U.S. stock market on May 10, 2017: thoughts and outlook


*These are our short term thoughts on the market. We invest purely based on our medium-long term model. We’re looking at how the market reacts to news, earnings, and other fundamental themes related to the key individual sectors.

Stock index

It was another quiet day for the S&P 500 with very little volatility. In fact, the broad index has been very quiet since April 26, after Macron and Le Pen won the first round of the French election. This quietness has caused VIX (volatility index) index to crash.
The quietness has unnerved some fund managers, investors, and bank CEO’s. For example, Goldman’s CEO said that “the recent lack of volatility is unsettling. Although the long term outlook is solid, perhaps the markets will experience some short term turbulence”.
History shows that low volatility does not guarantee that the S&P 500 will decline. Whenever the S&P trades within a tight range with little volatility, it either breaks out on the upside or breaks down. The probability of each scenario happening is 50-50!
So do not be unnerved by the lack of volatility. If a small correction does happen, which we expect, it won’t be a result of low volatility.
It’s interesting that the S&P completely ignored Trump’s firing of FBI director Comey. To some, this smells like the 1974 Nixon scandal. The S&P crashed during the lead up to Nixon’s resignation on August 4, 1974. The crash wasn’t entirely Nixon’s fault (the market was going down because of economic problems), but Nixon’s scandal definitely was a bearish factor.
If it turns out that Trump really did collude with Russia during the election, expect the S&P to make a small or big correction. If it turns out to be a big correction, that’s ok. Our model cannot catch every single big correction, and we do not predict political events.
*We do not think the Trump-Russia collusion story is true.

Sector breakdown

Energy
XLE (energy sector ETF) went up today because oil went up. Oil went up due to a bigger crude inventory drawdown than expected (5.25 million drawdown vs 0.93 million expected).
Who knows if the oil decline is over. However, XLE is still trading within its downwards sloping channel. Until this channel is broken, there is no reason to suspect that oil’s downtrend is over. In fact, XLE’s bounce over the past 4 days is normal. Throughout this downtrend, XLE has made many bounces that failed. None of these bounces lasted more than 2 weeks (10 trading days).

We still maintain our outlook. As long as oil remains below $50, the year-over-year change in oil will be negative. This will hurt energy sector earnings growth for Q2 2017, which will hurt the S&P’s earnings growth. In addition, a declining XLE typically precedes a small S&P correction (read post here).

Finance

XLF (finance ETF) finally went up with interest rates today. Rates went up because oil prices went up. This correlation exists because both interest rates and oil are tied to the “inflation” theme right now. Rising oil means that inflation and interest rates are going up.
Hence, both the short-medium term fates of the energy and finance sectors rest on oil. If oil prices continue to fall, both XLE and XLF will fall.
Despite today’s XLF rise, XLF is still stuck below its 50 sma.

Tech

The tech sector continues to outperform all other sectors. There is nothing that the bears can do here. Tech companies are crushing some traditional industries. Tech earnings are crushing it.
However, there are signs that XLK’s (tech ETF) rally might stop in the short-medium term. Over the past few days, the big name tech stocks have been rising.

  1. Apple
  2. Amazon
  3. Google
  4. Facebook

But today was completely different. These big name tech companies fell a little while smaller tech stocks rallied. Is this a sign that the recent rally in tech will stop temporarily? Perhaps. Who knows.

Bottom line

Nothing has changed in our short-medium term outlook. The S&P will make a small correction soon. The correction will be for technical reasons (this rally between small corrections has lasted too long). If oil prices fall, the S&P will have another reason to make a small correction.
We remain 100% long UPRO (3x ETF for the S&P 500). We invest purely based on our model, and our model focuses on big rallies and big corrections. The model does not foresee a big correction. Of course, the S&P might make a big correction if the Trump-Russia allegations are true. But we do not bet on political events.

2 comments add yours

  1. What are your thoughts on the new 4X leveraged ETFs ? Are you going to stick with your 3X S&P 500 or venture into the 4X?

    • We’re going to stick with the 3x. 4x is too volatile for us. And even if we were to switch to 4x, we’d like to wait a few months. The 3x ETF doesn’t have enough volume yet, which is a problem for a hedge fund like ours.

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