Stocks on October 4, 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. High yield spreads continue to narrow. A medium-long term bullish sign for the stock market.
  2. Unit profits are down: this equities bull market doesn’t have a lot of years left.
  3. Japanese stock market breakout!
  4. Interest rates are going up. NOT bearish for the stock market.
  5. U.S. stock market traders should ignore the stock market’s valuation.
  6. Improving the Short Term Trading Model

Read Distribution selling: this is a bullish sign for the stock market?
Read Stock market’s breadth is weak: stocks will crash! Just kidding
1 am: High yield spreads continue to narrow. A medium-long term bullish sign for the stock market.
High yield spreads continue to trend downwards.

This is a medium-long term bullish sign for the stock market and suggests that the stock market will continue to trend higher in the medium-long term. Bond market participants are smarter than stock market participants, which is why the bond market is a leading indicator for the stock market. Historically, high yield spreads widen (trends higher) before bull markets top.


1 am: Unit profits are down: this equities bull market doesn’t have a lot of years left.
Corporate unit profits have been trending downwards since the end of 2014.
This IS NOT a timing indicator for predicting the end of bull markets. Sometimes unit profits will fall a year or two before recessions and bear markets begin. Sometimes unit profits will fall for half a decade before bear markets begin. But this does tell us that 2014/2015 marked the halfway point for this economic expansion and bull market.

This indicator suggests that this equities bull market doesn’t have many years left. By the Medium-Long Term Model‘s estimates, mid-2019 is the most likely top.
1 am: Japanese stock market breakout!
The Japanese stock market has broken out of a big consolidation.

Historically, these breakouts are neither consistently bullish nor consistently bearish for the Japanese stock market.

1 am: Interest rates are going up. NOT bearish for the stock market.
Interest rates are going up again.


Remember earlier this year how everyone obsessed with interest rates said “the stock market will fall because interest rates are going up”?
That is a textbook case of financial dogma. Historically, the stock market goes up more often than it goes down when interest rates rise.

U.S. stock market investors and traders should mostly ignore rising interest rates.
1 am: U.S. stock market traders should ignore the stock market’s valuation.
Too many traders use “valuations” to to trade. This is silly, to say the least.

  1. Valuations tell you where the market will be in 5 years.
  2. Valuations don’t tell you where the market will be in the interim. I.e. valuations don’t tell you where the stock market will be next week, next month, or even next year.

I see this all the time. Short term traders being bearish because “the stock market is overvalued”.
Here’s the data to prove that valuations don’t matter for traders. It only matters for people who buy and hold forever.
These are the S&P 500’s 1 month forward returns vs. its valuation (P/E ratio). Notice how there is almost no correlation between the stock market’s valuation and 1 month forward returns.
R squared = 0.008

These are the S&P 500’s 3 month forward returns vs. its valuation (P/E ratio). Notice how there is almost no correlation between the stock market’s valuation and 3 month forward returns.
R squared = 0.0255

These are the S&P 500’s 6 month forward returns vs. its valuation (P/E ratio). Notice how there is almost no correlation between the stock market’s valuation and 6 month forward returns.
R squared = 0.05

These are the S&P 500’s 1 year forward returns vs. its valuation (P/E ratio). Notice how the correlation between the stock market’s valuation and 1 year forward returns is weak.
R squared = 0.0765

These are the S&P 500’s 2 year forward returns vs. its valuation (P/E ratio). Notice how the correlation between the stock market’s valuation and 2 year forward returns is weak.
R squared = 0.0646

Focus on the economy instead of valuations. The economy is still improving.
1 am: Improving the Short Term Trading Model
I am improving the Short Term Trading Model right now. This chart illustrates the model’s returns over the past 36 years (log scale).

Click here to download the data in Excel
Read Stocks on October 2, 2018: outlook

Outlook

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

  1. The S&P 500 has approximately 1 year left in this bull market (bull market top sometime in 2019).
  2. I will scale out of my long positions throughout 2019 (see why)

I am 67% long SSO right now (2x S&P 500 ETF) because my Medium-Long Term model does not foresee a big correction or bear market at this point in time. (This is a step down from being 100% long SSO previously). 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.

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