Stock market on January 3, 2018: outlook


*These are my discretionary thoughts on the market. My Medium-Long Term model determines my trades.
Go to the homepage for my latest market outlook. I update this webpage throughout the day.

Discretionary outlook

  1. Tech sector continues to lead the S&P higher. This is normal.
  2. The S&P 500 doesn’t care about rate hikes.
  3. The energy sector’s next resistance target.
  4. Every major country’s stock market went up in 2017. 2018 will not be the same.
  5. Do not buy emerging markets just because they are “cheaper”.

4 pm: Tech continues to lead the S&P higher.
Tech massively outperformed in 2017 while small caps lagged. This study demonstrated that tech might outperform in 2018 as well. Past outperformance ≠ future underperformance.
Tech has continued to outperform since the start of 2018. There is nothing bearish about this outperformance. Tech is always more volatile than other sectors, so tech will naturally outperform when the S&P is rallying.

  1. NASDAQ is up 2.3% year-to-date.
  2. Russell 2000 is up 1.1%
  3. Dow is up 0.8%
  4. XLF (finance sector ETF) is up 0.4%

3 pm: the S&P 500 doesn’t care about rate hikes.
Today’s FOMC minutes showed that a few FOMC members prefer “faster” rate hikes. And of course, you have the bears saying “this will kill the rally and bull market in stocks even faster”.
The S&P had no reaction to this news at all. This is normal and bullish price action.

History shows that the S&P usually goes up during a rate hike cycle. This is because the Fed hikes rates when the economy is strong. A strong economy = bullish for stocks in the medium-long term.
Here’s the S&P’s performance during the past 5 rate hike cycles.

6 am: The energy sector’s next resistance target.
XLE (energy sector ETF) continues to stand firmly above its trendline resistance since 2015. The next big resistance is $78-80. This is a big historical resistance: previous highs in 2016 and 2011.

4 am: Every major country’s stock market went up in 2017. 2018 will not be the same.
Here are the yearly gains for each country’s main ETF in 2017:

  1. South Korea’s EWY: 49.2%
  2. India’s PIN: 38.5%
  3. Hong Kong’s EWH: 36.5%
  4. China’s FXI: 36.2%
  5. Portugal’s PGAL: 31.6%
  6. France’s EWQ: 29.1%
  7. Italy’s EWI: 28.7%
  8. Germany’s EWG: 27.4%
  9. Spain’s EWP: 27%
  10. Japan’s EWJ: 24.3%
  11. Brazil’s EWZ: 23.7%
  12. U.S.’ SPY: 22.3%
  13. UK’s EWU: 21.6%
  14. Australia’s EWA: 19.9%
  15. Canada’s EWC: 15.7%
  16. Russia’s ERUS: 3.9%

We probably will not see a repeat performance in 2018.

  1. For starters, the U.S. stock market will be choppier in 2018 (and probably still close higher at year-end).
  2. Foreign economies (e.g. Europe) are a little too strong right now. Export economies like Germany’s are cyclical in nature. So when economic growth is too strong, it tends to dip a little, which brings the stock market down with it.

Here’s the chart from Tiho Brkan. Note that this indicator is a little too early. German Business Confidence topped in the beginning of 2007, while the stock market topped in October 2007.

4 am: Do not buy emerging markets just because they are “cheaper”.
I hear this every now and then in financial media:

The U.S. stock market is “fully priced” because valuations are high. Emerging market stocks have lower valuations. Therefore, you should invest in emerging markets and avoid the U.S. stock market.

Yes, it is true that emerging market valuations are generally lower than that of the U.S.
This argument is wrong . When the U.S. sock market’s valuation is high, it can only do 1 of 2 things.

  1. The U.S. stock market will make a bear market (e.g. 40%). In this case, the U.S.’ bear market will cause emerging markets to crash as well! All historical U.S. bear markets have caused foreign stock markets to crash. So emerging markets are no safer. There’s not much of a difference between a 40% decline and a e.g. 35% decline. Both U.S. and emerging market investors will be killed.
  2. The U.S. stock market will continue the last few years of this bull market. In this case, the U.S. stock market will soar along with emerging markets. The S&P 500 always sees double-digit increases in the last few years of bull markets (e.g. think 2006, 1999, 1972, 1967).
  3. Hence, there is no such thing as “fully-priced”. All that exists is “will the market go up or down”.

Yes, emerging markets might outperform the U.S. stock market in the final few years of this bull market. But the U.S. stock market will not go flat for years while emerging market soar just because “U.S. valuations are high”!

Conclusion

Here’s what I think will happen based on my discretionary outlook.

  1. The S&P will make a small 6%+ “small correction” in Q1 2018. The current rally is the longest one in history without a 6%+ “small correction”.
  2. 2018 will be much chopper than 2017. If you haven’t already, please read Are financial conditions “too easy”.

I do not use my discretionary outlook to trade. I remain 100% long UPRO because my Medium-Long Term model does not foresee a significant correction at this point in time. I ignore small corrections. I only sidestep significant corrections and bear markets.
I have been 100% long UPRO since September 7, when the S&P was at 2465 and UPRO was at $109.3
*I also have a small Day Trading portfolio. Click here to view my day trades.

3 comments add yours

  1. Excellent post.
    You should write a post about capital gains tax. Basically how holding for a year might be better than just selling immediately due to tax implications.

  2. Troy, are you short es sub 2700 as a hedge against your long trades? Every level I was shorting in 2017 (2290) (2500). I noticed once es broke through a solid number it never came back. But that was 2017. Do u feel we grind up to 2750-2790 before the rug pull 5% correction? Do u think the trigger to the 5-7% correction will. Be missed corporate earnings due to tax repatriation?

    • The Day Trading portfolio is simultaneously long nasdaq futures and short ES. So yes, it is a hedge.
      Perhaps you are right. Perhaps the correction doesn’t begin right now. I don’t know where the top before the 6%+ small correction will be. And nor do I know the exact trigger.

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