Stock market on February 24-25: weekend 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. Corporate earnings are strong. This is not “financial engineering”.
  2. Valuations are very high. This isn’t bearish for the next year.
  3. The stock market’s sentiment is once again “optimistic”. Not a bearish sign.
  4. The economy continues to improve. Medium-long term bullish for stocks.

Read Study: the stock market will go higher over the next year.
Feb 25. Corporate earnings are strong. This is not “financial engineering”.
Permabears love conspiracy theories. Every example of corporate mismanagement supposedly demonstrates that Corporate America is rigged, earnings reports are fake, and that we can never trust government statistics.
Permabears accuse companies of artificially “growing” Earnings-Per-Share via corporate share buybacks. (How this works: Earnings-Per-Share divides total earnings by total # of shares. Reduce # of shares = increase EPS).
This was indeed a big problem in the 1960s. Conglomerates abused this tactic to grow EPS until it caught up to them in the late-1960s. This is not a big problem today.
91% of the growth in Earnings-Per-Share since 2010 has come from more profits. Only 9% of the growth in EPS has come from corporate share buybacks. So earnings growth has indeed been strong, and this is not a result of “massaging the numbers”.
Feb 25. Valuations are very high. This isn’t bearish for the next year.
The U.S. stock market’s valuation is very high right now. There’s no doubt about that. But valuations are not useful for predicting future returns unless your time frame is EXTREMELY LONG TERM.

As you can see, the inverse correlation between valuations and future returns (1 year later) is VERY weak. So we can say:

  1. Valuations are very high right now. But valuations have very little impact on whether the stock market will be higher or lower 1 year later.
  2. But the longer your time frame, the more certain it is that high valuations will hurt the stock market.

I completely agree that we are in the final few years of this bull market and that the next bear market will see the S&P 500 decline more than 40%. I think we’ll be at the bottom of the next bear market by 2023. So the stock market’s returns will be negative on a 5 year time frame. But in the meantime, the stock market can go a lot higher before a bear market starts.
Feb 24. The stock market’s sentiment is once again “optimistic”. Not a bearish sign.
AAII Bulls is probably the best sentiment indicator for the U.S. stock market. As you can see in the following chart, the stock market’s recent correction didn’t really washout “excessive optimism”. Sentiment has gone back up along with the stock market’s bounce.

Some traders think that the stock market MUST reach “excessive pessimism” before this correction can end. I disagree.
Historically, “small corrections” (like the one right now) did not need to reach “excessive pessimism” before bottoming. Only “significant corrections” needed to reach “excessive pessimism”.
In addition, sentiment tends to remain elevated during the final 1-2 years of a bull market.
See how sentiment never reached “excessive pessimism” from mid-2006 to mid-2007, despite 2 “small corrections”.

See how sentiment never reached “excessive pessimism” in 1997 despite multiple “small corrections”.

Sentiment cannot be used to catch the bottom of this “small correction”.
Feb 24. The economy continues to improve. Medium-long term bullish for stocks.
The Chemical Activity Barometer is a useful leading indicator for the U.S. economy and stock market. Historically, the Chemical Activity Barometer’s “year-over-year % change” turned negative before a bear market and recession began.
This indicator expanded 0.5% in February and is decisively positive year-over-year. This is a medium-long term bullish sign for the U.S. stock market and economy.

Likewise, the Leading Economic Index continues to trend higher, as does its YoY % change. Historically, the Leading Economic Index’s “YoY % change” trends lower for months/years before a bear market and recession begins.


Read Stock market on February 23, 2018: outlook

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.

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