Stocks on March 27, 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. VIX: risk of a little more downside, but medium-long term bullish.
  2. This probably isn’t the stock market’s exact low for this correction.
  3. The U.S. and China are nearing a trade deal. “Trade war” isn’t medium-long term bearish for stocks
  4. This valuation indicator can’t be used as a long term bearish sign.

Read Study: what happens next when the stock market is very volatile
5 pm: VIX is telling us that there’s a risk of a little more downside, but the medium-long term is bullish.
Yesterday I said that the S&P 500 is following a standard crash, bounce, and retest pattern.
Although the S&P can fall a little more in the short term (i.e. next 2-3 weeks), VIX is telling us that the S&P’s downside is limited. It’s a medium-long term bullish sign for stocks.
The S&P and VIX are inversely correlated. And while the S&P is close to making a marginal new low vs the February low, VIX isn’t even close to making a new high.

This kind of divergence can happen in both “small corrections” and “significant corrections”. It means that VIX is leading the S&P higher in the medium-long term.
Here’s the S&P and VIX in the 2015 “significant correction”.

1 am: This probably isn’t the stock market’s exact low for this correction.
The majority of my portfolio focuses on the medium-long term, but I still do look at the market’s short term. I think the stock market still has to make a marginal new low before this correction can end.
When the market crashes like it did last Thursday and Friday, it almost always makes a lower low the next day. The market rarely tanks and then soars the next trading day (e.g. yesterday).
In addition, the S&P 500’s save on the 200 sma seems purely driven by algorithms. This is almost too perfect of a support.

The stock market crashed in February 2018. The market usually retests the crash’s low and makes a marginal new low 1-2 months later. We are here if you use a 2011 fractal.

Based on this fractal, the S&P 500 will bounce for a few more days before falling to a marginal new low.
Of course none of this matters if you’re a medium-long term trader like myself. The stock market’s risk:reward profile is decisively bullish.
1 am: The U.S. and China are nearing a trade deal. “Trade war” isn’t medium-long term bearish for stocks.
China is more desperate than the U.S. to avoid a trade war because China has more to lose.
Chinese vice premier Liu He effectively told U.S. Treasury Secretary Mnunchin that China would cave on several key U.S. demands:

  1. More foreign investment in Chinese firms.
  2. More imports of U.S. semiconductors.
  3. Uphold international intellectual property laws.

The U.S. has listed the following additional demands that China has yet to agree to:

  1. Loosen restrictions on U.S. auto imports
  2. Loosen restrictions on foreign investment in manufacturing, telecom, medical, and education.

So why is China so quick to agree to these points? The biggest point: more foreign investment in China, is something that CHINA WANTS TOO.

  1. Previously China did not allow foreign companies to own more than 51% (majority control) of a Chinese securities company.
  2. President Xi changed this rule a few months ago and had planned to allow foreign majority control as of July 2018.
  3. With Trump’s additional push via tariff threats, China is working to allow foreign majority control as early as May.

This is the point that Trump is making. The U.S. is still the world’s dominant economic and financial power (although this hegemony status is slowly slipping away). The U.S. can (and arguably should) use its might to get better trade terms for itself. Other countries know that they are at a disadvantage, so they are hesitant to put up a fight. This diminishes the odds of a trade war.
People refer to the Great Depression as a textbook case for why trade wars are bad. The key point to remember: the U.S. was not dominant before the Great Depression. Great Britain and Europe were still economically powerful. They had much more economic bargaining power than they do today.
Fears of a trade war are not medium-long term bearish for the stock market.
 
1 am: This valuation indicator can’t be used as a long term bearish sign.
Warren Buffett likes to use the stock market’s market cap to GDP ratio as a valuation indicator.

This is not a useful indicator for picking tops in bull markets. You can see that based on this indicator, valuations have been “insanely expensive” from 1994-present. The S&P 500’s nominal value in 1995 was 450. Anyone who stayed out of stocks because this indicator says that the “stock market is overvalued” would have missed out on massive gains.
Read Stocks on March 26: 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. Why I’m medium-long term bullish on the stock market from a discretionary point of view.
  4. 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.

4 comments add yours

    • Hi Ahmad,
      It doesn’t have to. But the odds are >50%. Personally I don’t trade on short term patterns like this. But just some food for thought.
      Regards,
      Troy

  1. Hi Troy,
    If the S&P bounces back up for a few days before dipping below the 200 day SMA in this current sell-off, does that mean there’s a high chance it’ll fall again before the corrections over? Conversely, if this current sell-off drops below 200 day SMA and bounces back up, would there be a low chance that S&P drops below 200 day SMA again before the corrections over?
    Thanks!
    Frank

    • That’s mostly a 50-50 bet. I.e. there is no pattern here.
      Regards,
      Troy

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