Outlook For Stocks - Tuesday, May 15

Thoughts

1. S&P 500 dividend yield fell below the 3 month Treasury bill rate for the first time in 10 years. NOT medium-long term bearish for the stock market.
2. Some short term technical weakness in the stock market.
3. Earnings growth will probably peak later this year. Then will become a medium-long term bearish factor for the stock market in the 2nd half of 2019.

1 am: S&P 500 dividend yield fell below the 3 month Treasury bill rate for the first time in 10 years. NOT medium-long term bearish for the stock market.

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Bears see this as a medium-long term bearish sign for the stock market because “investors will switch from stocks to bonds”. It isn’t. The bears are wrong on 2 levels:

1. This comparison is nonsensical. It makes more sense to compare the S&P 500’s EARNINGS yield vs bond yields. Companies retain the majority of their earnings. Only a portion of their earnings are issued as dividends.
2. Bond yields have exceeded dividend yields for most of history. So this isn’t a consistently bearish sign for the stock market.

1 am: Some short term technical weakness in the stock market.

A small pullback in the stock market here (i.e. for a few days) would be normal.

Small cap stocks (Russell 2000) are facing resistance at previous highs right now.

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Large cap stocks (Dow) have gone up 8 days in a row. The Dow is currently at its 50% retracement (resistance level).

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I think the pullback could bring the S&P 500 to retest its previous resistance trendline (approximately 2700).

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Please take my short term thoughts on the stock market with a grain of salt. I focus on the medium-long term.

1 am: Earnings growth will probably peak later this year. Then will become a medium-long term bearish factor for the stock market in the 2nd half of 2019.

Year-over-year earnings growth will likely peak sometime this year and start to fall next year when earnings have a stronger comparison. (Earnings right now are being compared to pre-tax cut quarters. Earnings in 2019 will be compared to post-tax cut quarters.)

For starters, earnings growth tends to peak when the yield curve inverts. Based on the curve’s current rate of flattening, the yield curve will probably invert at the end of 2018 or early-2019.

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The following chart also supports our prediction. It demonstrates the strong correlation between South Korean exports and U.S. corporate earnings growth.

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Notice how the 2 sets of data usually peak at the same time. U.S. corporate earnings growth continues to increase because of the tax cut. Without it, corporate earnings growth probably would have already peaked.

But investors and traders don’t need to be immediately concerned when earnings growth peaks. The economy and stock market typically top AFTER earnings growth has peaked.

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This means that if earnings growth peaks in 2018, bullish investors and traders don’t have to be concerned until 2019.

Outlook

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

1. The S&P has made a 6%+ “small correction”. This will not turn into a “significant correction”.
2. 2018 will trend higher but also be a choppy year.
3. The S&P 500 has approximately 1-2 years left in this bull market.