This is a guest post by Troy who is a private trader who blogs at Bull Markets
Why the stock market is going higher in the medium term:
Here’s what I think based on 3 time frames:
- Long term: This bull market has 1-2 years (closer to 1 year than 2 years)
- Medium term: The stock market will rally higher throughout the rest of 2018, although it will do so in a very choppy manner.
- Short term: The stock market might fall a little more in the short term, but the downside is limited.
Here’s why.
Long term
The stock market and economy move in sync over the long term. Leading economic indicators lead the economy, which means that they also lead the stock market. The major U.S. economic indicators show no signs of significant and sustained deterioration right now.
Although the unemployment rate and initial claims are flattening, they have not yet started to trend upwards.
Industrial Production growth continues to go up.
New Home Sales growth continues to trend higher.
Consumer Sentiment continues to trend higher.
The economy implies that a bear market is not imminent. Corporate earnings are exceptionally strong as well. Corporate earnings continue to beat expectations for Q1 2018 despite a very high bar.
Medium Term
Various studies suggest that the stock market is going higher over the next few months (i.e. throughout the rest of 2018). January 2018 wasn’t the highs.
For starters, the cumulative Advance-Decline Line (breadth indicator) has already made a new high. This is despite the fact that the S&P 500 has yet to make a new high.
We did the study for this. The Advance-Decline Line made a new post-correction high before the S&P. This has only happened twice since 1950. Both of the times the stock market’s bottom was already in. This suggests that February 9, 2018 was the bottom of this correction.
In addition, the stock market’s rally leading up to January 2018 was exceptionally strong. It wasn’t exceptionally big in terms of magnitude, but it was exceptionally steady (i.e. no volatility). Various studies all suggest that when the market makes an exceptionally low-volatility rally, the stock market then makes a correction followed by a higher high. Remember, the last rally before a bull market ends is supposed to occur on high volatility.
Lastly, commercial hedgers (smart money from the COT report) are still extremely bearish on VIX despite the recent decline in VIX. This implies that the smart money expects VIX to decline over the next few months (and the stock market to rally).
Short term
The stock market has some short term downside. But remember to think about risk:reward when trading. The short term side is limited.
The stock market might fall in the short term on any number of news:
- Trump tariffs.
- Mueller investigation.
- Rising interest rate fears.
But all of these fears and bearish factors will be short lived.
The stock market is having a smaller and smaller reaction to trade-war related news. China slapped retaliatory anti-dumping deposits on U.S. imports of sorghum, a type of grain. The stock market did not react to this news at all.
The stock market is not reacting in a big way to news on Mueller’s investigation. There has been no sustained selloff. These are both signs of bullish price action vs seemingly bearish news.
And lastly, fears of rising interest rates are mostly unfounded. There is no clear and consistent inverse correlation between rates and stocks. In fact, there is a positive correlation between the 10 year yield and S&P 500 right now!
The S&P 500 has been supported on its 200 daily moving average twice already. It’s clear that there’s a lot of buyers at this level. Companies are doing $800 billion of sharebuybacks in 2018, up from $525 billion in 2017. They are buying at a particularly intensive rate when the stock market is down. So even if the S&P does eventually break below its 200 daily moving average, I don’t expect this to be a big breakdown.
Troy Bombardia trades the stock market primarily using a medium-long term quantitative strategy. He shares his thoughts at Bull Markets.