Stock market on July 13, 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.
Go to our homepage for our latest market outlook.
*We update this webpage throughout the day.

Stock index & news

Topics discussed:

  1. When VIX is this low, it’s actually a medium-long term bull sign!
  2. Forward earnings growth continues to be strong.
  3. Could the finance sector use Q2 earnings to breakout from its resistance?
  4. Central banks
  5. Q2 earnings season starts tomorrow

4 pm: When VIX is this low, it’s actually a bullish sign!
VIX remains extremely depressed.

As we mentioned before, VIX cannot even be used to time 6%+ “small corrections”. And when VIX was insanely low, the next bear market or significant correction for the S&P was at least many months away.
For example, VIX bottomed in February 2007. Then the S&P made a small correction and quickly made new highs. As the S&P went up from March – October 2007, VIX slowly went up as well.

VIX bottomed in December 1995. The next significant correction began in July 1998, and the bear market began in March 2000.

We don’t pay much attention to VIX because VIX’s history is too limited.
Being long VIX using an ETF like VXX is a terrible idea. Unless your timing is perfect (and no one is always perfect), VXX’s erosion will kill you. When VIX is flat for a long time, VXX craters.
The first chart is VIX year-to-date.

The second chart is VXX year-to-date.

4 pm: forward earnings growth is still strong
It’s impossible to know if an individual earnings season will “beat” or “miss” expectations. However, “beats” and “misses” only impact the short term. The stock market’s medium-long term direction is driven by whether earnings are going up or down.
From June 29 to July 6, the S&P’s 12 month forward earnings increased from $139.3 to $139.6. This is strong growth, equivalent to 11% per year! Since 2017 began, forward earnings has been growing at around 0.3% per week.

Date Forward earnings $
6/07/2017 139.6
29/06/2017 139.3
22/06/2017 139
15/06/2017 138.9
8/06/2017 138.4
1/06/2017 138.1
25/05/2017 137.9
18/05/2017 137.4
11/05/2017 137.3
4/05/2017 136.9
27/04/2017 136.3
20/04/2017 135.9
13/04/2017 135.8
6/04/2017 135.1
30/03/2017 134.9
23/03/2017 134.5
16/03/2017 134.3
9/03/2017 134
2/03/2017 133.8
23/02/2017 133.8
16/02/2017 133.5
9/02/2017 133.4
2/02/2017 133.4
26/01/2017 133.9
19/01/2017 133.7
12/01/2017 133.3
5/01/2017 132.9
29/12/2016 132.7

4 pm: could the finance sector use Q2 earnings to break out?
Banks release their earnings reports tomorrow. Meanwhile, the finance sector is at a big resistance, poised to break out.

6 am: Central banks
Previously, a lot of traders were concerned that the Fed’s monetary tightening policy would kill this bull market.
After Yellen’s testimony yesterday, it’s clear that global central banks (Fed, ECB, BoJ) will remain accommodating throughout the rest of this bull market.
The “Fed’s rate hikes will kill this bull market” argument is a very old argument. It was reiterated in every historical bull market. The financial media repeated this phase from 2004-2006, 1998-2000, 1965-1969, etc. None of these bull markets were killed by the Fed’s rate hikes. The Fed hikes interest rates when the economy continues to grow. A growing economy is good for the U.S. stock market.
The financial media talks about a “Goldilocks scenario in which growth is good, but not so good as to induce rate hikes”. The Goldilocks scenario is nonexistent. A lot of the stock market’s biggest historical gains occurred when the Fed was raising interest rates. The economy determines the long term direction of the market, not the Fed. The economy isn’t going to tank just because the Fed hikes rates a measly <1%.
6 am: Q2 earnings season starts on Friday
Banks will start to release their earnings reports on Friday. Banks’ earnings go up when the year-over-year change in interest rates goes up because their revenues increase. This is counter-intuitive. “Shouldn’t banks’ costs (interest paid on deposits) go up too when interest rates rise?”
Not entirely. Interest rates on deposits go up much more slowly than yields on loans/bonds that banks issue. Depositors don’t shuffle around their deposits from one bank to another just for an additional e.g. 0.2%.
So although interest rates on loans in Q2 2017 are much higher than in Q2 2016, interest rates on deposits haven’t gone up. Hence, banks’ revenues have gone up, but costs haven’t really gone up. That’s why the finance sector is expected to experience strong earnings growth in Q2 2017.

Bottom line

Nothing has changed since our our July 12 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).
  4. Our portfolio is up 17% year-to-date.

Sectors

Energy and finance were inline with the S&P today. Tech massively outperformed. Nothing abnormal here.
Energy
Here’s XLE (energy sector ETF), still stuck in its downtrend.

Tech
Here’s XLK (tech ETF).

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