Stocks on April 20, 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. I update this webpage throughout the day.

Thoughts

  1. VIX will slowly grind higher over the next year. But the stock market will go higher too.
  2. Corporate debt is ballooning. Not yet a medium-long term bearish factor for the stock market.
  3. Leading Economic Index is still trending higher. A medium-long term bullish factor for the U.S. stock market.
  4. Initial Claims are starting to flatten. This bull market has at most 2 years left.

6 pm: VIX will slowly grind higher over the next year. But the stock market will go higher too.
The 10 year – 2 year Treasury yield differential is a good leading indicator for VIX, the same way it is a leading indicator for the stock market. Here’s the yield differential (inverted) overlapped onto VIX.

This implies that VIX will slowly chop higher as the yield curve continues to flatten over the next year. But is this medium term bearish for the S&P 500? No.
VIX tends to chop higher along with the S&P 500 during the final legs of a bull market. VIX’s bottom should precede the stock market’s top (VIX bottomed in January 2018 while the S&P topped in January 2018 – hence it wasn’t the bull market’s top).

1 am: Corporate debt is ballooning. Not yet a medium-long term bearish factor for the stock market.
Thanks to a decade of record low interest rates, the median firm has record net leverage (in other words companies have gone on a borrowing spree over the past decade). Bears use this to argue that a debt-fueled stock market crash is looming just around the corner. I disagree.
It doesn’t matter what the absolute level of debt is. What matters is whether or not companies can SERVICE that debt. Very high levels of debt are not a problem as long as companies can afford that debt.

Interest coverage measures Corporate America’s ability to service its debt. The higher the interest coverage ratio, the more easily companies can service their debt.
*Interest coverage ratio = a company’s earnings before interest and taxes (EBIT) / the company’s interest expenses for the same period
The interest coverage ratio is still very high right now because:

  1. Interest rates are still very low (historically).
  2. Corporate profits have surged over the past decade.

Hence, the massive amount of corporate debt is not yet a medium-long term bearish factor for the stock market. This will be a big problem in a few years when interest rates are significantly higher than where they are today.

1 am: Leading Economic Index is still trending higher. A medium-long term bullish factor for the U.S. stock market.
The U.S. economy and stock market move in sync over the long run.
There are a few small and insignificant signs of economic data deterioration right now. But as a whole, the U.S. economy is still growing at a healthy rate.
The Leading Economic Index increased 0.3% in March, down from 0.6% in February, However, it is still trending higher: this is important because the Leading Economic Index tends to turn negative before a recession begins.

This is a medium-long term bullish sign for the U.S. stock market.
1 am: Initial Claims are starting to flatten. This bull market has at most 2 years left. 
Initial Claims went down a little bit from the previous week’s reading (232k vs 233k), but has mostly been flat over the past few months.

*Initial Claims lead the economy and stock market. Historically, Initial Claims trended higher before a bear market in stocks started.
This suggests that the bull market in stocks is not over because Initial Claims have not trended higher yet (it is mostly flat right now).
HOWEVER, we are watching out for any SUSTAINED increase in this data series because Initial 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 1-2 years left.

Read Stocks on April 19, 2018: outlook

Outlook

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

  1. The S&P has made a 6%+ “small correction”. This will not turn into a “significant correction”.
  2. 2018 will trend higher but also be a choppy year. There will be another correction later this year.
  3. Why I’m medium-long term bullish on the stock market from a discretionary point of view.
  4. The S&P 500 has approximately 1-2 years 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 significant correction at this point in time. I ignore small corrections. I only sidestep significant corrections and bear markets. So please take my short term thoughts with a grain of salt.
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.

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