Stocks Outlook - Tuesday, June 26

Thoughts

1. A disastrous trade war is unlikely because China doesn’t have a lot of options.
2. New Home Sales are still trending higher. A medium-long term bullish factor for the stock market.
3. The stock market’s short-term downside is limited. VIX has come close to closing above its upper Bollinger Band.

1 am: A disastrous trade war is unlikely because China doesn’t have a lot of options.

The stock market has fallen a little bit recently. In the grand scheme of things, the U.S. stock market has been swinging sideways in 2018 in a very wide range.

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Trump’s tariff threats certainly are a negative right now for the stock market, but before we jump to the worst case scenario, it’s important to remember that a disastrous trade war is unlikely because China’s options are limited.

You probably already know that China cannot retaliate dollar-for-dollar against U.S. tariffs because the U.S. imports a lot more from China than China imports from the U.S. China’s other options are also self-defeating.

The media states that China could offset the tariffs by devaluing their currency. While this could happen to a limited extent, China does not want to massively devalue its own currency. China is trying to attract foreign capital and boost its Yuan (they want the PetroYuan to replace the PetroDollar). Massively devaluing the Yuan defeats their own financial goals. China is not dumb enough to shoot itself in the foot.

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Alternatively, China could sell its Treasury debt. The problem is:

1. China only owns 6-7% of U.S. Treasuries.
2. If China sold a little bit of Treasuries at a time, the market will easily absorb this additional supply. This wouldn’t cause interest rates to skyrocket.
3. If China dumped massive amounts of Treasuries all at the same time, there will be no buyers. China will be selling its hard-earned assets (Treasury bonds) for pennies on the dollar.

Alternatively, China could try to hurt U.S. companies. But hurting U.S. companies would hurt Chinese workers since many U.S. companies still have their factories in China.

So while the tariffs certainly are a short-term bearish factor for the stock market, they aren’t medium-long term bearish. This isn’t an equal trade dispute, and one side (China) really doesn’t want to fight.

Internally, China itself is starting to wonder whether it’s ready for this trade dispute with the U.S. (see Bloomberg)

Here’s the U.S.’ stock market (in bars) vs China’s stock market (line)

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1 am: New Home Sales are still trending higher. A medium-long term bullish factor for the stock market.

New Home Sales’ latest reading went up from 646k to 689k. But more importantly, New Home Sales are still trending higher. This is a medium-long term bullish sign for the stock market.

*New Home Sales tend to fall for 1-2 years BEFORE the equities bull market ends. We are watching out for signs of sustained deterioration in New Home Sales. There have been none so far.

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1 am: The stock market’s short-term downside is limited. VIX has come close to closing above its upper Bollinger Band.

VIX is a short-term contrarian indicator for the stock market. VIX’s intraday high has already tagged its 3 standard deviations upper Bollinger Band. If VIX goes up a little more, it’ll close above this upper Bollinger Band.

If VIX closes above its 3 standard deviations, that will be a very strong short-term buy signal for the stock market.

*This is for short-term traders.

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Outlook

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

1. 2018 will trend higher but will also be a choppy year.
2. The S&P 500 has approximately 1-2 years left in this bull market.