Stocks on February 9, 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 S&P has touched its 200 daily moving average.
  2. VIX is in backwardation. Bearish for VIX, bullish for stocks
  3. The stock market’s correction will not hurt the U.S. economy.
  4. Financial conditions are very easy. Not necessarily a bearish sign for stocks.

Read Study: the stock market will be higher in a few months
2 pm: the S&P has touched its 200 daily moving average.
I previously said that the S&P’s 200 daily moving average represents maximum downside risk (provided that our Medium-Long Term Model is right and this is not a “significant correction”).
The S&P just touched this level today.

The S&P reconnecting with its 200 daily moving average is important because it has not touched its 200 daily moving average since November 2016. Mean reversion is normal.

Our study this morning showed that the S&P would face a maximum downside risk of -12%. This correction has just hit -11.8%.
All in all, this has been a very standard correction. The S&P crashed, which was followed by a retest & marginal lows. The medium term risk:reward is bullish, and now the short term risk:reward is bullish as well.
A CLOSE below the 200 daily moving average is possible, which I think represents maximum downside risk.
3 am: VIX is in backwardation. Bearish for VIX, bullish for stocks
VIX is usually in contango, which means that futures contracts that are farther out in time more expensive. This makes sense. Volatility is more likely to increase as time goes on.
VIX is currently in backwardation, which is the opposite of contango. This is a rare situation in which futures contracts that are farther out in time are cheaper than contracts that are closer to today.

This rare VIX futures curve is bearish for VIX and bullish for stocks in the medium term.
3 am: the stock market’s correction won’t hurt the economy
Some traders and investors think that the current 10.1% “small correction” in stocks will hurt the U.S. economy, which will drag the stock market even lower. I disagree.
The economy leads the stock market, not the other way around. When stock prices and the economy diverge over the medium term, stock prices always mean revert to the economic data’s trend.
*”The economy” is not GDP. GDP is a terrible economic indicator that A) fluctuates a lot and B) lags the economy’s true trend.
The U.S. economy’s fundamentals are solid right now. This means that the stock market will ultimately move higher and re-align with the economy. Investors and traders should not lose sight of the bigger picture just because stock prices are falling. Fundamentals determine the medium-long term, technicals determine the short-medium term.
3 am: Financial conditions are extremely easy. Not necessarily a bearish sign for stocks.
Despite the current stock market correction, financial conditions are extremely easy right now in the U.S. according to the Goldman Sachs’ Financial Conditions Index. This is the easiest they’ve been since 1990.

Bearish investors fear this means that a bear market in stocks is imminent. They are wrong on 2 fronts:

  1. Financial conditions were extremely easy by 2011. The U.S. stock market has soared since then. This is not a useful timing indicator for bull market tops.
  2. The financial conditions index focuses more on interest rates than the stock market. 3 out of its 5 components focus on interest rates (short term Treasury rates, long term Treasury rates, credit spreads).

In essence, this index should be used to predict bond market tops, not stock market tops. Financial conditions have been extremely easy since 2010 due to global QE. Now that QE is turning into quantitative tightening, interest rates are on the rise long term. But interest rates are still historically low, so it will take at least a year or two before rates hurt stock prices.
Read Stocks on February 8, 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.

10 comments add yours

  1. Hi Troy,
    In light of the recent volatility – I am wondering if you have spent any time studying Beta Decay of leveraged ETF’s? Over the course of the last few years when volatility has been extremely low, this has actually worked in favour of UPRO… but now that Volatility is picking up UPRO will now underperform the theoretical exposure to a 3x S&P500. If your forecast for a volatile year ahead is accurate, this should mean a continued underperformance for UPRO, no?
    Imagine an asset that goes up 25% one day and down 20% the day after. A perfect double leveraged ETF goes up 50% the first day and down 40% the second day. On the close of the second day, the underlying asset is back to its initial price:
    (1 + 0.25) x (1 – 0.2) = 1
    And the perfect leveraged ETF?
    (1 + 0.5) x (1 – 0.4) = 0.9
    Nothing has changed for the underlying asset, and 10% of your money has disappeared.

    • Of course we have Mark 🙂
      Here’s the thing about UPRO’s decay. Yes, it is a problem. But when the stock market goes up, the compounding more than makes up for the decay. So whatever I lose during a correction will be more than made up for during a rally (because the S&P spends more time in rally mode than in correction mode). Of course this is only true during bull markets. UPRO gets slaughtered during bear markets, which is why sidestepping them is imperative.

      • If the market drop 33.3%, does that mean UPRO will become 0? Or the math is more complicated that that?

        • Depends on how the market drops 33.3%. If it drops 33.3% in one second, UPRO would go to zero. This is a very unrealistic scenario.
          But if the drop is spread out over a few days, UPRO would not go to zero. I’m going to publish a post soon explaining the math behind this.

  2. Interested to see the medium-long term model score after this week’s crazy volatility

  3. Omg I should have waited before I bought in. The fake reversal early in the week tricked me. I bought in right before the 1000 point drop this week and my account is blood red. Hope your right and that this is close to bottom!

  4. Hi Troy.. In an other post of yours ..you have mentioned that Stock Markets are looking very similar to 1986/87 . And in 1986 there were 2 back to back 10 % correction . Do you think there is going to be another small correction coming in Q2 or Q3 of 2018 and then a deeper decline in late 2019 ? Also wanted to let you know that you nailed this one perfectly ..hats off .

  5. Troy, we touched the 200dma again Friday and rallied into the close but 1.5 handles above Tuesday’s 2529 low. So a higher low was put in! This was important because if we closed below the 200dma on the Friday before Monday’s open, it would be very reminiscent of black Monday 1987. And we would be in an abyss with major uncertainty heading into Monday’s open. It was a major relief that not even the news headlines are talking about nor should they since we did not close below the 200dma. So now that is a double bottom put in at the 200dma. We should start to rally from here, at worse we retest to form a triple bottom. Any close below the 200dma should be extremely worrisome on all fronts and indicate a precipitous 20% flash crash since it would mirror the same conditions as black Monday 1987. We Must be very cautious of any daily closes below the 200dma and get flat in all cash as a just in case scenario.

    • I’m looking at the Day Trading Model, and it looks like it’ll start to scale in across-the-board on Monday.
      And remember, crashes tend to happen on Monday. So if there’s no crash next Monday, then the market is definitely stabilizing.

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