break through these levels means that major indexes may follow.

Clearly, potential warning flags are developing; yet actual confirmation of a bear market and recession will have to wait for additional evidence.

While new index highs cannot be ruled out with another Fed rate cut imminent on September 18, maintaining a defensive strategy is strongly advised, as we feel the potential for further gains is outweighed by the risk of a sudden downward reversal in this aging bull market.

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