Stocks on September 18, 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.
The economy and stock market move in the same direction in the medium-long term. Hence, leading economic indicators are also leading indicators for the stock market.

Thoughts

  1. Volatility will increase
  2. The stock market tends to swing sideways for a few weeks after each rate hike.
  3. Ignore the divergence between the U.S. stock market and Chinese stock market.
  4. Buybacks continue to put a floor under the stock market. Stocks with larger buybacks are going up more.
  5. High yield spreads continue to narrow. A medium-long term bullish sign for the stock market.

1 am: Volatility will increase
The stock market’s volatility has been low over the past 3 months. The S&P 500 has gone 74 consecutive trading days without a >1% gain.
Here’s what happens next to the S&P 500.

As you can see, these long streaks of very subdued volatility aren’t consistently bearish for the stock market. Low volatility isn’t necessarily bearish for the stock market. It merely means that sooner or later volatility will rise.
1 am: The stock market tends to swing sideways for a few weeks after each rate hike.
The Fed will most likely hike interest rates this month. Throughout the current rate hike cycle, the S&P 500 has usually swung sideways over the next few weeks after a Fed rate hike.

1 am: Ignore the divergence between the U.S. stock market and Chinese stock market.
As you probably know, the U.S. stock market continues to go up while the Chinese stock market has tanked on Trump’s trade war.
Some people are concerned that a falling Chinese stock market will bring the U.S. stock market down, just like in 2015.
This is recency bias. For starters, the Chinese stock market is less than 1/5 the size of the U.S. stock market. Moreover, the Chinese stock market had been falling from 2011-2015 while the U.S. stock market went up. That was a 4-5 year “bearish divergence”.
Historically, it is completely normal for the U.S. stock market to go up while the Chinese stock market falls.
Here’s the S&P 500 : Chinese stock market ratio. There’s nothing bearish about the U.S. stock market significantly outperforming the Chinese stock market.

1 am: Buybacks continue to put a floor under the stock market. Stocks with larger buybacks are going up more.
Bloomberg published an interesting article:
As you probably already know, stock buybacks have surged this year.

Stocks with larger buybacks have outperformed. This is logical. More buybacks = more demand for stocks.

The stock market is about to enter into its “blackout period”, which is the 5 weeks before earnings reports that companies aren’t allowed to buy back their stocks under SEC rules. From Bloomberg:
“Since 2000, S&P 500 returns have been comparable in blackout and non-blackout periods, but realized volatility has been nearly 1 point higher in blackout periods than when a majority of firms are free to repurchase stock,”
So expect increased volatility.
1 am: High yield spreads continue to narrow. A medium-long term bullish sign for the stock market.
High yield spreads continue to trend downwards.

This is a medium-long term bullish sign for the stock market and suggests that the stock market will continue to trend higher in the medium-long term. Bond market participants are smarter than stock market participants, which is why the bond market is a leading indicator for the stock market. Historically, high yield spreads widen (trends higher) before bull markets top.

Read Stocks on September 15, 2018: outlook

Outlook

Here’s what I think will happen based on my discretionary outlook.

  1. The S&P 500 has approximately 1 year left in this bull market (bull market top sometime in 2019).
  2. I will scale out of my long positions throughout 2019 (see why)

I am 67% long SSO right now (2x S&P 500 ETF) because my Medium-Long Term model does not foresee a big correction or bear market at this point in time. (This is a step down from being 100% long SSO previously). I ignore small corrections. I only sidestep big 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.

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