Stock market on December 12, 2017: thoughts and outlook


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

Stock index & news

  1. The S&P 500’s weekly RSI is very high. This is a medium-long term bullish sign.
  2. Will the stock market make a small pullback after Wednesday’s Fed meeting?
  3. 2018 is guaranteed to be a volatile year, and there will definitely be a 6%+ correction.
  4. The German stock market will have a choppy year too in 2018.

2pm: The S&P 500’s weekly RSI is very high. This is a medium-long term bullish sign.
This chart gives you a sense of just how high the S&P 500’s weeklyy RSI is.

The weekly RSI is insanely high because the S&P has rallied 8 months in a row. RSI is highest when there are no “red” bars on the chart.

When the S&P’s weekly RSI exceeds 80 and it’s making a multi-year high, the S&P is higher 6 months later every single time.

*By using the paramater “it’s making a multi-year high”, we avoid post-bear market rallies. Post-bear market rallies are much fiercer than normal rallies in bull markets, so RSI will naturally be even higher.

  1. June 9, 1950: +2.4%
  2. May 14, 1954: +16.5%
  3. December 31, 1954: +14%
  4. July 1, 1955: +9.6%
  5. December 20, 1985: +16.3%
  6. March 20, 1987: +5.6%
  7. May 5, 1995: +13.4%
  8. August 12, 1995: +8.9%

Based on this historical study:

  1. The S&P’s returns are 6 months are excellent.
  2. The returns from 1-6 months are weak. This fits with the fact that the current rally is the longest rally in history without a 6%+ “small correction”. That’s why I think the S&P will make a 6-10% correction in Q1 2018 and break this record.

4 am: Pullback after Wednesday’s Fed meeting?
The Federal Reserve is widely expected to hike interest rates after Wednesday’s Fed meeting.
All 4 rate hikes in the current rate hike cycle have been followed by short term weakness. This is useful for day traders, but medium-long term traders/investors should ignore this pattern.
December 16, 2015
The S&P tanked 2 weeks after this rate hike.

December 14, 2016

The S&P fell 1% over the next 2 weeks.
March 15, 2017

The S&P fell 2.6% after this rate hike.
June 14, 2017

The S&P fell 1.3% after this rate hike.
4 am: 2018 will definitely be a volatile year.
Last weekend I published a study asking “What happens after the S&P rises 8 months in a row”. The conclusion: the next year is choppy.
Here’s a similar conclusion done from a different study.

As you can see, years after “low volatility” years always experience a >6% correction.
However, a year of low volatility is a long term bullish sign for the stock market. When VIX hits a low, it means that the current bull market isn’t even close to topping.

4 am: The German stock market will experience a choppy year too in 2018
It’s not just the U.S. stock market that will come under pressure in 2018. The German stock market will too. I stated that the German economy has somewhat plateaued in a weekend post.
Here’s an in-depth look at the Ifo Business Climate Index, which is extremely high right now.
Germany is an export powerhouse and a cyclical economy that depends on global demand (eg Chinese demand for German industrial products). Whenever management was this optimistic about the future of the German economy, the German stock market suffered next year. Here’s the chart from Tiho Brkan.

The German and U.S. stock market don’t have a 1-to-1 correlation. But if the German stock market falls, the U.S. stock market will struggle as well.

Sectors

The U.S. stock market’s sectors had a bearish reathe section to today’s tax plan news (House and Senate Republicans might reach deal by Friday).
What should have happened: small cap Russell 2000 should’ve rallied strongly (small cap stocks benefit the most from a tax cut). NASDAQ should have underperformed.
What did happen: Russell and NASDAQ both fell after the tax plan news. Only the Dow went up because financial stocks rose. (Banks also benefit from a tax cut).
Here are the sectors.

Bottom line

In terms of my short term discretionary outlook, here’s what I think will happen.

  1. I think the S&P will make a small 6-10% correction in Q1 2018.
  2. Then the S&P will make a new high, before making a multi-month consolidation or multi-month “small correction” in the 2nd half of 2018.
  3. 2018 will be much chopper than 2017. As of October 2017, this is the longest rally in history without a 6%+ “small correction”. If you haven’t already, please read What will the S&P do after rising 8 consecutive months.

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 also have a small Day Trading portfolio. Click here to view my day trades.

7 comments add yours

  1. Great post. Do you think tech already went through a correction? Will the upcoming correction (6%) impact tech as well?

    • Yes. When the S&P goes down >6%, it brings every sector down. Since tech is a more volatile sector, it will probably fall more than the S&P.

      • I sort of view the s&p as a set of stocks, isn’t it possible that there is a 6% drop and tech isn’t impacted?

        • Since 2000, correlation between individual stocks has risen significantly.
          6% is a fair sized drop. So the tech sector as a whole will be impacted. Sure, a few individual Tech stocks may be fine. But as a whole, the sector will be adversely impacted.

  2. Troy,
    1) if you think the market will definitely have a 6% small correction, then why not hedge your upro with a put option or take on a small inverse s&p etf?
    2). Does the 2 week post fed 2 week market drawdown relate to one of your prior posts with the santa clause rally. Where u state the actual santa clause rally starts post xmas & not leading up to the actual holiday itself. So there would seem to be correlation with this fed rate decision tomm with the market having a 2-week small drawdown leading up to the post Christmas santa clause rally?
    Thank you Troy for your thoughts.

    • 1. If I wanted to hedge, I’d rather just shift some of my portfolio into cash. For all I know, the S&P might first rise 7% before falling 6%. This is an unlikely scenario, but could happen.
      2. Yes

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