U.S. stock market on May 24, 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.

Stock index & news

The S&P 500 closed higher today for the 5th day in a row. This is the 20th time this has happened since 2012. In all 19 prior cases, the S&P made a new high within the next week. So this is a bullish factor for the very short term (next few days).
There was a lot of important news today.

  1. Bridgewater agrees with us that if Trump is impeached and forced to resign, the U.S. stock market will most likely give up all of its post-election gains. That will bring the S&P down to “significant correction” territory (as defined by our model).
  2. Moody’s downgraded Chinese debt for the first time since 1989. This is significant because China only started to open its economy in the 1980s! We still don’t think that China’s credit contraction and economic slowdown is significant enough to impact the U.S. economy and stock market, but we need to monitor this situation.
  3. The FOMC minutes show that the Fed thinks the recent weakness in U.S. economic data is transitory. We agree. This is a very tiny slowdown and is completely within the range of normal economic fluctuations. Focus on the overall trend and not the month-to-month changes.
  4. Crude inventories continue to fall while crude oil production continues to rise. Inventories are a bad leading indicator while U.S. continental (excluding Alaska) production is a good leading indicator. Rising production is not good for oil prices in the medium term.
  5. The OPEC committee recommended an extension of its current production cut by 9 months. OPEC will vote on this tomorrow. Notice how oil prices did not go up at all on this news. Perhaps this is a bearish medium term factor for oil. The market has front-run and priced-in this extension already.

Overall, these factors support a small 6%+ correction in the S&P 500. This is one of the longest “small rallies” in history. When a rally becomes this aged, any number of bearish factors that are normally irrelevant can bring the market down.
*U.S. economic data continues to miss expectations. The Citigroup Economic Surprise Index continues to deteriorate.  Historically this is not a big bearish factor, but is worth noting.

Sectors

Energy
Once again, energy is the weakest sector in the S&P 500. With U.S. oil production rising, energy just can’t catch a break! The energy sector is much weaker than oil right now. During this rally, XLE (energy ETF) topped on May 15 while oil hit a new intraday high today.
Here’s the daily chart for XLE.

Here’s the daily chart for WTI oil.

We continue to believe that a weak energy sector will drag the S&P 500 down.
Finance
Like energy, the finance sector underperformed the S&P today. This is because interest rates got crushed this afternoon on the FOMC minutes. It’s interesting that interest rates fell despite the Fed outlining its plan to unwind its bond portfolio beginning in late-2017 (which theoretically should be bullish for interest rates). Perhaps the market’s reaction is telling us that the next medium term movement for rates is DOWN. If that’s the case, then banks’ profits will come under pressure and the finance sector will continue to be a drag on the S&P 500.
First is the daily chart for the 10 year Treasury yield.

Second is the daily chart for XLF (finance ETF).

Tech
The tech sector was mostly inline with the S&P today. Nothing special here.

Bottom line

Perhaps the S&P will go up in the next few days. This is likely based on the historical pattern of “the S&P closes higher 5 days in a row”.
But overall, not much has changed. We don’t think a significant correction will ensue and our model doesn’t foresee one either. But a small 6%+ correction can happen at any time now. Any one of the following risks can bring the S&P down:

  1. Falling oil prices (and a bruised energy sector).
  2. Trump-Russia investigations.
  3. Small temporary weakness in the U.S. economic data.

Who knows when the S&P will start to fall.

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