Thoughts

1. #Perspective Wednesday: the stock market holds its break support.
2. Fund managers are extremely bearish. This is a bullish contrarian sign.
3. An increasing deficit doesn’t mean that yields will soar and crush the stock market.
4. China’s Plunge Protection Team is stepping in to save its stock market.
5. Once China’s stock market bottoms, 1 more year before the U.S. stock market tops?
6. Medium and long term U.S. stock market traders shouldn’t worry too much about the trade war.

1 am: the stock market holds its break support.

Some perspective is important when looking at the U.S. stock market.

Despite the ongoing trade war, the S&P 500 has merely turned its January 2018 from resistance into support.

(Click on image to enlarge)

1 am: Fund managers are extremely bearish. This is a bullish contrarian sign.

Bank of America’s latest fund manager demonstrates that fund managers are the most pessimistic on the global economy since 2011.

On the surface, this seems bearish for U.S. stocks and the U.S. economy. But considering that only 10% of active fund managers outperform the S&P 500, this is actually a bullish sign for U.S. stocks. Active fund managers are mostly a contrarian indicator.

As you can see in the above chart, this level of bearishness DURING AN ECONOMIC EXPANSION (e.g. 1998, 2004-2006, 2011, 2016) marks a medium term buying opportunity. And with U.S. economic growth at 3-4%, a recession over the next 6-12 months is highly unlikely.

1 am: An increasing deficit doesn’t mean that yields will soar and crush the stock market.

As you probably know, the U.S. federal debt continues to rise (partially due to Trump’s tax cuts). Some people automatically assume that a rising federal debt means that U.S. interest rates will soar (because supply of Treasuries increases). This is an oversimplification.

Yields won’t soar if demand keeps pace with supply. That’s just how markets work. And when interest rates rise, demand increases as well (more buyers are attracted to higher rates).

Here’s a clear example. With interest rates higher this year than last year, there’s been a surge in demand for Treasuries from corporate pension funds. Surging demand puts a lid on how far interest rates can rise.

I expect interest rates to rise slowly. I don’t think there will be a cataclysmic surge.

1 am: China’s Plunge Protection Team is stepping in to save its stock market.

China’s stock market has been crushed by Trump’s trade war. And while most investors are fearful, China has started to take steps to directly stabilize its stock market.

From Bloomberg:

“A group of 21 entities with more than $145 billion in assets under management may already be propping up the market.

These investors were intervening in the market and insurance companies were directed to buy stocks. Subsequently, blue-chip equities — the preferred holdings of the National Team — outperformed, which signals the group has been operating “either directly or indirectly over the past few weeks.”

1 am: Once China’s stock market bottoms, 1 more year before the U.S. stock market tops?

In yesterday’s post I noted that it’s completely normal for the U.S. stock market to go up while the Chinese stock market goes down.

@SimoTrader commented on my Tweet and noted something interesting. The U.S. stock market vs. China stock market ratio tends to peak 1 year before the S&P 500 tops.

(Click on image to enlarge)

So even if the S&P:China ratio peaks right now, what we’ll probably see is:

1. Chinese stocks outperform over the next year (Chinese stocks making a strong bear market rally)…
2. Then the bull market’s top.

Either way, this suggests that the bull market’s top isn’t in.

1 am: Medium and long term U.S. stock market traders shouldn’t worry too much about the trade war.

Politics is mostly just noise. It causes short term fluctuations in the U.S. stock market, but has little impact on the market’s medium-long term direction.

Listening to mainstream financial media doesn’t really help your analysis of politics. When the market goes down, CNBC attributes the decline to “the trade war”. When the market goes up, CNBC also attributes the decline to “the trade war”.

CNBC's headline on the trade war this morning, vs...
CNBC's headline on the trade war this afternoon pic.twitter.com/bdrOT0Vvk0

— Troy Bombardia (@bullmarketsco) September 18, 2018

Here’s a very good piece of analysis from Paul Krugman. Ignore the headline and focus on the content.

Krugman calculates that even during a TOTAL TRADE WAR, it would only hurt world GDP by 2-3%.

Moody’s estimates that the current trade war will hurt U.S. GDP growth by -0.2% next year. This is peanuts for an economy that’s growing at 3-4% a year.

So why doesn’t the trade war signficantly hurt the U.S. stock market or economy? Because out of all the world’s major economies, the U.S. is a relatively isolated economy. The U.S. economy doesn’t rely significantly on import/export (vs. e.g. Germany or China), and S&P 500 corporations still derive most of its revenues from domestic sales.

As I’ve said for a long time, this “trade war” is not a fair fight because China exports far more to the U.S. than the U.S. exports to China. Trump placed tariffs on $200 billion worth of Chinese exports. China retaliated with $60 billion.

Outlook

Here’s what I think will happen based on my discretionary outlook.

1. The S&P 500 has approximately 1 year left in this bull market (bull market top sometime in 2019).
2. I will scale out of my long positions throughout 2019