Stock market on January 10, 2018: 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.

Thoughts

  1. Investors are insanely optimistic on stocks. Here’s what this means.
  2. Commodities and the stock market will go up together in 2018, but commodities will go up more.
  3. Massive earnings revisions: not a bearish sign.

Read What happens to the stock market when VIX and the S&P 500 go up together.
4 pm. Investors are insanely optimistic on stocks. Here’s what this means.
CNBC wrote 

The difference between market optimism and pessimism on the Investors Intelligence survey is at a level last seen in April 1986, 18 months before Black Monday. This is a warning sign.

Somehow, the author took this to be a bearish sign. It isn’t. It means that the stock market will not face a major problem for at least a year. The stock market SOARED more than 40% from April 1986 to August 1987!

In yesterday’s post, I demonstrated that insanely optimistic sentiment means the S&P will go higher in 6 months.
Based on current data, the Medium-Long Term Model predicts that this bull market has 2-3 years left. From a discretionary perspective, I think the U.S. stock market will soar during the next 2 years (although there will be “small corrections” along the way). This bull market will end in a fully-fledged bubble with every asset price in the world going up.
Then the next bear market can play out in a variety of ways. Let’s not jump to conclusions right now.

  1. The market can crash 50%, 60%, or even 70% (if all assets around the world go down together).
  2. But if we get medium-high inflation, then the market might just crash 40%. In other words, it’ll be a nominal decline of 40% but a much larger decline when adjusted for inflation.

7 am. Commodities and stocks will go up together in 2018
Jeff Gundlach thinks that commodities will surge in 2018 while the S&P will close this year in the red. This is primarily because the commodities-to-stocks ratio is at an all time low, which means that commodities should rise relative to stocks.

I agree that commodities will go higher in 2018, but I think the U.S. stock market will go higher as well.
Historically, a bull market in commodities was ALWAYS accompanied by a rally in stocks.

  1. Commodities surged from 1978-1980. The S&P 500 went up as well.
  2. Commodities surged from 2002-2007. The S&P 500 went up as well.
  3. Commodities surged from 2009-2011. The S&P 500 went up as well.

There’s a logical reason for this correlation. If commodity prices are to go up, then there needs to be a massive supply shock or an increase in demand.

  1. Massive supply shocks don’t exist today because OPEC’s power has been diminished (unlike the 1970s).
  2. An increase in demand for commodities can only exist when global growth is improving. An improving economy is good for the stock market, because the economy and stocks move in sync over the medium-long term.

So it’s entirely possible for stocks/commodities to go up, and the commodities-to-stocks ratio to go up as well. Commodities merely have to go up more than stocksfor this ratio to go up.
I think this is the most likely case. Commodity prices are much more volatile than stock prices. So if commodities rally in 2018, then they will rally faster than stocks.
7 am. Massive earnings revisions: not a bearish sign.
Bloomberg had an excellent piece

Analysts are ratcheting up their forecasts for U.S. corporate profits at the fastest pace in more than 10 years, according to the research firm Bespoke Investment Group. And that’s happening, unusually, right in the run-up to an earnings-season kick-off. While the upgrades could be taken as a positive reflection on the economy’s outlook, in the past such bullish analyst sentiment has served as a precursor to a market decline.

The last time the gap between analysts lifting forecasts and those lowering estimates was this wide was in May 2010.


There are a few things to note here:

  1. The recent surge in revisions is mainly due to the Republican tax cut. Earnings aren’t being revised higher because the stock market is rising!
  2. Most analysts do not expect the tax cut to yield a massive increase in economic growth. Instead, the tax cut is a direct boon to corporate profits.
  3. The chart is for the S&P 1500, not the S&P 500. Earnings for smaller stocks (in the S&P 1500) have been revised up at a faster rate than earnings for bigger stocks (in the S&P 500).
  4. Small companies benefit more from the tax cut than large companies.

Hence, I don’t believe that a “significant correction” is imminent (like in 2010) just because earnings revisions have soared. The Republican tax cut was unexpected, so analysts have to adjust their estimates. The tax cut is a medium-long term bullish factor for the stock market.
In addition, the Medium-Long Term Model doesn’t foresee a significant correction on the horizon.

Outlook

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. 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 Are financial conditions “too easy”.

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, do you think Friday with jpm earnings will be a sell the news event? Or do u think it will be a sell the market shock with revised earnings not taken into effect repatriation? When banks start reporting Friday.

    • I don’t know Matt. And I think anyone who tries to predict the short term with that level of confidence is trying to fool you. Nobody except insiders know if JPM will beat or miss. And nobody knows how JPM will react in the short term to that event.

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