Stock market on July 24, 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

  1. Insider Selling Ratio spikes
  2. The stock market is starting to react to Trump news.
  3. Q2 earnings season has been strong so far.
  4. Will the housing bubble hurt stocks?

4 pm: Insider Selling Ratio spikes
The Insider Selling:Buying Ratio in stocks is going up once again. Insiders are often referred to as “smart money”.
Is this a bearish sign for the U.S. stock market? Not necessarily. This is mostly an irrelevant indicator, so you can ignore it.
For starters, there is no definitive “smart money” in the stock market. Insiders are basically just contrarian. They sell when stock prices rise “too much” in a short period of time. But since the U.S. stock market has a natural long term bullish bias, insiders tend to sell way too early. Case in point – January and February 2017. Insiders sold a lot of stock because “the stock market went up too much after Trump’s election”. The market didn’t top. It continued to rally.
In addition, insiders are almost always selling more stocks than they are buying. This makes sense. Employees need to cash out on stock options, and mega-billionaires like Jeff Bezos need to fund their side-projects (i.e. Blue Origin) via stock sales.
More importantly, the recent rise in the Insider Selling:Buying Ratio has actually been accompanied by a decline in Insider Selling. The ratio is going up simply because Insider buying is falling even faster. In other words, even Insiders are neutral on the stock market.

6 am: the stock market is starting to react to Trump-news
After Comey tesified and revealed nothing of substance on June 8, the S&P 500 pretty much ignored any political news related to the Trump-Russia investigation. But over the past 2 weeks (last week in particular), the market has started to react to Trump-news.

Kushner will testify behind closed doors today, and Trump Jr will publicly testify on Wednesday. Here’s the risk

  1. Someone will leak details about the Kushner testimony.
  2. To be blunt, Trump Jr doesn’t know when to shut his mouth. As an inexperienced politician, he might say something on Wednesday that will significantly broaden Mueller’s investigation. Trump Jr is even worse than his father at knowing what not to say in public.

We still think that if the stock market goes down on Trump-news, it will only result in a pullback. We still think the next 6%+ “small correction” will probably begin around the time of the debt ceiling.
To be clear, the debt ceiling is not a real concern. It’s just a show that Congress needs to put on every once in a while in the name of “fiscal responsibility”. But when a stock market rally is extremely aged like today, any trigger can push the market down.
6 am: Q2 earnings season has been strong
As we expected, Q2 earnings season has been strong thusfar. The key highlight is revenue growth, which has been sluggish ever since this economic recovery began.

Out of the 97 S&P 500 companies that have reported earnings, 77% beat sales estimates. Compare this to the average of the past 5 years, in which just 53% of companies beat sales estimates.


We expect strong earnings seasons in the next few quarters as well. Like our sister fund said, a U.S. dollar bear market is good for U.S. corporate earnings and revenues.
6 am: Will the housing bubble hurt stocks?
U.S. home prices continue to rise beyond the high in 2007. Here’s the Case-Shiller National Home Price Index.

This brings back some memories of the housing-induced 2008 financial crisis. Will the current housing “bubble” result in another recession and bear market? No.
For starters, the index measures NOMINAL house prices. Over the long run, house prices will go up because of inflation! It’s been 10 years since Home Prices peaked in 2006. So adjusted for inflation, National Home Prices are still much lower than they were in 2006.
Let’s assume that we’re wrong. Let’s assume that the doomsayers are right, and that housing will collapse right now (which we think is a ridiculous assumption). The impact of housing and residential investment on the U.S. economy is much smaller than it was in 2005-2007.
Today, residential investment is 3.6% of GDP. At the peak of the housing bubble in 2005, it accounted for 6.1%. That’s a 40% decrease! So even if the real estate market collapses today, the impact on the broader U.S. economy will be much smaller.

In addition, the housing “bubble” today is very different from that of 2005/2006

  1. The housing bubble is primarily confined to a few large cities that are frequented by international investors (i.e. Chinese investors).
  2. These foreign investors pay mostly with cash! In 2005/2006, many Average Joe speculators had multiple mortgages. When real estate price appreciation merely slowed down, they were forced to default because they couldn’t afford the mortgage payments in the first place. In other words, they had to sell their houses just because prices weren’t rising fast enough. It was a ponzi scheme.
  3. Today, these international and wealthy investors pay mostly with cash. So they have no immediate need to sell when home price increases slow down.

The bottom line – the next bear market in stocks and economic recession will be driven by another factor. The Housing Bubble story is unlikely to replay.

Bottom line

Nothing has changed since our our July 21 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 have been sitting on 100% cash since May 13. Prior to that we were 100% long UPRO. 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
The energy sector fell a little today despite rising oil prices. Analysts’ estimates for future energy sector earnings are falling.
Here’s XLE (energy sector ETF).
Finance
The financial sector has been flat since earnings season began.

Tech
The tech sector led the S&P today (again).

 

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