Stocks on February 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. I update this webpage throughout the day.

Thoughts

  1. The 10 year Treasury yield above 3% will not kill the economy and stock market.
  2. Bitcoin’s bear market is not going to drag the stock market down.
  3. VIX: the stock market’s bottom is very close or is already here.
  4. Trump’s tax cut is a medium-long term bullish factor for the stock market
  5. The labor market is medium-long term bullish for stocks
  6. Some weak Chinese economic data. Not necessarily a bearish sign for the Chinese economy.

Read Study: this is not the start of a bear market
4 pm: the 10 year Treasury yield above 3% will not kill the stock market and economy
Some bearish traders think that the stock market and economy will tank if the 10 year Treasury yield rises above 3%. I disagree. They are confusing technical analysis with fundamental analysis.
3% on the 10 year yield is a key technical level. A 10 year yield above 3% breaks the bearish pattern of “lower highs”. This will confirm the bull market in bond yields.
 

3% is not a fundamental level for the economy and U.S. stock market. Interest rate increases have a slow and steady impact on the economy. The economy does not work like technical analysis. The economy doesn’t “break down” if it falls below a key technical level.
When interest rates become too high, the economy slowly deteriorates and rolls over, which is why the stock market’s bull market tops are flat.
The U.S. economy is growing at a healthy pace right now. It’s impossible to guess when interest rates will start to impact the economy. But with the 10 year yield almost at 2.9%, a 0.1% increase to 3% is not going to kill the stock market and economy.
Focus on the economy and not interest rates. We are on the lookout for deterioration in the U.S. economy.
4 pm: Bitcoin’s bear market is not going to drag the stock market down.
There is a moderately positive correlation between the stock market and Bitcoin.

If Bitcoin’s bubble is over, does this mean that Bitcoin’s bear market will drag the S&P 500 down into a bear market? I don’t think so.

  1. The cryptocurrency space is tiny compared to the stock market. The S&P 500’s valuation is $20 trillion. The top 10 cryptocurrencies have a combined market valuation of less than $340 billion.
  2. Bitcoin and other cryptocurrencies topped long before the stock market topped on January 26. Bitcoin is already down more than 55% from its all-time high, and it has not caused a crash in the stock market. So even if the entire cryptocurrency space went to $0, the effects on the stock market would be muted.

And most importantly:

Correlations can break at any time. Correlation does not equal causation.

I expect the correlation between Bitcoin & stocks to flip from positive to negative in the next few weeks/months.
3 am. VIX: the stock market’s bottom is very close or is already here.
The VIX futures curve is usually in contango, whereby the spot price is lower than future prices. This is because traders generally expect volatility to increase as time goes on.
The VIX futures curve is currently in backwardation, whereby the spot price is higher than future prices. VIX is rarely in backwardation. Backwardation is historically a bullish sign for the U.S. stock market, even when the stock market has already made a “significant correction”.
*The S&P has fallen -11.8%. This is still “small correction” territory.

The last 2 times VIX fell into backwardation marked the S&P 500’s bottom.

  1. VIX fell into backwardation on August 24, 2015. This marked the exact bottom of the S&P’s 15% decline.
  2. VIX fell into backwardation on January 15, 2016. The S&P bottomed on this date, bounced, and made a tiny marginal new low in February. That was the S&P’s exact bottom.


VIX is currently in backwardation. Forget about the short term. Nobody can guess the market’s exact bottom. Focus on medium term risk:reward, which is very bullish right now.
3 am. Trump’s tax cut is a medium-long term bullish factor for the stock market
I’ve said for weeks that the Republican tax cut is a big boon for U.S. corporate buybacks, which is medium-long term bullish for the stock market. It looks like my hypothesis is correct. U.S. buybacks are surging right now.

  1. U.S. companies bought back $88.6 billion worth of stock from January 1 – February 6, 2018.
  2. U.S. companies bought back $40.3 billion worth of stock from January 1 – February 6, 2017.
  3. In other words, corporate share buybacks have doubled.

I expect buybacks to remain elevated throughout 2018, especially now that the stock market has fallen more than 10%.
3 am. The labor market is medium-long term bullish for stocks
Initial Claims came in at 221k last week. This is very close to Initial Claims’ lowest reading during this economic expansion. Initial Claims continue to trend lower, which is medium-long term bullish for stocks.
Historically, initial claims tend to trend higher before a bear market or recession begins.


Some weak Chinese economic data.
Rail freight growth used to be a good leading indicator for the Chinese economy. Chinese rail freight growth is falling right now.

Is this a long term bearish sign for the Chinese economy and stock market? I don’t think so.
China’s economy is transitioning from manufacturing to services/consumption. Hence, Chinese economic indicators that reflect heavy-industry & manufacturing are deteriorating while indicators that reflect services & consumers are improving. As a whole, the Chinese economy continues to grow at a healthy rate. This is a long term bullish sign for the Chinese stock market.
Read Stocks on February 9, 2018.

Outlook

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

  1. The S&P has made a small 6%+ “small correction”. This will not turn into a “significant correction”.
  2. The S&P 500 has approximately 2 years left in this bull market.

I do not use my discretionary outlook to trade. I remain 100% long UPRO 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.
I have been 100% long UPRO since September 7, when the S&P was at 2465 and UPRO was at $109.3
*I also have a small Day Trading portfolio. Click here to view my day trades.

4 comments add yours

  1. Hey Troy,
    Why just 2 years left in the bull market? Many analysts that I read about, talk about 5-6 years left.
    If the economy continues to grow, we should be fine right? As you mention, the economy drives the stock market.

    • Based on current data, the economy will start to deteriorate in 1.5-2 years time. This is not a static target.
      But you are right. The bull market will be fine as long as the economy is growing. I’m not looking to predict “sell in 2 years!” I’m saying “it’s a bull market as long as the economy is growing. But the economy might start to deteriorate in 2 years time, so be careful when that comes around”.

  2. Awesome article. The fundamental indicators are not easy to Enterpret and form a directional bias in any specific market. Your article helps to understand them. You are clearly an expert in your field and a good communicator.

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