Q3 has been exceptionally strong. Here's why stocks will do well in Q4


Q3 2018 is now over. So far, the U.S. stock market’s price action has exhibited extreme strength.

This is from yesterday’s market study.
The S&P 500 has gone up 6 months in a row. This is bullish (historically). Look at the 9 months forward returns.

Moreover, the S&P has completely ignored “sell in May and go away”. Historically, this is a sign of bullish price action.

As you can see, both of these studies have 1 thing in common: the consistency of forward bullish returns seems to taper off at the 9 month-later mark. This supports the case that the U.S. stock market will make a major top somewhere in mid-2019 (9 months from today).

Here’s today’s market study.

This quarter (Q3 2018) has been the strongest quarter since 2013. This is uncommon, considering Q3 is typically weaker than the rest of the year (seasonality). Remember: when the market ignores “bearish” seasonality, it’s typically a bullish sign.
*If a market goes up when it “should” go down, imagine how much more it’ll go up when it “should” go up.
Here’s what happens next (historically) when the S&P goes up >7% in Q3.

Moreover, the S&P has now gone up 11 out of the past 12 quarters. Here are the dates, overlapped onto a chart of the S&P 500. During an economic expansion, this first happened in:

  1. Q2 1997 (bull market topped in 2000)
  2. Q1 1965 (bull market topped in 1968)
  3. Q2 1952


As you can see, this is a sign of late-cycle behavior. However, late-cycle behavior can last for years!
And lastly, the S&P 500 has made a new all-time high in September while the Russell 2000 (small caps index) fell. Before people tell you “this is a sign of non-confirmation”, here’s the data.
Here’s what happens next when the S&P closes at a monthly all-time high, when the Russell 2000 index falls. (Data from 1987 – present)

And before people tell you “this is just statistical noise, the stock market tends to go up in the long run anyways”, take a look at this chart.

Based on these market studies, the market’s forward returns are a lot stronger than “random”.

Conclusion

The U.S. stock market has shown extreme strength over the past quarter. Strength usually begets more strength. This is because the stock market’s rally usually becomes a lot weaker and choppier prior to major market tops. That’s why market tops are called “flat tops” or “head and shoulders”.
We’ll likely see volatility and the U.S. stock market go up together over the next few months (i.e. the stock market goes up, but in a choppier manner).

Outlook

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

  1. The S&P 500 has approximately 1 year left in this bull market. This is a MOVING TARGET.
  2. I will scale out of my long positions throughout 2019 (see why)

I am 67% long SSO right now (2x S&P 500 ETF) because my Medium-Long Term model does not foresee a big correction or bear market at this point in time. (This is a step down from being 100% long SSO previously). I ignore small corrections. I only sidestep big corrections and bear markets.
I have been long the S&P 500 since September 7, 2017 when it was at 2465.

3 comments add yours

  1. Troy, I wonder why being so bullish and with what appears to be good risk:reward ratio in the short/medium term you would scale down your SSO position from 100 to 67 and not keep higher? Is this because we are so late in cycle or because you want to tame volatility?

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