Stock market on December 19, 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

Read 2 year Treasury yield crossed above the S&P 500’s dividend yield: what happens next.

  1. The S&P 500 is up 20% in 2017. What this means for 2018.
  2. A small sign of short term weakness in the U.S. stock market.
  3. The Republican tax cut’s real impact.
  4. Even a tiny pullback in the S&P 500 can result in a VIX spike.

3 pm: The S&P is up 20% in 2017. What this means for next year.
A 20% yearly gain is significantly higher than the 8.9% average yearly gain. However, a 20% gain is common. This has happened 18 times since 1950. Here the 18 historical cases.

  1. 1950. Up 16.3% next year.
  2. 1954. Up 26.4% next year.
  3. 1955. Up 2.6% next year.
  4. 1958. Up 8.4% next year.
  5. 1961. Down -11.8% next year.
  6. 1967. Up 20% next year.
  7. 1975. Up 19.1% next year.
  8. 1980. Down -9.7% next year.
  9. 1985. Up 14.6% next year.
  10. 1989. Down -6.5% next year.
  11. 1991. Up 4.4% next year.
  12. 1995. Up 20.2% next year.
  13. 1996. Up 31% year year.
  14. 1997. Up 26.6% next year.
  15. 1998. Up 19.5% next year.
  16. 2003. Up 8.9% next year.
  17. 2009. Up 12.7% next year.
  18. 2013. Up 11.3% next year.

As you can see, there is nothing exceptional about the magnitude of 2017’s gain. This is not “euphoria”. What’s exceptional in 2017 is the lack of volatility.
After the S&P gained >20% in a year, there were only 3 historical cases in which the next year was negative: 1962, 1981, and 1990.
Each of these 3 historical cases saw a “significant correction”.
Here’s 1962.

Here’s 1981.

Here’s 1990.

Based on current data, our Medium-Long Term model does not foresee a significant correction in 2018. The 1981 case in particular does not apply to today. The U.S. economy was in a deep recession by 1981. In stark contrast, U.S. economic growth is solid in 2017 and shows no signs of deterioration for 2018.
3 pm: a small sign of short term weakness in the U.S. stock market
I’m a little surprised that the U.S. stock market did not go up on today’s House of Representatives tax cut vote. Yes, the House vote was already a foregone conclusion. But the stock market did not react AT ALL to this vote. No “buy the dip” today I guess.

This is a small sign of bearish price action in the stock market. It shows that the U.S. stock market’s strong momentum in 2017 is weakening, and that 2018 will be a more volatile year.
5 am: The Republican tax cut’s real impact
The Republican tax cut has a significant long term impact on the U.S.
Its impact on the U.S. economy will be limited. The argument “corporate tax cut and cash repatriation = more investment and higher economic growth” is mostly false. There are 2 kinds of industries:

  1. Non-capital intensive industries such as tech. High tech doesn’t use a lot of capital in the first place! So even if tech companies repatriate cash that’s held overseas, they will not reinvest much of that into the U.S.
  2. Capital intensive industries such as manufacturing and automakers. These industries are unlikely to reinvest in the U.S.

Capacity utilization is very low. This means that capital intensive industries can increase production WITHOUT increasing investment in the U.S.. They don’t have a need for significant reinvestment. Hence, a tax cut and cash repatriation will not result in a massive surge in U.S. investment.

Instead, the Republican tax cut will probably result in:

  1. A surge in corporate buybacks.
  2. A surge in mergers and acquisitions. The current FCC is very pro-business and will support many M&A deals. This is in stark contrast with the FCC under Obama, which blocked many M&A deals.

Both of these are long term bullish factors for the U.S. stock market.
5 am: Even a tiny S&P pullback = VIX spike. 
I only trade the S&P 500’s ETFs. But here’s a trade idea for those who are bold enough.
Long VIX is usually a terrible trade. Time decay kills VIX options and long VIX ETFs erode like crazy. But you can see that over the past few months, even a TINY decline in the S&P 500 = a VIX spike.

  1. The S&P fell 1.3% from October 23 – October 25. VIX spiked 32.7%!
  2. The S&P fell 1.5% from November 7 – November 15. VIX spiked 56.1%!
  3. The S&P went up from November 24 – December 1. VIX spiked 70.3%!

Is long VIX a great short term trade? That’s up to you to decide. VIX is once again approaching its $9 support.

Word of advice: if you do long VIX, I suggest you wait until AFTER the Republican tax cut passes through Congress. There’s a >60% chance the S&P goes up on the tax cut announcement. (The S&P goes up on 60% of days.) Time decay is a big problem when you long VIX.

Conclusion

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

  1. 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 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.

11 comments add yours

  1. While the VIX index does spike up to 50-70% on minimal shocks in the system, I have a hard to getting reasonable risk/reward to capture that. Going long at the current cost of -20%/month (via things like VIXY) still seems like a high risk trade. If we do have a pull back, it very well could be in 3 months, at which point you’re down maybe 60% and would need to the pull back to try and break even, no? Buying some options to try and get exposure to a VIX spike maybe isn’t a bad idea. Costly though, because you’d have to buy several months out and the premiums would be high, but you could get 15 strike calls or something for 1.65/1.70 on Mar21 expiration and hope to get a 25% ROI on that. I guess I’m just thinking out loud because i’ve had a hard time finding the best way to trade VIX index spikes. Thoughts?

    • Yes. If you’re going to long VIX via options, you have to buy one that’s several months out. Like you said, you have no idea if the pullback is in January or February.
      I think the best course of action is:
      1. Buy VIX options, but only as a small chunk of your portfolio. This is something that Jeff Gundlach advocated a couple of months ago. He called “being long VIX via options = free money”. Granted, his timing was lucky and VIX spiked within 2 weeks of his being long.
      I’m a chicken for risk, which is why I only play the S&P 500’s ETFs. But if I was younger and hungrier, I would definitely be long VIX now. Just not through a VIX ETF. Those erode like crazy, and time is not on your side.

      • First, thanks for the reply! Since I had to include my email address in the form to post, I thought I would get an email if you had replied, glad I checked back at the page. 🙂
        I actually sold off all my positions about two weeks ago and am sitting on only cash at the moment. I know I should be waiting to invest back in until a decent enough correction, but, yeah, I’ll be honest, patience is difficult. Haha. Luckily I’m still fighting off the urge, was thinking some small options positions would keep the ever-present FOMO at bay a little better.
        Please send encouragement to stay in cash for while. Lol.
        Thanks.
        Shawn

        • I understand how difficult patience can be. That’s when your hobbies need to come into play! There’s a time for making money, and there’s a time for enjoying life. Being in cash is when you should be enjoying and improve other areas in your life (e.g. excercising, family time).
          But if you really can’t resist the urge, maybe try a TINY VIX position? A tiny one.
          Kind Regards,
          Troy

    • I don’t trade VIX for the reason that time decay kills both ETFs and options. But if I had to choose:
      1. Avoid VXX like the plague. It erodes like crazy, and it doesn’t match the VIX. E.g. if VIX spikes 20% in a day, VXX might only go up 8%.
      2. I think VIX options is a better idea.

  2. Would it be wise To stay long into year end because profits taken now until the end of the year have to pay taxes on the higher old rate
    If any profits will be for the taking it will be in January when the lower tax rate takes into effect for April 2019 tax season

    • Yes, holding it into January is the best idea. Even if the S&P does go down in these last 1.5 weeks of December, I don’t think SPX will go down by much. That compared to the new tax rate: new tax rate is more attractive.

  3. Since there was no buy the dip today, is that a good indication it’s a sell the news event? Is it smart to start a small short vs a 2700 stop in es futures based on the negative reaction to the house vote.

    • No. Price action is more important in markets like Forex and commodities than SPX. It doesn’t work that well in SPX. A lot of times SPX will seem short term weak, only for it to suddenly become strong.
      Today’s SPX price action is just an observation

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