U.S. stock market on May 11, 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

The S&P 500’s rapid decline on today’s opening bell and subsequent “buy the dip” show 2 facets of the stock market right now:

  1. This market is getting nervous, and can make a short term decline on any excuse.
  2. The fundamentals of the economy are solid, which is why investors will continue to buy the dip.

The stock market’s rapid decline from 9:30 – 10:20 am happened for no apparent reason. Investors attributed it to Macy’s terrible earnings report, but that wasn’t true. Macy’s released earnings an hour before the opening bell and had already crashed by 9:30. During that time, the S&P 500 futures actually went up a few points.
This rapid selling for no reason shows that the market is experiencing some short term jitters. This validates our short term case that the S&P 500 will make a small correction very soon (read that post).
However, the immediate “buy the dip” shows that this is still a long term bull market, despite the short term bearishness. The fundamentals continue to improve. For example, Initial Claims continue to drop to new lows.

Sectors

Energy
The energy sector XLE continued to rise a little bit today because oil continued to rise.
We still think that this is just a temporary bounce in XLE and oil’s downtrends. OPEC’s monthly report revealed that OPEC has recognized America’s surging oil production. From purely a supply-demand perspective, the surge in supply hurts oil prices (and thus XLE).
But perhaps we are wrong. Perhaps oil has bottomed and will go back to $50. This is why we don’t bet on oil and we don’t trade the S&P 500 in the short term – we haven’t a clue. Remember that oil prices below $50 means the year-over-year change in oil prices is negative, which hurts energy sector earnings growth.
Finance
The finance sector was one of the biggest losers today. Since the first round of the French election (April 23), finance has been very weak.

  1. Finance did not go up on Q1 2017 earnings season (released in mid-April) despite very solid earnings reports from banks.
  2. XLF’s (finance ETF) entire bounce was due to Macron and Le Pen’s victory on April 23. XLF did not continue to rally after April 24.
  3. Over the past 2 weeks, XLF has been down by whichever asset is weaker each day: oil or interest rates. When oil falls but rates rise, XLF is dragged down by oil. When oil rises but rates fall (like today), XLF is dragged down by rates.

*Both rates and oil impact the finance sector right now. Interest rates affect banks’ profit margins. Oil impacts inflation, which impacts interest rates.

Tech 
As we demonstrated in a blog post, declines in the tech sector cannot be used to predict the S&P’s small corrections. Histoically speaking, sometimes tech will lead and sometimes tech will lag the broad index’s corrections.
There was nothing noteworthy going on in tech today. XLK (tech ETF) fell like the S&P 500.
Retail
Macy’s released a horrible earnings report today. We expected this. Retail is under a lot of pressure from 2 sources:

  1. Tech companies like Amazon are undercutting their prices.
  2. A lot of private equity firms and hedge funds invested in retailers over the past decade. Their strategy has been “hit-and-run”. These investors force the retailers to sign expensive leases, which is how the investors really profit. So as long as the retailers continue to pay their leases, the investors make out like bandits. It doesn’t matter if the retailers lose money and are crushed under mountains of debt. As long as the retailers pay their leases, the investors couldn’t care less. (This is the story of Sears).

As you can imagine, retail was the worst sector today. XRT (retail sector ETF) fell 3.4% from top to bottom.
However, investors in the broad S&P should ignore retail’s woes. Retailers have trouble even during the best of years. For example, many large retailers like K-Mart were closing down hundreds of stores in 1995 while the S&P 500 soared.

Bottom line

The odds of a small correction happening soon are still high. However, our model does not see a significant correction or bear market. Hence we are still 100% long the U.S. stock market.

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