Stock market on December 26, 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. When will volatility return to the U.S. stock market?
  2. Which stock market sectors will underperform/outperform in 2018?
  3. When Business Optimism is this high, the stock market goes up next year.
  4. Corporate earnings growth has been strong in Q4 2017.

4 pm: When will volatility return to the U.S. stock market?
After a long year of low volatility, the stock market needs a specific trigger/news to bring volatility back.
This news doesn’t have to directly impact the stock market. It just needs to remind investors that the world isn’t all nice and rosy. Here are some triggers that can bring volatility back to the S&P 500.

  1. January 19: potential government shutdown. I don’t think the stock market will care about this trigger. Everyone knows that Congress will keep kicking the can down the road. Historically, the stock market’s reaction to government shutdowns has been mixed (i.e. the stock market doesn’t care).
  2. mid-January: Merkel’s deadline. Merkel’s party and the SPD have until mid-January to form a grand coalition. Otherwise, Merkel will be forced to form a minority government. A minority government creates political uncertainty for Germany, which will at the very least adversely impact the Euro.
  3. mid-March: the U.S.’ review of NAFTA concludes. The U.S.’ review of NAFTA will conclude by mid-March. Although Trump cannot unilaterally withdraw the U.S. from NAFTA, he can make a lot of noise about trade wars.

The point is that when a rally is this stretched, any unexpected news can push the S&P down a few percent.
3 am: Small Business Optimism is very high. This is a long term bullish factor for the stock market.
NFIB’s Business Optimism is near all-time highs thanks to the Republican tax cut.

This is what happened historically when the Optimism Index was very high.

Notice how the S&P 500 closed higher in every one of these historical cases! In addition, the S&P was generally weak around the 3-4 month mark.
This somewhat matches my discretionary outlook. I think the S&P will make a 6-10% “small correction” in Q1 2018.
3 am: Corporate earnings growth has been strong in Q4 2017
Earnings reports for Q4 2017 come out in the second half of January. Earnings growth is expected to be very strong: around 10% year-over-year. If this estimate is correct, then this will be the strongest earnings growth since 2011, when China/Europe/EM economies first started to slow down!

The reason for such strong earnings growth is simple. More than half of S&P 500 corporate revenues come from outside the U.S.. The Chinese, European, and Emerging Market economies have been recovering since 2016. Hence global revenues and earnings have been on the rise.
There are no notable signs of deterioration in the global economy today. So I expect S&P 500 earnings growth to remain solid in 2018.

Conclusion

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

  1. The S&P will make a small 6-10% “small correction” in Q1 2018. This will not become a “significant correction”. 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 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.

8 comments add yours

  1. I’m like you in that I’m long in my after-tax portfolio. Even though your prediction on the choppiness of 2018 shouldn’t affect my overall long-term goals, I still will find myself observing the market more than I should. I’ve actually made a new year’s resolution not to look at the market so often; let’s see how it goes 🙂

    • Watching something closely and not doing anything are 2 different things. We always need to be on our toes in case something super-bearish happens. Not being alert is how many investors went over the cliff in 2008.

  2. Hey Troy,
    As a future holiday gift, do you plan on sharing with us if your model mentions to sell? 🙂
    I really enjoy your readings; keep up the excellent work!
    Best,

  3. I’m waiting for the correction! I anticipate 2018 to be rough too, though I thought that with 2017 as well.

    • I think we as investors tend to overestimate political forces (Trump uncertainty) and underestimate macro forces (the economy has been on fire throughout most of 2017)

    • Expectations are indeed high. It’s extremely hard to guess what is or isn’t “priced in” to the markets, which is why I don’t attempt to do so. The Medium-Long Term Model doesn’t attempt to say “the market’s fair value = XYZ”. The model only predicts major turning points in the market.

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