U.S. stock market on June 13, 2017: thoughts and outlook


*These are our short term thoughts on the market. We combine our medium-long term model and discretionary outlook when making investment decisions. We’re looking at how the market reacts to news, earnings, and other fundamental themes related to the key individual sectors.
Go to our homepage for our latest market outlook.

Stock index & news

Close to new all-time highs.
Well that was quick. The S&P is once again close to new all time highs. This is why the optimal investment decision is to follow our model to the letter, focus on significant corrections, and ignore small corrections. The U.S. stock market has a natural bullish bias during bull markets because too many retail investors/institutions “buy the dip”. No one can consistently and accurately predict the tops before small corrections.
Our model does not use any short term indicators. No matter how “good” a short term indicator has worked historically, it can fail in a heartbeat. Case in point. We only use short term indicators to aid our discretionary outlook. Our model consists of medium and long term indicators.
Sentiment is too bearish.
We don’t use sentiment at all because historically speaking, it has not been a good contrarian indicator for the S&P 500. During strong rallies, the S&P can continue to soar despite “extremely optimistic” sentiment. This is what we saw in 2013 and 2014.
However, it’s worth noting that a lot of investors, fund managers, traders, and financial pundits think that the stock market will make a correction right now. This is unsettling. When “everyone” thinks the same way and their opinion is against the long term trend (i.e. they’re bearish in a bull market), they tend to be wrong.
Perhaps the small correction that we’ve been predicting won’t start right now. Who knows. Perhaps it will start in September or October 2017. By the time we get to October, the current”small rally” will be the longest in history. That will be the TIME extreme.
Federal Reserve decision tomorrow.
The market has set tomorrow’s rate hike odds at 90%+. Yes, it’s true that S&P has fallen at least a few percent after every rate hike in the current rate hike cycle. However, there have only been 3 hikes in the current cycle, so that’s not a lot of cases.
Similarities between 2017 and 2013.
History shows that the S&P rallies the most during “quiet years” like 2013. As we explained yesterday, there are no geopolitical worries in the next few months. The next few months should be “quiet”.
Sector rotation.
Yesterday/Friday’s selloff in tech was classic “profit taking”. Tech has led the S&P year-to-date, and now investors are shifting to other sectors that are relatively “cheaper”.
What sectors will investors buy in the next leg of this bull market? What sectors will outperform? Here’s a random guess. (We only invest in the broad index. It’s notoriously hard to predict which sectors will underperform/outperform at any given point in time.)
Energy
The energy sector is one of the cheapest sectors in the S&P 500. Year-to-date, it has underperformed the S&P and oil. But over the past few days, the energy sector has started to pick up.
Here’s a weekly bar chart for XLE (energy ETF).

Finance
From a long term perspective, finance is relatively cheap. The financial sector is at its 2000 highs and below its 2007 highs.
Here’s a weekly bar chart for XLF (finance ETF).

Healthcare
The healthcare sector has significantly lagged other sectors in the S&P 500. It hasn’t really broken out from its 2015 highs.
Here’s XLV (healthcare ETF).

*All these sectors have fundamentals that impact their relative underperformance/outperformance. However, a lot of traders and funds don’t look at fundamentals. They simply buy whatever sectors are cheaper.
Tech
Yes, tech is one of the more expensive sectors. It’s P/E ratio is high and it has soared year-to-date. However, tech is always the more volatile sector. So in a bull market’s “big rallies”, tech tends to outperform. Overvaluation won’t kill tech stocks until the bull market is over. And this is still a bull market.
Please read our post on “Using an inverted yield curve to predict bear markets in stocks“.

Bottom line

Looks like we’ll have to be patient again. There will be a 6%+ “small correction” in the next few months. We just can’t pinpoint its start date.
Right now:

  1. Our model says that this is a big rally in a bull market.
  2. Despite our model’s bullishness, we’re sitting on 100% cash. Here’s why.
  3. We’re waiting for the next 6%+ small correction.

Sectors

There was nothing abnormal going on in the sectors today.
Today’s report showed that oil production soared after OPEC’s extension of its production cut. We were a little surprised that oil prices didn’t really fall on this news. Is this a bullish sign for oil? Who knows. We don’t trade oil.

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