Stock market on July 10, 2017: thoughts and outlook


*These are our short term discretionary thoughts on the market.  We’re looking at how the market reacts to news, earnings, and other fundamental themes. Our models determine our trades.
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Stock index & news

Topics discussed:

  1. The Economic Surprise Index is improving.
  2. A big difference between 2017 and 2007.
  3. Trump-Russia political risks are subsiding.
  4. No more potential trade war.
  5. Sector rotation continues.

Economic Surprise Index
In the first half of 2017, permabears were worried that the Economic Surprise Index was tanking. We said:

The economy has normal and random fluctuations. No economic expansion goes up in a perfectly linear line. Small economic deterioration can end in a heartbeat. The economy can return to a pace of healthy growth on a dime.

Well it looks like the economic data deterioration is ending. Citigroup’s Economic Surprise Index is rising just as fast as it was falling.

The Economic Surprise Index DOESN’T measure the real-time state of the economy. It measures the economic data vs. analysts’ expectations. Analysts’ expectations were too high after the Trump election. They just needed time to lower their expectations. And now they’ve done it.
2017 is not like 2007
A decade has passed since the last bull market topped. The media loves these statements “10 years has passed, 20 years has passed, 30 years has passed, etc”. They make great headlines, but don’t mean much.
There is a huge difference between today and 2007. Soaring oil prices hurt the U.S. economy in 2007 and 2008. With the economy going in reverse and oil soaring in 2007-2008, the U.S. experienced stagflation.
Today, global economic growth (including U.S.) is healthy and oil prices aren’t surging. There is no stagflation. In 2007, the U.S. was a massive net importer of oil, so a soaring oil price had a significant negative impact on the U.S. economy. Today, the U.S. is a small net importer of oil thanks to shale.
The stock market doesn’t care about Trump-Russia.
We’re finally starting to get some details about the Trump-Russia investigation. According to a report from the NY Times, Trump’s son met with a Russian lawyer who promised to give him damaging information about Clinton during last year’s campaign.
In other words, the Trump-Russia investigation can be linked to Clinton’s own potential wrongdoings. This is an idea that one of my colleagues suggested a few weeks ago, but I dismissed it as being too ridiculous. She said “Don’t you find it weird that Clinton is uncharacteristically quiet during the Trump-Russia uproar? She should be out there rallying the Never-Trump troops every day! There’s only 1 explanation for this. The Trump-Russia investigation is really complicated, and digging deeper will reveal some of her own wrongdoings”. (The Clintons are as dirty as politicians come e.g. Pay-for-Play). In other words, implicating Trump could potentially damage her.
In the NYTimes twisted logic, it was the Trump campaign that was “evil”, while Clinton was on the side of angels. We think both parties are dirty. Politics as usual.

Clinton wouldn’t be having these problems if she hadn’t been so dirty. It’s not possible to taint someone who doesn’t have any dirt! Don’t shoot the messenger (Russia).

Since when was it illegal to find dirt on your political opponent? Every politician does that. In addition, the Trump campaign clearly did not use whatever dirt they got from Russia, if they got any.
But enough of my political ramblings. They’re irrelevant to the market. The bottom line is simple. The large private investors, fund managers, and institutional investors all know that these non-black-and-white political investigations tend to fizzle out. This is different from the Nixon investigation. In the Nixon investigation, there was a clear bad actor (Nixon) and a clear good actor (the Democrats). In the current case, neither parties are super clean.
Let’s assume that Mueller’s investigation does ultimately implicate Trump. The Mueller investigation is unlikely to make public any findings until 2018 because these thorough investigations typically take a year. So even if Trump does become implicated, this is not a concern in 2017. Wait until 2018.
No more trade war.
Many investors were concerned that Trump would slap steel tariffs on China and spark a global trade war. This concern is mostly irrelevant now.
Trump got the message after the G20 met on July 7-8. “If Trump starts slapping tariffs, he stands alone. It is 19 countries against the U.S.”.
China, Germany, and Russia are all allying against Trump on trade. Individually, none of these countries are strong enough to stand up against the U.S. (Trump). But combined, Trump has no choice but to abandon his destructive trade war policies.
After talking tough on China in late-June, Trump had no choice but to play nice with Chinese President Xi Jinping (from CNBC). He stands alone.
In fact, Germany made a clear swipe at Trump. Here’s the picture from the G20 meeting.

Leaders are typically placed according to their country’s importance. This means that China, Germany, and the U.S. are usually placed front-center. Trump was placed to the far left, away from Merkel (Germany), Xi (China), and Putin (Russia). Trump doesn’t look too happy. Traditionally, Germany was not an economic ally of China or Russia. But “the enemy of my enemy is my friend”. So China/Russia are cozying up to Germany, which leads the EU bloc.
Hence, various political risks to the U.S. stock market are subsiding.

Bottom line

Nothing has changed since our our July 7 bottom line.

  1. Our medium-long term model says that the U.S. stock market is still in a “big rally within a bull market”. There is no significant correction or bear market on the horizon. The optimal investment decision is to follow our medium-long term model and be 100% long stocks.
  2. We are sitting on 100% cash. Based on our Easy Trading model, the most risk-free and guaranteed part of the current “small rally” is over.
  3. We’re waiting for the next 6%+ small correction. Then we’ll shift into 100% long UPRO (3x S&P 500 ETF).

Sectors

The S&P’s sector rotation continues, and we’re heading into Q2 earnings season. It’s not looking good for the short term bears.
Energy
The energy sector was inline with the S&P today. XLE (energy sector ETF) is still stuck in its downwards slopping channel. Oil went up a little. Oil is also stuck in its downwards slopping channel.
Here’s XLE.

Here’s WTI oil.

Finance
Finance fell a little (underperformed the S&P) today because interest rates fell.
Here’s XLF (finance ETF).

Here’s the 10 year Treasury yield.

Here’s the 2 year Treasury yield.

Tech
Tech outperformed the S&P today. Here’s XLK (tech ETF).

2 comments add yours

  1. Good political insights. You’re right on Hilary, O awfully quiet on this as well. Good sign for stability. If no tariffs or devaluation is there another mechanism to simulate exports?

    • Not that I can think of. The purpose of tariff/devaluation is to make U.S. goods relatively cheaper.

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