There is a strong correlation between stocks (U.S. and foreign), oil, the U.S. dollar, and gold/silver. These correlations cannot be completely quantified, but they exist right now. These correlations exist because inflation will rise over the next 2 years. Our Medium-Long Term Model predicts that core inflation (excluding oil) will rise, particularly in the 2nd half of 2018. Rising inflation (excluding stagflation) is bullish for stocks, bullish for oil/gold/silver, and bearish for the USD.
- There is a clear “risk on” play in global equities right now. U.S. and global stocks are surging like crazy. Momentum is insanely overbought.
- Oil and other inflationary commodities are surging as well.
- The U.S. dollar is in a bear market because inflation is on the rise (long term). The U.S. dollar always goes down when inflation picks up.
- Gold and silver are in long term bull markets. They have an inverse correlation with the USD right now.
As a result of these correlations, the next correction will be a correction in everything.
- The U.S. stock market, foreign stock markets, oil, and gold/silver will all make a correction together.
- The U.S. dollar will make a bounce within its bear market.
Here’s what I think will happen over the next few months. This is the most likely path. If I had to assign a probability, this case would be 60%.
Step 1: Assets will rally at least 1 more month
1 more month brings us into February.
This study concluded that the S&P 500 will rally at least 1 more before beginning a 6%+ “small correction”. This is logical. The S&P 500 is insanely overbought on every single time frame. When this happens, we typically need to see a bearish divergence on the weekly chart before a correction can begin.
It’s hard for the S&P to make a correction right now in January. The stock market doesn’t always rise on earnings season, but it seldom makes a correction on earnings season (particularly when investor sentiment is already so exuberant).
I expect emerging markets and global stocks to make bearish divergences as well.
Here’s EEM (emerging market ETF) on a monthly bar chart.
Here’s the MSCI All-Country World Equity Index. This looks more like the S&P 500 than EEM because 52% of the MSCI Index are U.S. stocks.
Oil paints a similar picture. Oil’s momentum is insanely high, which means that a bearish divergence to its 50% retracement at $67 is likely. Bearish divergences on weekly charts take at least a few weeks.
Meanwhile, the U.S. dollar has just broken down from multi-year support. I expect the USD Index to continue falling at least 1 month before it makes a bear market bounce.
Gold/silver and the USD have an inverse correlation, Hence, gold and silver will breakout from multi-year consolidation patterns as the USD breaks down. I expect a sizable rally over the next 1+ months.
Here’s silver on a monthly chart. Notice how it’s EXTREMELY compressed by its 50 and 200 monthly moving averages.
Here’s silver on a weekly chart.
Here’s gold on a weekly chart.
Step 2: the correction in everything
No one knows what will trigger the next correction. It could be Trump attempting to pull the U.S. out of NAFTA.
Regardless, I think the S&P 500’s correction will be rapid. I.e. It’ll take 2-4 weeks from top to bottom. Here’s the logic.
- Short term speculators and traders are INSANELY long equities right now. There’s no doubt about that.
- When speculators and traders are insanely long, their stop losses are very tight. They don’t have enough cash to stick to their long positions when the market goes down. Hence, a normal pullback (e.g. 3%) will trigger a tidal wave of stop losses on the way down. The selling becomes self fulfilling, which is why a 10% “small correction” is more likely than a 6% “small correction”. This tidal wave of stop losses is also why the correction will be rapid.
- The S&P’s correction will bring global stocks, oil, and other commodities down.
This is what the correction of September-October 2014 looks like.
Step 3: the correction’s bottom
I’m not sure if the bottom will be V shaped or if the S&P will bounce for 2 weeks at the bottom. This doesn’t really matter to medium-long term investors and traders.
Step 4: blast off
Based on current data, our medium-long term model predicts that the S&P 500’s bull market has 2-3 years left. From a discretionary perspective, I believe 2 years is far more likely than 3 years. The faster the economy and stock market heat up, the less time this bull market and expansion have left.
The upcoming correction will be a “buy the f*#@ing dip” moment. Contrary to popular belief, the stock market doesn’t die on exuberance. When sentiment is insanely high (e.g. right now), the U.S. stock market will not experience a significant correction or bear market in the next year (see study). Equity bull markets end when exuberance has died down a little.
The global economy is on fire right now and will overheat in the next 2 years (see U.S., Europe, and emerging market economies). That’s why we will experience a massive bubble in all assets over the next 2 years. Investor exuberance is based on a simple truth right now: the global economy will heat up in the final inning of this economic expansion.
Hence, this correction will be a once in a lifetime buying opportunity before global assets (stocks and commodities) enter into a full-blown bubble.
I completely agree with Jeremy Grantham’s view: assets will melt-up over the next 1-2 years.
Step 5: the next bear market
It’s too premature to predict how the next bear market will play out. Let’s take things one step at a time. Here are my thoughts.
My one concern
I believe there’s a 60% chance that “the correction in everything” will begin in February (and more likely late-Feb than early-Feb). This is not an extremely high probability like 80% or 90%. Why?
I’m concerned about the U.S. dollar’s breakdown. It just broke down. Normally, a market will continue to fall for a few months after it initially breaks down.
So if the U.S. dollar continues to fall until e.g. March-April, then gold and silver will continue to rally until March-April. Under the current correlation, this means that stocks and oil will not begin corrections until March-April!
Here’s how I would assign probabilities.
- A 60% chance that the correction will begin in February (probably late-February).
- A 20% chance that the correction will begin in March.
- A 20% chance that the correction will begin in April.
Aside from my small Day Trading portfolio, I will remain 100% long UPRO because my Medium-Long Term model doesn’t foresee a significant correction at this point in time. I ignore small corrections. I only sidestep significant corrections and bear markets.