U.S. stock market on May 16, 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

Once again, the S&P 500 made a marginal new all-time high today. And once again, these new highs were not sustained.
Some investors think that this is a sign of weakness. Not true. It is neither a bullish sign nor a bearish sign. It is an irrelevant sign. A similar pattern happened very often in 2013. Every day, the S&P would open higher and then fall for the rest of the day. But overall, the S&P kept going up. The bears got skinned in 2013.
Several traders have pointed out that the stock market’s breadth is weak. This is true. Most of the S&P’s gains over the past 3 months came from FAANG (Facebook, Amazon, Apple, Netflix, Google). While tech stocks have soared, many other sectors have lagged.
But remember that breadth is a terrible indicator. Breadth was “weak” in 2013-2014 when the stock market soared.
 
Housing Starts and Industrial Production were released today. Housing Starts missed expectations by a lot while Industrial Production beat expectations by a lot. Some investors are worried that growth in Housing Starts is slowing down. This is not a concern.
Investors should be asking “is Housing Starts growing?” and not “how much is Housing Starts growing?” Overall, the trend still points higher for housing. Today’s dip is merely a normal fluctuation. See the following chart.

And if you look deeper into the data, you’ll know why today’s housing report was not bad:

Housing starts is split into 2 parts: single-family (i.e. house) and multi-family (i.e. apartment). At this stage of the economic expansion, single-family construction should start to rise and multi-family construction should stagnate. Today’s decline was due to a big decline in multi-family and not single-family. So the housing expansion will continue on the backs of single-family growth.

As millennials settle down and start families, demographics favor a shift from single-family to multi-family. This is normal.

Sectors

Energy
Once again, everything is tied to oil. The S&P closed flat because oil put downwards pressure on the energy sector. After a few days of big rallies, crude oil’s temporary pause today is to be expected. However, strong momentum in a market like oil doesn’t just die. After today’s pause, oil will probably go higher in the short term.
We think that the S&P will begin its small correction when oil tops.
We talked to some excellent oil traders who think oil will go up to $51 and then reverse downwards. If they are correct, then the S&P-oil’s current correlation means that the S&P should push to marginal new highs (i.e. 2410-2420).
Who knows. We are not in the business of guessing day-to-day changes in the stock market.
Finance
As is expected, interest rates and oil have a strong day-to-day correlation right now. The 10 year Treasury yield fell because oil fell a little. There is a strong over-all correlation between interest rates and the finance sector.
Since late-April, the finance sector ETF XLE has been flat because interest rates have been flat.
Information technology
Once again, the tech sector went up the most today. This is to be expected. In a big rally within a bull market, tech usually outperforms. There is nothing “bearish about this” (contrary to what some perma-bears think).

Bottom line

Overall, everything is within expectations.

  1. Like our model predicted, this is still a big rally in a bull market.
  2. The economy is perfectly normal and is acting in accordance to standard patterns in an economic expansion.
  3. Who knows when the next small correction will begin. But short-medium term risks are high right now. The S&P’s current small rally is in the 91 percentile of small rallies.
  4. The S&P will start to go down when oil starts to go down again.

We remain in cash and will buy UPRO (3x ETF for the S&P 500) when the S&P falls 6%.
 

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