Stocks on February 7, 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 Fed will be supportive of the stock market. Medium-long term bullish factor for stocks.
  2. VIX and its ETFs: a bullish sign for stocks.
  3. Nobody knows if the stock market’s exact bottom is in. But this is a good price to buy from a risk:reward perspective.
  4. The S&P 500 has almost reconnected with its 200 daily moving average.

Read Study: what happens next when the stock market crashes on one day
2 pm: The Federal Reserve is going to be supportive of the stock market. Medium-long term bullish factor.
Some people attribute Monday’s stock market crash to “fears of faster Fed rates hikes due to rising inflation.” This is silly on several fronts.

  1. We’ve already established that rising interest rates aren’t consistently bearish for stocks.
  2. Even if inflation were to go up another 1%, it would still be below its long term average. Inflation is not about to spiral out of control any time soon. The Fed will only need to increase the pace of rate hikes if inflation really started to surge. I expect inflation to rise slowly in 2018 and pick up in 2019. Hence, surging inflation is not an immediate concern.
  3. Here’s the most important point of all. The new Fed chairman has a track record of being dovish. There’s no way he’s going to increase the pace of rate hikes after Monday’s stock market crash. No Fed Chairman wants to cause a bear market on his/her watch. That’s why every Fed chairman since Volcker has implemented the “Greenspan put” i.e. support stocks whenever the stock market falls. The Fed would rather err on the side of being too dovish than on the side of being too hawkish. The Fed would rather hike rates slower than expected than hike rates significantly faster than expected.

And remember, The Donald is watching. We’ve never had a president that cared more about the stock market. If the stock market enters into a “significant correction” or bear market, The Donald will probably call Powell every day and ask “why isn’t the stock market going up today? Activate the Plunge Protection Team!”

New York Fed chief Dudly said today “if the stock market were to go down precipitously and stay down, then that would actually feed into the economic outlook and that would affect my view in terms of what’s the implications for monetary policy”.
In plain English, the Fed would ease and support stocks if the stock market made a significant correction like August 2011.
6 am: VIX and its ETFs: a bullish sign for stocks
VXX is VIX’s non-leveraged ETN. UVXY is VIX’s 2x leveraged ETF. VXX almost always underperforms VIX due to ETN/ETF erosion. That’s why VIX is flat over the long run while VXX loses 99% of its value.


VXX (and UVXY) massively outperformed VIX yesterday when the S&P surged. VIX fell significantly while VXX barely went down.


This is an extremely rare case that only happens at VIX tops (S&P short term bottoms). The last time this happened was August 24, 2015.
VIX topped on August 24. The S&P bottomed on August 24. VXX kept going up for a few more days until September 1.


This is a short-medium term bullish sign for the U.S. stock market.
4 am: Nobody knows if the stock market’s exact bottom is in.
Let’s be honest. It is impossible to know for sure if the stock market’s exact bottom is in. That’s why we can only trade & invest from a medium term risk:reward perspective.
Risk:reward favors bullish investors right now, which is why now is the time to be long stocks. Our crash study comes to 2 conclusions:

  1. The stock market might make another marginal new low over the next few days. Or it could bounce for a few weeks, followed by a retest or marginal new low. Some short term weakness should not surprise investors/traders.
  2. Even if our Medium-Long Term Model is wrong and this “small correction” turns into a “significant correction”, this is still a good price to buy at. Any losses will be erased within a few weeks. This is called bullish risk:reward.

4 am: the S&P has almost reconnected with its 200 sma
The S&P’s rally before this “small correction” set all kinds of records. For example, the S&P did not reconnect with its 50, 100, and 200 daily moving averages for an extremely long time. Hence, mean reversion was to be expected.
The current 6%+ “small correction” broke those records. S&P futures has already reconnected with its 200 daily moving average. The S&P 500 was extremely close to reconnecting with its 200 daily moving average on Tuesday. I think the 200 daily moving averages represents MAXIMUM downside risk. That’s equivalent to a 12% “small correction”.


Read Stocks on February 5, 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.

8 comments add yours

  1. VXX is a very complex instrument.
    1) it tracks a VIX short term futures index, i.e., a mix of Feb. and Mar. 18 VIX Futures, as VIX spot index is not tradeable.
    2) When the stress scenario like Monday happened, VXX was priced significantly under its NAV (fair value), due to Market Maker’s risk aversion, thus cannot track its index efficiently.
    3) Based on the underlying futures price, VXX NAV should increase by around 100% on Monday. However, the traded price that we could see only increased by around 33%.
    4) On Tuesday, VXX NAV crashed by 30%, while the trading price didn’t reflect that.
    5) Even on Wednesday, VXX is still priced lower than its NAV. But it would converge to the NAV gradually in the next few days (so if NAV stays the same, price will increase)

    • Clearly you know more about the intricacies of VXX than me. Thank you for the wonderful write up 🙂
      Kind regards,
      Troy

      • BTW: the inverse VIX ETNs XIV and SVXY both dropped 96% on Monday, which sort of reflect the NAV..
        Really love your articles, thank you so much!

  2. Dear Mr. Troy,
    I have a question for you and this is related to your personal position in the market.
    As disclosed by you, you have been long in the market at the S&P level of 2465 and S&P had gone up to 2872 levels. Also, you had been correctly predicting a “small correction” of 6%-10% in the market in 1Q18. Also, maximum correction could be till 200DMA which is around 2500 levels.
    My questions to you are –
    1) When you were very well aware that in the “expected correction” market can come down to 200DMA, which is very close to your buying price, why did you not sell the position and bought back later.
    2) Are you not concerned about the missed opportunity to book the profits?
    Even if the market had not come down as expected and rather gone up, you had made your profits, anyways.
    Don’t mind. I am asking you these questions because, I felt your trading style is very similar to mine. I’m in this market (as a Pro) for the last 17
    years and my trading style is very similar to yours.
    But, many times (or should I say, most times) I repent for not executing the trades as mentioned above and bringing down the cost of purchase.
    I would be grateful, if you could put in your views here, so that I could learn something from you.
    Thanks in advance.
    With Regards,
    Praveen Shamain
    from India

    • Hi Praveen,
      That’s a terrific question. In all honesty, my correction call was lucky. If I had to guess, there was a 60% chance going into this week that SPX would make a correction. But what if it hadn’t? What if SPX soared 7% first before falling 6%?
      That’s the thing about all these geniuses who tell you “I told you the market would make a correction!” If they tell you to sell when SPX was at 2400, someone who’s been sitting in cash since 2400 would still be worse off than someone who’s been 100% long all the way.
      I am not concerned about not booking profits. My goal is to beat a 3x benchmark to the S&P. Essentially, my goal is to beat “buy and hold” to UPRO. I can tell you for a fact that 95% of professional traders can’t beat a simple buy and hold to UPRO.
      Back in my hedge fund days we tried a lot of different ways to trade more short term. Of course we backtested each of those strategies. The result was always the same: over the long run (ie multiple decades), nothing beats buying and holding outside of bear markets and significant corrections. The stock market’s long term bullish bias is just too strong.
      Also, SPX could easily have fallen just 6% instead of almost 10%. The odds favoured a 10% correction, but what if it only fell 6%? From a risk:reward perspective, you cannot wait to get in until SPX falls 10%. You have to buy on the close of the day SPX falls 6%.
      Like I said, there was a lot of luck in the timing of this small correction call. Timing is everything. I have no intention of saying “I told you so”, unlike a lot of other traders and fund managers. I don’t think I’ll be as lucky next time in calling for a small correction, which is why I rarely try to predict small corrections.
      Kind regards,
      Troy

      • Dear Mr. Troy,
        Thank you very much for replying to me in detail.
        If I understood your view correctly, it is like this –
        As long as “Medium-Long Model” does not give a sell signal, it is MORE profitable to take a position and sit on it, rather than trading in and out. By trading in and out, I make my broker rich and I personally MAY NOT be able to re-enter the same, later. Your experience in the market and study has proved it.
        Thanks once again.
        God bless you.
        With Regards,
        Praveen

        • Exactly. By trading in an out, ultimately you miss out on more of the rally. The additional gains that you make from trading the pullbacks/small corrections do not make up for what you’re missing out on.

      • I will copy this Question and Answer, print them, put into a frame and keep in my room for future.
        That’s the very core of long-term investment revealed.
        Thank you, Praveen and Troy.

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