*These are my short term discretionary thoughts on the market. My model determines my trades.
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Stock index & news
- The S&P’s price action vs. news is becoming more bearish.
- The similarities between 2017, 1964, and 1995 keep piling up.
- The NFIB’s Small Business Optimism is too high. Not good for small cap stocks
3 pm: the S&P’s price action vs news is becoming more bearish.
House and Senate Republicans reached a tentative tax cut agreement at around noon today. Previously, such tax-related news would have been greeted with a multi-point bounce in the S&P 500. Today? The S&P fell a little on this news.
The S&P’s medium term tops are typically flat, which means that price action slowly turns from bullish to bearish. We are seeing that today. The S&P is no longer reacting as bullishly as it should to tax cut news.
5 am: 2017 is extremely similar to 1964 and 1995.
All 3 of these years have 2 things in common:
- The U.S. stock market (S&P 500) rallied a lot.
- The S&P rallied in a nonstop, low-volatility manner.
Here are 2 new studies demonstrating how similar these 3 years are.
- Low volatility: Today, the S&P has gone 52 consecutive weeks without a 2% up or down movement (weekly close vs close). This is the 2nd longest streak in history, and only 1964 was longer (79 consecutive weeks).
- Low volatility: the S&P has made 60 new daily all-time-highs YTD. Only 1995 (77 all time highs) and 1964 (65 all time highs) had more.
Here’s what 1964 looked like.
Here’s what 1995 looked like.
As you can see, both 1964 and 1995 were followed by choppy years. This is why I think 2018…
- Will generally grind higher.
- Will be much choppier than 2017, with multiple 6%+ “small corrections”.
I am leaning towards a 1996 case more than a 1965 case.
5 am: The NFIB’s Small Business Optimism is too high. This is not good for small cap stocks.
NFIB’s Small Business Optimism is ridiculously high thanks to Donald Trump and the Republican Party’s upcoming tax cut.
There have only been 2 historical cases when the Optimism Index is as high as today:
- July 31, 1983
- November 30, 2004
Both of these historical cases are different from today: they occurred 1-2 years after a recession. Business sentiment always rises the fastest after a recession because the economy grows the fastest after a recession (mean reversion is fierce).
Despite the extreme optimism in small business sentiment, the small cap Russell 2000 underperformed the larger cap S&P 500 in both historical cases!
Now a study involving 2 historical cases isn’t very useful. But this fits with our What happens when small cap and NASDAQ diverge so much study. The conclusion is simple:
The media thinks that a tax cut will definitely benefit small cap stocks the most. They could be wrong. Small cap might continue to underperform large cap.
This is why my Medium-Long Term Model only trades the S&P 500’s etfs. It’s too hard to predict which sectors will underperform/outperform.
Yesterday’s price action suggests that small cap might underperform large cap once the tax cut is signed into law. Brady said at 12:25 pm that the Republican House and Senate deals are on track to reach a tax bill deal by this Friday. The S&P rallied a few points on this news while the Russell 2000 fell!
The S&P’s sector performance reflected the USD and interest rates’ decline today.
Finance was the worst because Treasury yields got crushed.
In terms of my short term discretionary outlook, here’s what I think will happen.
- I think the S&P will make a small 6-10% correction in Q1 2018.
- Then the S&P will make a new high, before making a multi-month consolidation or multi-month “small correction” in the 2nd half of 2018.
- 2018 will be much chopper than 2017. As of October 2017, this is the longest rally in history without a 6%+ “small correction”. If you haven’t already, please read What will the S&P do after rising 8 consecutive months.
I do not use my discretionary outlook to trade. I remain 100% long UPRO because my Medium-Long Term model does not foresee a significant correction at this point in time. I ignore small corrections. I only sidestep significant corrections and bear markets.
*I also have a small Day Trading portfolio. Click here to view my day trades.