*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
Our model says that this is still a “big rally” in a bull market. However, we shifted to 100% cash on May 15 when the S&P was at 2393 because this is one of the longest “small rallies” in history. A small 6% correction is long overdue. The current small rally has lasted longer than 92% of all small rallies since 1962.
Over the past 2 weeks, we saw various small bearish factors that should have been enough to cause a small correction. But many of these small bearish factors have disappeared or aren’t as bearish as we thought.
- We’ve repeatedly stated that falling oil and a weak energy sector should drag the S&P 500 down. History proves this point, with one exception. But thus far, the S&P 500 has completely ignored oil’s weakness. So perhaps this is the second exception in history.
- U.S. crude oil production continues to soar. That’s why we thought oil prices would fall. But we do not have a good understanding of the oil market and we don’t trade oil.
- Since the Trump election, there has been an overall positive correlation between interest rates and oil. According to the COT report, hedge funds are extremely bullish on bonds and bearish on rates right now. Over the past year, hedge funds have been consistently wrong on the bond market. So if interest rates head higher in the medium term, it’s hard to see why oil should crater to e.g. $40 a barrel.
- North Korea is no longer a risk. Historically, “boots on the ground” wars have caused significant corrections in the S&P 500. We previously thought that the U.S. might try a preemptive strike to hobble North Korea’s nuclear development efforts. This no longer seems to be the case. It seems that the U.S. has decided to play defense instead of offense. The U.S. will carry out its first ICBM interception test next week. It’s estimated that North Korea’s ICBM’s will have the capability to reach the U.S. by 2020, near the end of Trump’s term.
- The U.S. economy is still solid. The first revision for Q1 GDP showed growth of 1.2% vs an initial estimate of 0.7%. Like we said before, Q1 GDP is always weak due to seasonal reasons.
- Soaring tech stocks and valuations are not long term concerns. Yes, valuations are above the long term historic average. However, valuations are nowhere near as high as they were at previous bull market tops. For example, the S&P 500 technology sector’s P/E ratio is 20 right now. It was above 80 at the top of the dot-com bubble.
- China’s economic and credit problems are not big enough to impact the U.S. stock market yet.
- We still don’t think the Trump-Russia investigation will result in Trump’s incrimination. If the FBI had anything solid that would directly led to Trump’s impeachment, someone at the FBI would have leaked it already. The government can’t seem to stop leaking classified information these days.
Here are some charts.
The optimal decision right now is to be 100% long stocks because our model does not foresee a significant correction. It’s possible that there will not be a small 6% correction for many months (i.e. into autumn 2017).
But that’s ok. We’re still going to sit on 100% cash. Here’s why.
- Year-to-date our portfolio is up 17%. It’s time to take our chips off the table and reduce our short term risk.
- Small corrections can happen at any time on no news/fundamental reason at all. Historically, the majority of small corrections happened for no reason at all. They are just part of the market’s normal fluctuations.
- The only reason to stay in cash right now is because this “small rally” has gone on for too long. A small correction can happen at any time. By staying in cash, we’re reducing our portfolio’s volatility and short term risk.
- We sold when the S&P was at 2393. As long as the S&P doesn’t rise above 2545 before a small correction begins, the next 6% correction will still bring the S&P below our selling price.
- Making money isn’t hard if you’re on the right side of the medium term and long term trend! E.g. Let’s say the S&P falls 6%, and then we buy UPRO (3x S&P 500 ETF). By the time the S&P makes a new high, our UPRO position will be up almost 20%!
- So if a small correction happens at any time in 2017 and then makes a new high, our portfolio will be up 40% this year! And if the S&P keeps rallying after it makes a new high, our returns will match the S&P’s by 3x.
*We’re updating this over the day.
As of 6:05 am:
As of 2:05 am:
As of 12:15 am:
As of 12:02 am:
Today was a quiet day in the markets. Enjoy your Memorial Day long weekend everyone!