Stocks are trading like nothing happened.

Following a brief dip into bear market territory, the S&P 500 is now within 2% of the prior all-time high.

That’s despite ongoing uncertainties. The U.S. and China just reached a “framework” for trade negotiations to continue. But no deal was actually struck.

The 90-day pause on reciprocal tariffs against other countries runs out in a month.

And the Federal Reserve is keeping interest rates at the highest level since before 2008’s financial crisis.

The S&P 500 has continued its bull run. But investors are ignoring the damage awaiting the economy and corporate earnings.

One indicator points to deterioration… and it’s only getting worse.

Dropping Sharply

A massive divergence is opening up between leading economic indicators and the stock market’s gains.

Every month, the Conference Board releases the Leading Economic Index (LEI). It’s made up of 10 indicators that historically lead to changes in the economy.

That includes metrics like building permits and average weekly hours worked in manufacturing jobs.

As the name implies, the LEI is meant to provide advanced warning of trouble ahead.

For example, heading into 2008’s financial crisis, the LEI peaked and started moving lower two years before the recession hit.

The stock market also tends to lead the economy. Historically, the S&P 500 and LEI have often moved together.

But not this time. Take a look at the chart below:

The LEI peaked in 2022 and has been moving lower since (blue line). But the S&P 500 has kept grinding higher (orange line).

It’s a huge spread that’s only growing wider as the S&P recovers from the trade war but the LEI drops further.

It’s easy to ignore warning signals when the S&P 500 is trading near record highs.

But you shouldn’t ignore the cracks showing in key areas of the economy…

Getting Worse

During this cycle, the LEI peaked back in March 2022. That followed the Fed’s move to start increasing interest rates to the highest level in over 20 years.

So far, the economy has withstood the impact of higher rates despite the warning from LEI.

But LEI warnings can happen years before a recession strikes. So you need to be on the lookout for other signs that the economy could be heading for trouble.

Adding a trade war on top of tight monetary policy might be the last straw. We’re seeing it in the data.

The “soft” data is already pulling back. That includes surveys of businesses and consumers, like consumer confidence. But now the “hard” data is reflecting troubles as well.

Consider last week’s May payrolls report, for example. You probably saw headlines that job gains totaled 139,000 last month. That figure comes from data gathered across businesses.

But a report covering households showed that 696,000 jobs were lost during the month. It was the second-largest decline since 2020. That shows not all job figures are painting a positive picture.

That also followed an ADP report on private sector payrolls that showed just 37,000 jobs added during May… the second-lowest total going back nearly five years.

The labor market is usually the last part of the economy to worsen when recession is on the way. So don’t dismiss signs of weakness.

Investors could find themselves exposed if the LEI’s warning is finally catching up to the economy…

Happy Trading,

Larry Benedict
Editor, Trading With Larry Benedict