Stock market on December 28, 2017: 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. Problem with using the yield curve to predict a bear market in stocks
  2. Growth stocks have massively outperformed value stocks. This is not a bearish sign.
  3. The next recession and bear market will be exacerbated by U.S. government debt.
  4. Odds of a “small correction” and weak U.S. economic data in February.
  5. The U.S. consumer is healthy, so this economic expansion and bull market  still have room to run.

4 pm: Why I don’t use the flattening yield curve to predict a bear market in stocks.
This post examined the lag between an inverted yield curve and a bear market in stocks.
An inverted yield curve can sometimes be used to predict “significant corrections”. However, it is not a perfect indicator. It often fails to predict significant corrections. Sometimes it predicts significant corrections and recessions AFTER they have already begun.
While the inverted yield curve was a good predictor of past bear markets, I don’t think it will be very useful for the next bear market (which our Medium-Long Term Model predicts will begin in 2-3 years).
Central bank intervention in the bond markets via QE was almost non-existent before the Great Financial Crisis. Trillions of dollars of global QE have artificially distorted the bond markets. Hence, the inverted yield curve is no longer a free-market indicator. It is heavily influenced by a few large actors (i.e. central banks).
Many investors and traders think that the yield curve will be inverted in 6 months. This is true if the curve continues to flatten at the current rate.
Here’s the 10 year – 2 year yield differential.

It’s entirely possible that the yield curve will not invert in 2018. Notice how the yield curve almost became inverted in late-1994, but did not invert until 1998!
 
4 pm: Growth stocks have massively outperformed value stocks. This is not a bearish sign.
Here’s a chart that seems bearish: “the stock market crashes after growth stocks massively outperform value stocks”.

This chart isn’t as bearish as it seems.
The 1929 crash happened when the value vs growth differential was a mere -1 standard deviation below trend (i.e. growth didn’t outperform by a lot).
More importantly, there is a logical reason why growth stocks have outperformed value stocks by so much in the current economic expansion.
Growth stocks are mostly tech stocks, and value stocks are often stodgy industry incumbents. Never before in history has tech (growth) disrupted old industry leaders as quickly as they are doing today. Tech startups are disrupting every field you can imagine, from farming to energy to finance. In other words, many “value” companies are seeing their products/business models destroyed by new “growth” companies. Since business disruption is happening at a faster pace than any time in history, it’s only logical that growth stocks should outperform value stocks by more than any period in history.
Such disruption did not even exist during the dot-com bubble. The dot-com bubble was purely a bubble. Even industry leaders like Amazon were not a serious threat to established industry at the time. Fast forward 20 years, and growth stocks like Amazon are seriously disrupting old value stocks like Wal-Mart. Some “value” companies like Borders have already gone bankrupt.
7 am: Odds of a “small correction” and weak U.S. economic data in February.
The 2017-2018 winter will probably be an extra cold winter in the U.S. Historically, economic data tends to disappoint in February due to weather-related reasons.
U.S. short term economic data is about as good as it gets right now. Historically, this means that the Economic Surprise Index (which calculates actual data vs. analysts’ expectations) will either plateau or fall in the next few months.

The stock market and U.S. economy move in tandem over the long term. Meanwhile, there is a weak positive correlation between the U.S. stock market and short term economic trends (i.e. the Economic Surprise Index). This short term correlation is weak, but it does exist.
Combine the cold winter with the Economic Surprise Index’s peak, and it becomes likely that U.S. economic data will disappoint in February.
Combine the odds of weak economic data in February with the longest stock market rally in history, which is why I think the next 6%+ “small correction” will begin in February 2018.
4 am: What the U.S. consumer tells us about this economic expansion and bull market in stocks.
Retail sales during this holiday season have been extremely strong. Retail sales grew at the fastest pace since 2011, when the U.S. economy bounced back from the previous recession. This means that the December 2017 Retail Sales Report (to be released in January 2018) will likely be strong.
More importantly, strong retail sales means:

  1. The U.S. economic expansion is not over, and…
  2. The bull market in equities still has room to run.

70% of U.S. GDP comes from personal consumption, so retail sales is important.

  1. Robust retail sales = an improving economy.
  2. An improving economy = bull market in stocks because the economy and stock market move together in the long run.

Notice how the YoY change in Retail Sales is going up. December’s Retail Sales Report should push this economic indicator to new highs.

 

Conclusion

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

  1. The S&P will make a small 6%+ “small correction” in Q1 2018. This will not become a “significant correction”. The current rally is the longest one in historywithout 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.

7 comments add yours

  1. Still trying to understand your decision to short es @ 2683. Even as yesterday’s closing rally was very strong.

  2. That’s good news coming from the US consumer. Glad consumer spending is strong for the economy. The consumer has made a great come back from the depths of the recession 9 years ago. Tom

    • I’m not forecasting. That’s the consensus. And even if it isn’t, the economic data usually takes a dip during February due to weather related reasons.

  3. Troy, do u really think the last trading day of the year is going to be met with tax loss selling, which is why u shorted es @2683?

    • I don’t think tax loss selling has any consistent impact on $SPX.
      I shorted ES simply because the model said so. Once again, this is a VERY SHORT TERM (day) trade. It has nothing to do with medium-long term fundamentals, and nor is it event-driven.

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