*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.
Go to our homepage for our latest market outlook. We update this webpage throughout the day.
Stock index & news
- The financial sector will lead the S&P in the next few quarters
- Prepare for a bumpy few months ahead.
- GDP growth will probably improve in the next few quarters.
4 pm: the financial sector will lead the S&P in the next few quarters
Right now, the tech sector is still the primary driver behind the S&P’s gains. We think the financial sector will also lead the S&P in the next few quarters (e.g. 1 year).
Q2 earnings season for financial stocks is mostly over, and earnings at the biggest banks are close to making an all-time high.
Right now, the primary drag on financial earnings are “low trading revenues”. With extremely low stock and bond market volatility, banks aren’t making as much money as they used to on the trading side.
Here’s stock market and bond market volatility.
*Banks are terrible at directional trading (on balance). They’re no better than the average retail trader because directional trading isn’t that easy. They have thousands of traders. So by definition, some of their prop traders will beat the index while others will underperform the index. But unlike retail traders, banks don’t beat the index via directional trading. They beat the index via insider information, trading the bid-ask spread, front-running clients, etc. But when volatility is extremely low, the primary source of revene – trading the bid-ask spread – disappears!
We all know that volatility in the markets cannot remain subdued forever. When volatility returns in the next few months, this drag on financial corporate earnings will disappear. Hence, a major medium-long term drag on financial stocks will disappear as well.
The financial sector has not gone up despite a decent earnings season. Is this price action bearish? Not necessarily. Price action isn’t a useful predictive tool in the U.S. stock market. Sometimes the financial sector will be flat on a strong earnings season and then go up AFTER earnings season is over. This is what happened in Q2 2016.
*Take our sector-related thoughts with a grain of salt. We only trade UPRO (3x S&P 500 ETF). We don’t trade individual sectors.
6 am: Prepare for a few bumpy months ahead
These 2 charts have become popular among trading circles. Here is the S&P 500’s seasonality since 2013.
Here’s the S&P’s seasonality since inception.
Both of these charts point to the same thing – the S&P tends to experience some weakness in the months after July (Q2 earnings season).
Some traders think that the S&P will begin a 6%+ “small correction” in August. We disagree. We still think the most likely scenario is that the S&P will begin a “small correction” in late-September or October when the debt ceiling fight begins.
We don’t think Trump-Russia fears will trigger the next 6%+ correction. You can clearly see that the market is starting to react to Trump-related news. Over the past few weeks, the S&P has often spiked down 10 points on Trump-news, only to rally back up within a few hours. With so many attempts to push the S&P down on Trump-news, one of these attempts will eventually succeed. But how far down will the S&P go?
*Trump’s son is testifying next Wednesday.
We think a 6% correction on Trump-news is unlikely. A 6% decline is 150 points. Instead, perhaps the S&P will make a small 2-3% pullback on Trump-news in the next few weeks.
So perhaps the S&P will make a 2-3% pullback in August, make a new high, and then begin a small correction in September/October. Who knows. We’re not in the business of making short term trades. We focus on the medium and long term. All we know is that the S&P will have a bumpy road ahead in the next few months.
*VIX will probably spike on a 2-3% pullback. When VIX is this compressed, even a small decline in the S&P can lead to a huge spike in VIX. Ironically, VIX’s spike will limit the S&P’s decline (VIX is a contrarian indicator for the S&P).
6 am: 3 main drags on GDP growth are disappearing
Last week we explained why U.S. GDP growth is so “low”. We don’t use GDP as an indicator because
- It lags the real-time economy. This data series only comes out once a quarter, has massive revisions, and has too much statistical noise.
- GDP is actually broken down into many parts!
Sometimes, GDP growth will be “weak” merely because some unimportant parts are contracting.
The 3 biggest and most important parts are “GDP from Manufacturing, GDP from Public Administration, and GDP from Services”. All of these 3 main parts have grown nonstop over the past few years.
Here’s GDP from manufacturing.
Here’s GDP from services.
Here’s GDP from Uncle Sam (Big Government anyone?)
From 2015-2016, 3 sectors have dragged down U.S. GDP growth. Agriculture, mining, and utilities. (Commodity prices tanked from 2014-2016. So it’s only natural that nominal GDP from these 3 sectors fell too).
Here’s GDP from agriculture.
Here’s GDP from mining.
Here’s GDP from utilities.
Our sister fund thinks that the bear market in commodities is over. If they are right, then these 3 GDP sectors will no longer drag down U.S. GDP growth.
Nothing has changed since our our July 20 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 have been sitting on 100% cash since May 13. Prior to that we were 100% long UPRO. 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).
- Our portfolio is up 17% year-to-date.
The energy sector did not fall a lot today even though oil tanked. This is a bullish sign for the energy sector – it’s starting to breakout from its downtrend.
Here’s XLE (energy sector ETF).
Here’s WTI oil. Notice that oil is starting to make higher lows! Attempts from the bears to push oil down are becoming weaker and weaker!
The financial sector has been flat despite a strong earnings season. The financial sector’s weakness is primarily due to falling interest rates.
Here’s XLF (finance ETF)
Here’s the 10 year Treasury yield.
The tech sector is resting after a 9 day streak. This is normal.
Here’s XLK (tech ETF)