U.S. stock market on June 19, 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

The S&P rallied to new highs on no news at all.
The S&P rallied today on no fundamental “reason” at all. This is normal. The S&P 500 is in a “big rally within a bull market” (as defined by our model). The market doesn’t need any reason to rise. It has a natural bullish trend.
The optimal decision is to be 100% long until the next significant correction/bear market. The optimal decision is to avoid all small corrections because no one can consistently and accurately time small corrections. Timing significant corrections and bear markets is much easier.
However, our fund ignores the optimal decision. We shift into cash when the current “small rally” becomes very aged. By doing so, we reduce our fund’s performance by 1/3 but reduce our portfolio’s volatility by more than 1/2.
As of June 20, it has been 248 trading days since the last “small correction”. By the end of June, this small rally will have lasted 258 trading days. Out of the 79 small rallies since 1962 (excluding the current one), only 3 small rallies will have lasted longer. Here they are, ranked by number of trading days:

  1. 284
  2. 297
  3. 335

Hence, the current “small rally” will be in the 96% percentile of all small rallies!
So if you want the optimal investment decision, stay 100% long stocks now. If you want to minimize your portfolio’s volatility and reduce risk, shift to 100% cash (as we’re doing) and buy UPRO (3x S&P 500 ETF) when the S&P makes a 6% “small correction”.
Is the “small correction” starting right now or in October?
We keep revisiting this question, and the honest answer is “we don’t know”. Perhaps it will start in October.

  1. By October 2017, the current “small rally” will be the longest in history. That is the TIME extreme.
  2. A lot of people are expecting a small correction right now (including ourselves). This is not a good sign for us short term bears – we may have to be a bit more patient.
  3. The market is more likely to get bad news in September/October. By the fall of 2017, the special investigation into Trump-Russia will start to release some official information. The market isn’t reacting to all these Washington Post / New York Times reports because investors can’t ascertain the accuracy of these reports. Investors are waiting for the official results.

Correlations between the U.S. stock market and other assets.
Our model does not use correlation. Historically, correlation has not been an accurate predictor of the S&P 500’s future performance. Correlations work until they break, and you have no idea when they’ll break. However, we still look at correlation to inform our discretionary outlook for the U.S. stock market. Correlation gives you a clue as to what themes are driving the market at the moment.
*Take our thoughts on non-U.S. equities with a grain of salt. We only invest in UPRO (3x S&P 500 ETF). We’re not that knowledgeable about other markets.
Here’s the S&P 500 since Trump’s election.

Here’s the U.S. dollar index.

After rallying together in November-December 2016, the USD-S&P positive correlation has broken down. This is normal. In the later stages of an economic expansion cycle, inflation starts to pick up. Inflation is positive for the S&P 500 but negative for the U.S. dollar. For example, the U.S. dollar cratered from 2002-2007 and 1985-1990 while the S&P soared.
Here’s WTI oil.

The S&P and oil went up together in November/December 2016. Since then, oil has slowly drifted downwards while the S&P has rallied. Oil’s weakness is primarily due to increasing supply.
Here’s the 10 year Treasury yield.

The S&P has continued to rally since March 2017 while the 10 year yield has fallen. This is not a concern for the U.S. stock market’s inflation theme. When the Fed is on a rate hike cycle, long term yields rise more slowly than short term yields. The correlation between yields and the S&P becomes erratic. Here’s a chart for the 10 year yield during the 2000’s. As you can see, the S&P and 10 year yield went up together from 2003-2007 overall. But the medium term correlation was very erratic.
Since the Trump election, the S&P and interest rates have gone up together overall.

The yield-S&P positve correlation is stronger than the USD-S&P correlation. This makes sense. Although the yield curve does flatten during the last leg of a bull market, it doesn’t mean that long term yields don’t go up. It just means that short term yields rise faster than long term yields.
Overall, the S&P is still going up on an “inflation” theme. This is the theme that drives most bull markets’ final “big rallies”.
Yes, it’s true that global inflation has dipped a little since early-2017. However, inflation overall is still higher than it was in 2016. Just like global economic data, the trend in inflation is pointed higher. Inflation will start to rise again once oil bottoms. We think oil is making a bottom around $40-$43. So we think the bottom in inflation is close as well.

Bottom line

Nothing has changed. Once again, the perma-bears are being skinned alive. Yes, valuations are “high. But valuation is not a timing indicator for bull market tops.
Right now:

  1. Our model says that this is a big rally in a bull market. There is no significant correction on the horizon.
  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.


We continue to see rapid sector rotation. Today, tech outperformed. Last week, finance and energy outperformed. Before that, tech outperformed.
Today’s tech outperformance is normal. Tech has made a large pullback over the past week, so today is mean reversion.
The energy sector fell today because oil prices fell. However, we think oil prices are close to bottoming. Oil is constantly retesting its $43-$44 low from May 5, 2017.
Here’s XLE (energy ETF)

Here’s WTI oil

*Take our thoughts on oil with a grain of salt. We don’t trade oil. We only observe this market with a passing curiosity.
The financial sector was inline with the S&P today. Nothing abnormal. Interest rates went up too.
Here’s XLF (finance ETF).

Here’s the 10 year Treasury yield.

The tech sector mean reversed today. Previously, it fell more than the S&P. Now it’s rising more than the S&P. Nothing special. Here’s XLK (tech ETF).

2 comments add yours

    • It magnifies the S&P’s returns by 3x. So if the s&p falls 1%, upro will fall 3%. Vice versa is also true.

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