Stock market on December 21, 2017: thoughts & 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.

Stock index & news

  1. Too many gap ups over the past month.
  2. Trying to pinpoint the next 6%+ “small correction”
  3. If the S&P and Dow go up 9 consecutive months, what does this mean for the stock market?
  4. The yield curve is finally steepening.
  5. The finance sector is not reacting to the Republican tax cut.

4 pm: Too many gap ups over the past month.
In the past month, more than 100% of the S&P 500’s gains have come from the overnight gap up. There were 19 gap ups out of the last 22 trading days!
This is usually a sign of a weakening market (in the short term). This implies a few things:

  1. Foreign investors/traders are more eager to buy U.S. equities via pre-market, post-market, and futures. Foreign investors/traders are usually late to the game. It’s not a good sign when Americans start selling U.S. stocks and foreigners pick up their buying.
  2. Volume on the overnight is much lower than volume during the day. A real bullish trend needs to be confirmed by high volume. Going up on low volume is a sign of weakness.
  3. When a massive fund/organization wants to sell stocks (because they anticipate a meaningful correction), they will sell a lot of stocks during the day (when volume is heavy) and then buy a few stocks at night (when volume is light). In doing so, they prevent their own selling from killing the market. If all they did was sell and not buy, the market would fall significantly on their own selling.

4 pm: Here’s my attempt to pinpoint the next 6%+ “small correction”
The de-trended Equity Put/Call ratio is falling and will hit -0.15 within the next few weeks. The S&P usually goes up for a few more weeks after the Put/Call ratio falls to -0.15. Then the S&P makes a correction.


Based on this historical pattern, I think the odds of a 6%+ “small correction” beginning in e.g. February-March are higher than the odds of a correction beginning in January. Keep in mind that January has earnings season. It’s harder for the stock market to fall during earnings season.
5 am: If the S&P and Dow close higher in December, they’ll both be up 9 consecutive months.
The conclusion here is similar to “What happens after the S&P 500 rises 8 months in a row?

We can draw 2 conclusions from this study:

  1. The next significant correction is at least 5 months down the road (approximately). This coincides with my model, which does not foresee the start of a significant correction in the next few months.

  2. 2018 will be significantly more volatile than 2017, with multiple “small corrections” and pullbacks.

Here’s the data after the S&P and Dow close higher 9 months in a row.

2017 has been a year of exceptionally low volatility. The Dow has made 70 daily all-time highs this year. This is a new record. Historical bull markets did not end when the Dow made a massive number of record highs (1925, 1964, 1995, and 2017). This implies that the current bull market still has a few more years left.

Think about the logic behind this. Momentum is very high when the stock market’s volatility is very low. Very high momentum does not immediately give way to a bear market. Bull markets tend to have a flat top, which weakens bullish momentum.
5 am: The yield curve is steepening.
The yield curve (10 year Treasury – 2 year Treasury) is finally steepening after flattening for most of 2017. The 10 year yield has risen much faster than the 2 year over the past few days.


This steepening is expected. Historically, the yield curve never flattens nonstop. It flattens a little, steepens a little, flattens a little, steepens a little, etc until it is inverted.
A temporarily steepening yield curve is a long term bullish factor for the stock market. It buys time for the current economic expansion and bull market. Historically, the U.S. economy has gone into a recession on average 14 months after the yield curve was inverted. Historical bull markets usually peaked before recession began.

 
5 am: Finance is not reacting to the tax cut
Conventional thinking states that the Republican tax cut should benefit finance and small cap stocks the most. Instead, the sector that should be rising the most (finance)  isn’t rising. This is a bearish sign for the stock market in the short term.
XLF (finance sector ETF) has not gone up since December 4.

This is despite the S&P 500’s rally….

….and the 10 year yield’s rally. (There is a moderate correlation between finance and Treasury yields).

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.

2 comments add yours

  1. Troy, does research confirm on the first 1-2 weeks of the start of a new qtr buying in the market? So fund managers, institutional pension investors, new fund flows have a head start to building portfolio profits as a cushion before any real profit taking occurs or market pullbacks? Perhaps we get a parabolic blowoff top confirmed with 3-4 parabolic candles to the start of the new qtr to blow out all shorts before the 3-7% correction starts? I remember the major mistake I made when s&p was at 2500 oct.1st which was the start of the 4th qtr. the buying was relentless! I got caught with all the blog posts, cnbc, even this blog talking about the long overdue historical rally ” without a 5% correction”. I figured why not start shorting to capture the potential correction and I mistakenly gave back all my hard earned summer profits shorting right into the 1sr qtr at 2500. So perhaps we rally into the start of the new qtr in January and then start seeing weakness 1-2 weeks after that?

    • Hi Matt,
      There is no particular research suggesting that the first 1-2 weeks will be stronger than normal.
      Keep in mind that seasonality such as this isn’t very useful.
      I dont know exactly how January will play out. Nobody does.

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