Stocks Outlook - Wednesday, July 25

Thoughts

1. The S&P 500 isn’t “completely relying on FANG”. Gains are widely dispersed.
2. There’s a bearish divergence between the S&P 500 and its equal-weighted counterpart.
3. Corporate profits continue to trend higher. A medium-term bullish sign for the stock market.
4. High yield spreads continue to narrow. A medium-long term bullish sign for the stock market.

1 am: The S&P 500 isn’t “completely relying on FANG”. Gains are widely dispersed.

I see one of these statements every single day: “the stock market is completely relying on FANG. If it wasn’t for FANG, the market would be completely toasted”.

This is factually incorrect. FANG accounts for a big portion of the stock market’s gains merely because FANG has a big market cap. Big market cap companies ALWAYS account for the bulk of the index’s gains (this is simple math).

In fact, the S&P 500’s gains are widely dispersed. This is the S&P 500’s equal-weighted index. Notice how this equal-weighted index is trending up year-to-date in 2018, just like the S&P 500 itself.

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1 am: There’s a bearish divergence between the S&P 500 and its equal-weighted counterpart.

Here’s one of the first bearish factors I’ve seen in a long time. The ratio between the S&P 500’s equal-weighted counterpart and the S&P 500 has been falling since 2017.

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In the past, this has led to increased choppiness in the S&P 500, which is what we’re seeing year-to-date 2018. The S&P 500 was either:

1. In a bear market
2. In a “big correction” in a bull market, or…
3. Making “small corrections” in a bull market.

While this is a medium term bearish warning sign in the stock market, taken together with all the other bullish signs, I wouldn’t pay too much attention to this. Remember: the market is never going to be 100% bullish or 100% bearish. What matters is whether the majority of indicators are bullish or bearish.

1 am: Corporate profits continue to trend higher. A medium-term bullish sign for the stock market.

Corporate profits are still trending higher, even after adjusting for inflation.

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This is a medium-term bearish sign for the stock market. Historically, corporate profits (inflation-adjusted) tend to go down for a few quarters before an equities bear market or “big correction” begins (see study)

1 am: High yield spreads continue to narrow. A medium-long term bullish sign for the stock market.

High yield spreads continue to make new lows even though the stock market is still below its January 2018 highs.

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This is a medium-long term bullish sign for the stock market and suggests that January 2018 wasn’t the stock market’s top. Bond market participants are smarter than stock market participants, which is why the bond market is a leading indicator for the stock market. Historically, high yield spreads widen before a bull market tops.

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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 year left in this bull market.