U.S. stock market on May 25, 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

We’d like to reiterate this point:

The optimal decision right now is to be 100% long stocks because our model foresees neither a bear market nor a significant correction. The optimal decision (based on historical backtesting) is to ignore ALL small corrections because it is impossible to consistently and accurately predict a “small rally’s” top. However, we are going against the optimal decision by being in 100% cash. In doing so, we are giving up potential profits but also reducing out portfolio’s risk and volatility. The short term risks are high, and we have significant profits to protect. Year-to-date our portfolio is up 17%. The more risk-free decision is to wait for the next small correction and buy UPRO (3x S&P 500 ETF) when the market falls 6%.

There were 2 key highlights today:

  1. Oil got KILLED on OPEC’s decision to extend its production cuts by 9 months.
  2. The S&P 500 soared to new all time highs.

Earlier this week, we thought that oil would fall after OPEC’s meeting on Wednesday-Thursday. We thought that the market had already priced in a production cut extension. So far, it seems that we were right. Perhaps oil will bounce tomorrow because it is a little oversold right now. But overall, oil is not bullish. Here is WTI oil’s daily chart.

We continue to focus on this point:

We don’t know much about the oil markets. But with oil production (supply) surging, it’s hard to be bullish on oil in the medium term.

Hence, we still think that oil is a medium term bearish factor for the S&P 500 because it hurts the energy sector.
The S&P’s rally today was no surprise. Yesterday, we said that:

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).

This is the nature of big rallies in bull markets: there is a natural bullish bias. The market doesn’t need any news/reason to rally.
We are a little surprised that the S&P completely ignored oil’s mini-crash today.
Let’s take a step back and examine the bigger picture. We do not see a significant correction on the horizon, but we still see enough small bearish problems for a small correction to occur. We don’t know when the small correction will begin. Perhaps now. Perhaps when the S&P hits 2500. Perhaps when the S&P hits 2600. Who knows.
The Economy
Despite the recent TINY deterioration in U.S. economic data, the U.S. economy remains solid. The overall trend in all of the important indicators still show that the economy is growing decently. It’s likely that the recent “deterioration” is just a normal statistical fluctuation in the data.
Hence, the economy is a bullish factor for the U.S. stock market.
In addition, U.S. corporate earnings growth is solid.
TIME Extreme
This is still one of the longest “small rallies” in history. The longer this “small rally” continues, the more likely a small correction becomes.
*This TIME extreme cannot be used to predict a significant correction.
Crude oil’s continued weakness
Oil’s and the energy sector’s continued weakness should be a drag on the S&P 500. Historically, a big decline in the energy sector was almost always followed by a small correction in the S&P 500. There was only 1 exception.
Right now, the energy sector has declined significantly. Could this be the 2nd exception in history? Perhaps. But the odds don’t favor an exception.
Overvaluation in tech and “weak breadth” is not a problem
We don’t have a bearish bias. We just stick to the facts. Traders with a bearish bias are pointing to the fact that:

Tech stocks are overvalued. They should crash. Breadth is weak. The tech sector is the only thing that’s lifting the S&P up. The market should fall. The S&P’s P/E ratio is 33, but if you throw out Amazon, the S&P’s P/E ratio would be 23.

These bears are wrong. History shows that breadth is “weak” in EVERY rally. For example, in most of the 1990s and 2000s fewer than 25 stocks accounted for more than 2/3’s of the S&P’s gains! Breadth is a terrible timing indicator.
Trump
We still don’t think that the FBI has enough to incriminate Trump. It is very hard to impeach a President. However, it’s possible that Trump dealt with some gray areas. The continuing cloud from the White House at least isn’t bullish for the stock market.
China
China’s economy has been deteriorating a little over the past few months. In addition, its stock market has fallen. However, these problems are not big. So U.S. stock market investors should not be worried.

Bottom line

There are no big risks that can cause a significant correction. Our model doesn’t foresee a significant correction either. But the short term risks are still enough to warrant a small correction.
*We’re updating this over the day.
As of 5:25 pm:

As of 3:30 pm:

As of 7 am:

As of 6:40 am:

 

Sectors

Energy
The energy sector significantly under performed the S&P 500 today because oil got killed. The magnitude of today’s oil decline is astonishing. Oil has given up 38.2% of its gains in just 1 day.
Here is a daily oil chart.

Here is XLE’s daily bar chart. (XLE is the energy sector ETF).

XLE has almost fallen to a new low. This is still a bearish factor for the S&P 500.
Finance
The finance sector underperformed the S&P today because interest rates fell a little. There is still a modest correlation between interest rates and oil.
This is the 10 year U.S. Treasury yield.

This is XLF (finance ETF).

Tech
Once again, tech is leading this rally. Nothing special here. In a bull market, it’s normal for overvalued tech stocks to become even more overvalued.
This is XLK (tech ETF).

2 comments add yours

  1. XLE is definitely not doing very well. I though they looked a bit oversold at this point but clearly the market didn’t think so. Hopefully things come swinging back but it’s definitely not looking good.

  2. Great webpage – and you are quite the prolific writer.
    I like your thoughts on long-term ownership of stocks – falls in line with mine. While I think we are due for a “correction” I don’t plan on losing any money, because I won’t sell my positions.
    I’ll tune in regularly for your articles.

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