Stocks on July 12, 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.
The economy and stock market move in the same direction in the medium-long term. Hence, leading economic indicators are also leading indicators for the stock market.

Thoughts

  1. Too many people are long term bearish on the stock market. This is not what stock market tops look like.
  2. There is nothing bearish about the fact that FANG and small caps are outperforming the S&P and Dow.
  3. Why the stock market won’t “crash” if China devalues its currency in this trade war.
  4. Philadelphia’s Leading Index suggests that the stock market’s top isn’t in.

Read Study: Q2 2018 earnings season will probably be strong. What this means for stocks
Read Study: why Q3 2018 probably won’t be as bearish as seasonality suggests
Read Study: how long it usually takes for a 10%+ “small correction” to make new highs
1 am: Too many people are long term bearish on the stock market. This is not what stock market tops look like.
Here’s something I’ve noticed anecdotally: the majority of professional investors and traders are bearish. All the headlines on mainstream financial media go somewhere along these lines:

  1. The trade war is going to be a disaster.
  2. Investors are fleeing risk-assets.
  3. We should all watch out for the yield curve inversion (the yield curve inversion wasn’t really noticed before previous bear markets – it only came to mainstream attention during this economic expansion cycle).
  4. The Fed is tightening, hence the economic expansion will end.
  5. High valuations, which means that stocks “must” go down.
  6. The deficit is exploding (except in reality, the deficit has consistently gone higher over the past 30 years).

This is the consensus view. And more often than not, the consensus view is wrong. The majority of professional investors and traders were not this bearish during previous bull market tops (2000 and 2007). For a group that on average underperforms buy and hold (the average hedge fund and professional doesn’t do much better than buy and hold), this makes me wonder if their bearishness should be a contrarian sign.
1 am: There is nothing bearish about the fact that FANG and small caps are outperforming the S&P and Dow.
FANG (Facebook, Amazon, Netflix, and Google) and the Russell 2000 (small cap index) have outperformed the S&P 500 and Dow year-to-date. Some people see this as a sign of “irrational exuberance” in the stock market. It isn’t.

FANG and the Russell 2000 are outperforming large caps for a good reason: the trade war has little impact on them.

  1. Facebook is blocked in China
  2. Amazon’s presence in China is small.
  3. Netflix is blocked in China
  4. Google is blocked in China
  5. Russell 2000 companies (small caps) derive more of their revenues and earnings from within the U.S.

This factor is neither bullish nor bearish. It’s perfectly normal for sectors that aren’t really affected in a trade war to outperform during a trade war. I expect this outperformance to continue as long as the trade war lasts. If it wasn’t for the trade war, large cap Dow would be going up with the rest of the stock market in 2018.
Investors tend to overestimate the influence that international factors have on the U.S. stock market, economy, and corporate earnings.
From Factset:
Only 1/3 of the S&P 500’s revenues are exposed to international (ex-U.S.) sources.

1 am: Why the stock market won’t “crash” if China devalues its currency in this trade war.
Some people are afraid that China will devalue its currency (Yuan) to retaliate against the U.S. in this trade war. I previously said that China doesn’t want to devalue its currency. China wants a strong Yuan right now because it wants to replace the U.S. Dollar as the world’s reserve currency. Weakening the Yuan on purpose will undermine China’s own financial goals.
More importantly, devaluing the Yuan doesn’t even help China. It doesn’t significantly boost China’s exports to the U.S. (contrary to what economic theory tells you).
China’s currency depreciated in 2015 and 2016.


China has the weaker hand in this trade war, which is why U.S. stocks aren’t falling significantly. None of China’s options are as effective as the U.S.’ options in this trade war. China is a net exporter, the U.S. is a net importer.
1 am: Philadelphia’s Leading Index suggests that the stock market’s top isn’t in.
The Federal Reserve of Philadelphia’s leading index for the U.S. is still sending a medium-long term bullish sign for the stock market right now.
This Leading Index needs to fall below 1% before an equities bear market or economic recession can begin.

Read Stocks on July 11, 2018: outlook

Outlook

Here’s what I think will happen based on my discretionary outlook.

  1. 2018 will trend higher but will also be a choppy year.
  2. The S&P 500 has approximately 1 year left in this bull market.

I do not use my discretionary outlook to place entry/exit trades. I am 100% long SSO (2x S&P 500 ETF) because my Medium-Long Term model does not foresee a big correction at this point in time. I ignore small corrections. I only sidestep big corrections and bear markets.
I have been long the S&P 500 since September 7, 2017 when it was at 2465.
*I also have a small Day Trading portfolio. Click here to view my day trades.

4 comments add yours

  1. Could you please take a look at commodities such as copper.
    Do you have a study for copper trend – is it still in a bear trend?
    Thank you
    Vic

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