Stocks on October 27, 2018: fundamental outlook


*Go to the blog for my latest market outlook. Members can go here to see our trading model’s latest updates and how we’re trading the U.S. stock market right now based on these models.
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. Stock buybacks resume in the 2nd week of November, after the midterm elections. Setup for a nice second-half of November rally.
  2. Initial Claims are starting to trend sideways. Not yet long term bearish for the stock market, but will be long term bearish in 2019.
  3. Continued Claims are still trending downwards. But watch out if this start to trend upwards.
  4. Earnings are strong, but stocks are sinking on earnings

Read: The stock market’s volatility is very high. What’s next.
1 am: Stock buybacks resume in the 2nd week of November, after the midterm elections. Setup for a nice second-half of November rally.
I mentioned this on October 11 and October 25:
Late-September to the end of October is the “blackout period” for stock buybacks. A “blackout period” = 5 weeks before an earnings report during which companies aren’t allowed to buy back their stocks.

*Earnings season is in the second half of October.
As you probably know, share buybacks have SOARED this year, putting a floor under the stock market. With the absence of share buybacks right now, the stock market is falling right now. But once buybacks resume….
Deutsche Bank published a chart detailing when the blackout period will end.

As you can see, most companies will have exited their blackout period 2 weeks later, which is after the midterm elections. Remember how stocks tend to surge in the 6 months after midterms.

1 am: Initial Claims are starting to trend sideways. Not yet long term bearish for the stock market, but will be long term bearish in 2019.
Yesterday’s reading for Initial Claims went up a little from its previous reading (from 210k to 215k). While Initial Claims have mostly been trending lower, they are now starting to trend sideways right now.

*Initial Claims lead the economy and stock market. Historically, it trends higher before a bear market in stocks started (see study).

This suggests that the bull market in stocks is not over because Initial Claims have not trended higher yet. HOWEVER, we are watching out for any SUSTAINED increase in this data series because Initial Claims are very low right now (historically speaking).
At such low levels, Initial Claims will probably trend upwards in 2019.

1 am: Continued Claims are still trending downwards. But watch out if this start to trend upwards.
Yesterday’s reading for Continued Claims made a new low for this economic expansion. The key point is that Continued Claims are still trending lower right now.

Like Initial Claims, Continued Claims lead the stock market and economy.
This suggests that the bull market in stocks is not over because Continued Claims have not trended higher yet. HOWEVER, we are watching out for any SUSTAINED increase in this data series because Continued Claims are very low right now (historically speaking). We are trying to catch the bull market’s top because the bull market most likely only has 1 year left.

This chart demonstrates the inverse correlation between the S&P 500 and Continued Claims. A downwards trending Continued Claims = medium-long term bullish for the stock market.

1 am: Earnings are strong, but stocks are sinking on earnings
Here’s the latest on the current earnings season from Factset:

  1. 77% of earnings reports have beat expectations. This is above the 5 year average of “beats” (71%).
  2. 59% of earnings reports have beat expectations. This is inline with the 5 year average of “beats”.

So this has been a solid earnings season.
However, the average company that beat earnings expectations saw its stock price fall -1.5% from the 2 days before earnings to the 2 days after earnings. This is the worst reaction to “earnings beats” since July 2011.

As you would recall, the stock market tanked in August 2011.

Does this mean that the stock market will crash another 10% in November 2018? I think it is unlikely.

  1. July-August 2011 is a sample-size of one. We don’t have data before that
  2. Our technical studies show that the stock market’s volatility is already at an extreme. Volatility is mean reverting. When volatility eventually subsides, it’ll be medium term bullish for the stock market.
  3. You can see that the concept of “stocks fell on good earnings reports, hence they must fall even more after earnings season” is a flawed concept. Stocks often fell in 2017 on strong earnings. But they still went up afterwards.


How the stock market reacts to earnings season isn’t an accurate reflection of how the stock market will react after earnings season.
Read Stocks on October 25, 2018: outlook

Outlook

Here’s what I think will happen based on our discretionary outlook:

  1. The S&P 500 has less than 1 year left in this bull market (bull market top sometime in 2019).
  2. The recent decline is just a correction in a bull market. The medium term direction is still bullish  (i.e. trend for the next 6-9 months)

Our discretionary outlook is usually, but not always, a reflection of how we’re trading the markets right now. We trade based on our clear, quantitative trading models, such as the Medium-Long Term Model.
Members can see exactly how we’re trading the U.S. stock market right now based on our trading models.

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