Stock market on July 6, 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. Last updated 4 pm.

Stock index & news

Topics discussed:

  1. The S&P’s recent consolidation is not surprising.
  2. Friday’s jobs report.
  3. Inflation will surge in 2018. Rising inflation is not bearish for the U.S. stock market.
  4. Why the U.S. stock market does not care about North Korea.

The recent consolidation
After rallying in the second half of May, the S&P has swung in a wide range (2450-2400). This is not surprising.
As we mentioned in a previous study, the U.S. stock market will face some weakness in the first half of July. The S&P made a 6%+ “small correction” in 5 of these 6 historical cases. The S&P made a 1 month consolidation in 1 of these 6 historical cases (1995).
If the S&P wants to make a small correction, it needs to do so ASAP. Q2 earnings season is coming, and it’s likely that the S&P will go up on earnings season.
*Based on our Easy Trading model, we’ll shift from 100% cash to 100% long UPRO (3x S&P 500 etf) when the S&P makes a 6% “small correction”.
Friday’s Nonfarm Payrolls
Today’s ADP employment report came in below expectations at 158k. Historically, the ADP report has not been very effective at predicting the BLS’ nonfarm payrolls. Sometimes the ADP report misses expectations while the nonfarm payrolls report beats expectations.
Based on the small correlation and regression between these 2 reports, we estimate tomorrow’s nonfarm payrolls will come at at 175k, which is slightly under analysts’ estimates (183k).
This makes sense. Employment growth typically declines as an economic expansion ages. Based on our medium-long term model, the next recession will begin in approximately 2-3 years (2019-2020). Since the economy (ignore GDP) leads the stock market, the bull market will end around 2019-2020 as well.
Here’s a chart for nonfarm private payrolls growth.

*Guessing individual economic data is meaningless. Focus on the overall trend.
Inflation will rise, which is good for the U.S. stock market.
We think oil will slowly rise in an upwards slopping channel for the rest of 2017. We think oil will start to surge in late-2017 to 2018. If we are right, then inflation will hover around 2% throughout 2017, and then tick up in 2018. (The year-over-year change in oil impacts headline inflation).
*If the economy continues to grow at its current pace, U.S. unemployment will reach approximately 3.7-3.5% in 2018. The last time unemployment was this low (mid-1960s), U.S. inflation started to surge. This is economists’ definition of “full employment”. When the unemployment rate falls below NAIRU, inflation starts to surge.

 
There’s a common misconception that rising inflation is bad for stocks. History proves that this is not true. Rising inflation boosts nominal corporate earnings, which is good for the U.S. stock market in the medium-long term. Rising inflation does not kill bull markets. Here are some historical examples.
Inflation went up from 2002 to 2006. The S&P 500 went up. 
First chart is inflation, second chart is the S&P.


Inflation went up from 1987 – 1990. The S&P went up as well (despite a significant correction in late-August 1987).


Inflation went up from 1978-1980. The U.S. stock market went up as well during this period.


North Korea is a joke.
As you probably know, North Korea is threatening to nuke the U.S. again. So why isn’t the U.S. stock market falling? Why is the market completely ignoring this “geopolitical risk”?
Because this isn’t a risk at all. Serious investors know that North Korea is simply using nukes as a bargaining chip for supplies. There is no way North Korea will attack the U.S.. If North Korea launched just 1 ICBM at the U.S. or its allies, the U.S. would completely annihilate North Korea. By various estimates, North Korea has 12 nukes and the U.S. has 2000. Yes, the U.S. will suffer a little bit of damage in the event of a war. But there will be no North Korea left. Kim may be crazy but he is not stupid.
By threatening retaliation, Trump is calling Kim’s bluff. And Kim is indeed bluffing.

Bottom line

Nothing has changed since our our July 5 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

Energy
The energy sector is still stuck in its downwards sloping channel. It has not been able to break its resistance.

Finance
The finance sector outperformed the S&P (fell less than the S&P) because interest rates went up today.
Here’s XLF (finance ETF).

Here’s the 2 year Treasury yield.

Here’s the 10 year Treasury yield. You can see that XLF follows the 2 year Treasury yield more than it follows the 10 year Treasury yield. Too many investors focus on the 10 year. The 2 year is better.

Tech
The tech sector’s decline today was inline with the S&P. Nothing abnormal.

1 comment add yours

  1. I know this blog is written from a DAILY perspective, but in the case of North Korea a longer time-frame helps.
    In my book, what we have here is a country stubbornly resisting integration (into – well, whatever. Not important) .
    Much like Serbia pre 1914 resisted big bully Austria‘ s push to integrate the neighbourhood (we all know how this turned out) the North Koreans over time have succeeded in doing the same, despite suffering horrific consequences https://en.wikipedia.org/wiki/Korean_War#Bombing_of_North_Korea .
    So, no bluffing on their side .
    Obviously unlike Australians, we Austrians know an abyss if we see one
    https://www.nytimes.com/2017/07/05/world/asia/north-korea-south-us-nuclear-war.html?hp&action=click&pgtype=Homepage&clickSource=story-heading&module=photo-spot-region&region=top-news&WT.nav=top-news
    Korea is not a joke.
    And not a casino. Mr. Trump better know the difference.

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