A strategist's proprietary model tells him financial conditions are tightening

The six-month stretch from November to April that usually produces the best stock-market returns may fail to do so this time around.

That's according to the veteran stock-market strategist Jim Paulsen, who thinks tightening financial conditions may sabotage that usually fertile stretch.

Paulsen outlined his theories in a Substack article published Monday in which he described his new, proprietary gauge for U.S. financial conditions, a model that incorporates five key economic policies and three potent economic forces.

The policy inputs are 2- BX:TMUBMUSD02Y and 10-year Treasury bond BX:TMUBMUSD10Y yields, the spread between those two yields, the trailing 12-month federal deficit or surplus, and the annual growth in real money supply.

His economic variables are oil prices (BRN00), real wages and the consumer price index.

This octet of components allows Paulsen to judge whether the overriding financial conditions are contractionary or accommodative.

Between Sept. 2024 and February of this year those conditions were extremely accommodative. Since May, however, these forces have become contractionary as seven of the eight components reversed.

Paulsen believes that because they have a lagging effect on economic activity and the stock market, these next two quarters may not be so positive as investors might anticipate.

The reading for these components at present puts them in the top quartile for contractionary impetus dating back to 1970, and it has produced, on average, November through April annualized returns of just 4.79% for the S&P 500 SPX. The lowest, or most accommodative, quartile generates 18.4% annualized on average.

Forward 1-month average annualized S&P 500 total return by restrictiveness quartiles 1970-2026

The seasonality argument isn't foolproof. In fact, November through April has delivered a negative return 25% of the time, most recently in 2024 and 2019.

So, while Paulsen observes many strategists and investors breathing a sigh of relief that the weak summer season for stocks is coming to an end, he disagrees that this is the right moment to be increasing equity exposure and boosting leverage.

-Jules Rimmer