*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.
The S&P just made a new all-time intraday high today. This is why it’s notoriously difficult to consistently and accurately predict the top before small corrections. Hence, the optimal strategy is to buy and hold until you see a significant/big correction. Our model does not see a significant correction on the horizon. The U.S. economy is still growing at a normal rate and corporate earnings continue to improve.
We do not follow the optimal strategy (follow our model the letter) because we try to reduce our risk-exposure at all times. The short term risk for the U.S. stock market is high right now. In fact, the probability of a 6%+ small correction beginning today is 91%! (We’ll have more on this in a later post).
And as you can see today, the market’s price action is becoming increasingly bearish. Despite a surge in oil and the energy sector, the S&P was not able to sustain its new all time highs. In other words, the previous all-time high resistance has not really been broken.
Some traders mentioned the fact that VIX was up today during the intraday while the S&P was also up. (VIX and the U.S. stock market typically have an inverse correlation). They say this means that VIX will continue to rise and the S&P will make a small correction right now. This is not true.
VIX is a terrible timing indicator. Historically speaking, VIX often starts to rise weeks before the S&P 500 starts a small correction.
On an unimportant sidenote, we’d like to mention that the German stock market index DAX has soared over the past few months. This is because EVERYONE is buying European stocks. Everyone thinks that European markets are a great buy because they’re relatively undervalued compared to the U.S. stock market. From a contrarian perspective, does this mean that DAX will fall very soon? Who knows. Extreme sentiment is not a good timing indicator. But just know that sentiment is extremely bullish for European markets.
Likewise, DAX’s weekly RSI (momentum indicator) is high. This does not guarantee that DAX will top right now. See the following weekly bar chart.
Today’s big story was in oil. Both Saudi Arabia and Russia agreed to extend OPEC’s oil cuts past May 25. Thus, oil and XLE (energy sector ETF) jumped. Saudi Arabia’s logic is simple: they cannot afford a price war against U.S. shale. Since they started dumping oil in 2014, Saudi Arabia’s sovereign wealth has fallen by $200 billion.
OPEC still needs to vote on a formal decision on May 25, 2017. We are not so sure that OPEC will agree to an oil cut. Saudi Arabia is just one member. All the other members know that U.S. shale production will soar in the future. So any production that they do cut will be offset by increased U.S. production. So if prices are going down anyways, why would OPEC want to give up market share? The break-even cost of production for U.S. shale is $36.5 in 2017.
Interest rates went up a little today because oil went up. There’s a positive correlation right now between oil and rates because oil drives inflation, which drives rates.
However, you can see that interest rates are much less bullish than crude oil. The 10 year yield is up a mere 0.36% while WTI crude is up 2.11%.
XLF (finance sector ETF) went up today with interest rates. XLE slightly outperformed the S&P 500 today.
The tech sector performed in-line with the S&P 500 today. There’s nothing special about this.
We sold our stocks today and are looking to buy them back at the bottom of a 6% small correction. It’s almost impossible to pick the top before a small correction, but in selling we have reduced our short term risk. Even if the S&P rises to 2540, it will still fall back to the price that we sold at.
Our model says that this is a rally within a bull market. The model does not predict small corrections.