Stocks on March 24-25, 2018: 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. Stock market investors should watch out for a sustained rise in corporate bond spreads.
  2. New Home Sales fell a little. Something to watch out for.
  3. Leading Economic Index is going higher. A medium-long term bullish factor for the U.S. stock market.
  4. Sentiment is extremely pessimistic. A short-medium term bullish sign for the stock market.
  5. The forex markets tell you that the odds of a trade war are low. Not a medium-long term bearish factor for the stock market.
  6. China’s reaction to Trump’s tariffs are mild. Not a medium-long term bearish factor for the stock market.

Read Study: the Fed’s rate hikes aren’t bearish for the stock market
March 25. Stock market investors should watch out for a sustained rise in corporate bond spreads.
Corporate bond spreads are rising right now.

Some bearish investors see this as a bearish sign for the stock market. It isn’t.
In most cases, bond spreads rise when the stock market falls at the same time. That’s exactly what’s happening now. Bond spreads are rising with the falling stock market.
This isn’t usually a leading indicator for the stock market: it’s a coincident indicator. The only time this is a leading indicator is when bond spreads rise A LOT while the stock market rises.

So this isn’t a bearish sign for the stock market right now. It will be a medium term bearish sign if the stock market bottoms, rallies, and the bond spread still increases.
March 25: New Home Sales fell a little. Something that stock market investors should watch out for.
New Home Sales fell from 622k to 618k. Sales have been falling for 3 consecutive months.

This is not a major concern for the bull market right now, but we need to watch this closely for further signs of deterioration.

  1. New Home Sales tend to fall for a 2 years BEFORE the equities bull market ends.
  2. The decline in New Home Sales is still part of a broader uptrend in New Home Sales. We have no confirmation that this is the beginning of a sustained downtrend in New Home Sales.


March 25: Leading Economic Index is going 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 is still trending higher. It increased 0.6% in February. 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.
March 24: Sentiment is extremely pessimistic. A short-medium term bullish sign for the stock market.
CNN Money’s Fear and Greed Index combines 7 indicators to create a sentiment index for the stock market. Sentiment (a contrarian indicator) is extremely fearful right now. This is a short-medium term bullish sign for the stock market.
Such extremely fearful sentiment marked the S&P 500’s February 9 lows.


Remember Warren Buffett’s words: be greedy when others are fearful and be fearful when others are greedy. This is the former.
March 24. The forex markets suggest that the odds of a trade war are low. 
The media tends to blow things out of proportion. The stock market is making more of a technical retest (February 9’s lows), and it’s just using these trade war talks as the trigger/excuse for this retest.
The real threat of a trade war is low. If the odds of a trade war and tariff escalation are high, then the forex markets should be showing increased volatility. Instead, volatility in the forex markets is low and decreasing.
For starters, the USDCNY (U.S. Dollar to Chinese Yuan) is virtually flat.

The Euro is relatively lat.

Even JPMorgan admits that volatility is shockingly low in and decreasing in the forex markets.

The odds of a potential trade war are low. Not a medium-long term bearish factor for the stock market.
March 24. China’s reaction to Trump’s tariffs are mild. Not a medium-long term bearish factor for the stock market.
Trump placed tariffs on $50-$60 billion worth of Chinese exports to the U.S.. China “retaliated” with tariffs on $3 billion worth of U.S. exports to China.
There is a possibility that China will slow down its purchase of U.S. treasury bonds. The bears think this is a big medium-long term bearish factor for the bond market and stock market. I disagree.
If this was a real threat, then U.S. Treasury bond yields should be rising (because bond market investors should be expecting China to push Treasury bond prices down).
Yields aren’t rising. They’re falling.


Moreover, people tend to overestimate the impact that China has on Treasury yields.

  1. China is the biggest FOREIGN creditor. They hold $1.17 trillion, which is 19% of total foreign holdings. Japan is a close second.
  2. The U.S. debt is $21 trillion. In other words, China owns a little over 5% of total debt.

In addition, demand for Treasuries has been strong recently. This demand has come from the PRIVATE SECTOR, which suggests that China is no longer the biggest factor in the bond market. We said on March 13:

Demand for bonds was very strong in the latest Treasury auction. The bid-to-cover ratio for the 10 year Treasury bond was 2.5. The bid-to-cover ratio for the 3 year note was 2.94.
*The bid-to-cover ratio represents demand for bonds. Any ratio above 2 = strong demand.

China’s threat isn’t as bad as it seems. For starters, it’s unlikely that China will go through with its threats. Moreover, China doesn’t have that big of an impact on the bond market as conventional “wisdom” would have you believe. China doesn’t “own” the U.S. government. This isn’t a medium-long term bearish factor for the stock market.
Read Stock market on March 23: 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. 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.
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.

7 comments add yours

  1. Hello Troy
    I think SP500 will bottom out in mid-april and then resume rally to
    new all-time high toward summer
    How do you think about it ?
    kind regards

  2. I think we are approaching a very strong rally within the next 8 weeks going into the U.S. Memorial Day weekend, which starts the kickoff to summer. This is 1 of 4 major U.S. Holidays that the market rallies strong into for the 2/3rds of retail spending that the US economy is based on. After this we will have a strong rally into the 4th of July weekend. Then have sideways contractual range bound trading. The next rally will be into Labor Day weekend in sept. Then a correction followed by the traditional rally into thanksgiving. These 4 holidays traditionally are market rallies leading up to the actual holiday. Please do a historical backtesting on this when u get a chance. Thank you.

  3. My opinion regarding China slowing down their purchase of US bonds is that it doesn’t matter in the short run also. A country’s capital account must equal its current account, and since US runs a big current account deficit, a lot of dollars are held by foreign entities which includes China. All these dollars must find its way back in to the US markets as re investments, hence US runs a capital account surplus that exactly equals its current account deficit. If China runs down its purchases of US bonds, they must do something with the leftover dollars. If they buy other assets, the sellers of those assets will be now allocating capital and they will be the new buyers of Treasuries. So unless China starts dumping their holdings in a very short period of time(which is quite unlikely), this isn’t going to be an issue even in the short term.

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