*These are our short term discretionary thoughts on the market. We’re looking at how the market reacts to news, earnings, and other fundamental themes. Our models determine our trades.
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Stock index & news
- The S&P’s strong momentum is long term bullish.
- Overvalued FANG stocks will become more overvalued.
- Soaring oil supply is starting to turn around.
The U.S. stock market’s strong momentum is a long term bullish factor.
As of June 2017, the S&P has closed higher for 7 consecutive quarters. Since the S&P’s inception in 1950, this has happened 5 times. In all of these historic cases, the next significant correction was at least 1 year away.
*The S&P existed before 1950, but not in its current form.
The S&P closed higher for 7 consecutive months by Q3 1996. The next significant correction began almost 2 years later in July 1998. Our medium-long term model predicted that significant correction in April 1998.
The next significant correction began in early-1994, more than 1.5 years later.
The next significant correction began 2 years later in early-1966.
The next significant correction began in mid-1956.
The next significant correction began almost 2 years later in early-1953.
The reason for this historic pattern is simple. When the stock market’s momentum is very strong, the stock market cannot die instantly (i.e. significant correction or bear market). The strong momentum must be slowly worn down.
This ties into our study which demonstrated that when the stock market’s volatility is low, the next significant correction is far away.
This doesn’t mean that the S&P can’t make a 6%+ “small correction” within the next 4 months. The current “small rally” has lasted 262 trading days. Out of the S&P’s 79 historical “small rallies”, only 3 have lasted longer. By the end of October 2017, the current small rally will be the longest in history.
Any “small correction” that the S&P makes will be normal and healthy. Our fund will shift from 100% cash to 100% long UPRO (3x S&P ETF) on the next 6% correction.
The bull market in overvalued FANG stocks is not over.
Overvalued stocks tend to become even more overvalued, as long as the broad stock index is still in a bull market. Here’s why.
*Our medium-long term model states there are still 2-3 years left in the current bull market.
High-flying, overvalued stocks tend to be high-growth stocks. In bull markets, revenues in these stocks grow very quickly (that is the definition of a “growth” stock). Hence, investors are ecstatic and extrapolate the strong revenue growth to infinity. Investors assume revenues will double, triple, quadruple, etc and justify today’s overvalued stock price. Thanks to investor sentiment, the stock price rises even faster than revenue growth. Hence P/E ratios soar.
This pattern has played out in every historical bull market.
- Conglomerates were high-growth stocks in the 1960s. Revenue growth was high, but their stock prices went up even faster.
- The Nifty Fifty were high-growth stocks in the 1970s.
- Internet darlings were high-growth stocks in the 1990s (despite obscene valuations).
Throughout these historical bull markets, high-flying stocks saw many large corrections. But their bubbles only burst when the entire stock market’s bull market ended.
FANG stocks are the high-flying, overvalued companies of today. Their revenues are growing rapidly, so investors are jubilant.
- Facebook expects 40% revenue growth this year. (Facebook is really increasing the number of adds it shows to its users.)
- Amazon expects 22% revenue growth. (Amazon reinvests a ton of profits into its business, so no on really knows how high Amazon’s revenue growth can be.)
- Netflix expects 28% revenue growth.
- Even Google expects 20% revenue growth.
That is why FANG stocks have outperformed the S&P year-to-date.
By comparison, the S&P 500’s year-over-year sales growth is merely 4.8%.
These FANG stocks will probably continue to outperform the S&P as long as this is still a bull market.
Oil is starting to turn around.
Last week we mentioned that the fundamentals for oil are starting to turn bullish. Growth in oil production is starting to slow down because production costs are rising. Inventories are being drawn down.
Yesterday’s API report on oil inventories supports our hypothesis. Inventories declined significantly and much more than expectations.
As we said in our previous post, oil started to top in February 2017 just as the year-to-date cumulative change in inventories turned positive. Today, the year-to-date cumulative change in inventories is almost negative. This is a medium-long term bullish sign.
*We don’t trade oil. These are just some thoughts on oil, so take them with a grain of salt.
Energy stocks have been stuck in a downtrend since December 2016. We think that as oil prices start to swing higher in a wide channel, the energy sector will breakout from its downtrend too.
Here’s XLE (energy sector ETF).
Nothing has changed since our our July 11 bottom line.
- Our medium-long term model says that the U.S. stock market is still in a “big rally within a bull market”. There is no significant correction or bear market on the horizon. The optimal investment decision is to follow our medium-long term model and be 100% long stocks.
- We are sitting on 100% cash. Based on our Easy Trading model, the most risk-free and guaranteed part of the current “small rally” is over.
- We’re waiting for the next 6%+ small correction. Then we’ll shift into 100% long UPRO (3x S&P 500 ETF).
After underperforming the S&P for a month, tech is now outperforming.
The energy sector underperformed the S&P today despite rising oil prices.
Here’s XLE (energy ETF).
Here’s WTI oil.
Finance underperformed the S&P today because interest rates sank across-the-board.
Here’s the 10 year Treasury yield.
The tech sector vastly outperformed the S&P today.