Before I get into the market action from Thursday, let’s finish off the bear market checklist. It says the rising U.S. estimates/EPS growth rate will turn into a peak in U.S. estimates/EPS growth rate. That’s true, but it seems like that is very obvious. I doubt any trader doesn’t already know that the EPS growth rate in 2018 won’t be sustained. In fact, I think this has been known since the tax cuts were passed in December and was on people’s minds when the tax cuts were being discussed in 2017.

The obvious question is when these changes get priced in. I think that the market has already priced in the growth rate peak by now since those earnings will be released later this year. Investors are already focusing on the changes in Q3 estimates to understand where the market is headed. Yes, this is a situation where earnings affect stocks and stock prices affect earnings.

I don’t get as worried about factors everyone is talking about as I do about issues which aren’t discussed. I also think the earnings growth rate peak is a ‘nothingburger.’ It’s not like earnings growth is going to turn negative in 2019. If you think earnings will shrink in 2019, then you have a non-consensus trade that you should bet on. I don’t see that situation playing out. The most confusing part about the bearish case for equities is that bears say high earnings growth is bad because the Fed usually hikes sharply, and growth eventually decelerates, while they also say the earnings growth rate peaking is bad.

After the earnings growth rate peaks, growth will be back in the so called sweet spot that the bears claim is amazing. I feel it’s inconsistent to believe both points. I have never been bearish because of high earnings growth, but I am cautious since the 2017 appreciation at least partially priced in the positive effect from the tax cuts. I will be bearish when I see a reason for earnings to miss current estimates. A yield curve inversion is an example of a catalyst I’m looking for. A second catalyst is if the European economy weakens further because that would push the slowdown near a recession which could spread to America.

The last bullet says the Morgan Stanley cycle model will go from rising to peaking. I can’t comment on the future of the index because I don’t know exactly what’s in it. However, if it does peak, I will be bearish. It’s quite likely that if it is peaking there will be other signs in the data which I will pick up on.

Thursday Stock Market Recap

The stock market showed that the reaction on Wednesday was just a temporary blip as it digested a more hawkish Fed. In the near term, the market is dealing with an economy that is red hot. That’s great news for stocks, but some are sounding the alarm that this is the last gasp of growth for this cycle. The S&P 500 was up 0.25% on Thursday and the Nasdaq hit a record high, rising 0.85%. The market is ignoring the warning signs the bond market is giving off just as they usually do. I have mentioned previously that stocks do well when the curve flattens in this current range.

The S&P 500 is still slightly off the high made on Wednesday afternoon, but it’s up a respectable 4.07% year to date. The CNN Fear and Greed index has moderated slightly as the market has stalled; it’s now at 63. It’s won’t be bad to see some weakness in the next few days to prevent the market from getting overheated.

Dollar Hits An 11 Month High

The dollar had a big day on Thursday as the index was up from $93.71 to $94.94. This is the reaction I was expecting from the dollar after the hawkish rate hike on Wednesday. It’s now at the highest point since July 2017, which to me makes this a clear bull market. There will be negative currency side effects on S&P 500 earnings. The chart below explains why the dollar is rallying.

As you can see, the Fed is at the end of its hike cycle, while the global average is just about to start hiking. The global average is about as dovish as it will get this cycle. There’s a sharp divergence in Fed policy and ECB policy as the ECB still has negative rates. The bearish factors the dollar is dealing with are that Trump has supported a weak dollar and the market is in ‘risk on’ mode which isn’t good for the dollar. Inflation is also increasing, hurting Americans’ purchasing power.

Yield Curve Is Worrisome

Everyday the yield curve is a big story since it is very close to an inversion. The start of my danger zone prediction I made a few months ago was July 1st. The highest likelihood of an inversion is Q4 2018; each day the curve flattens pushes a potential recession closer. On Thursday, the 10 year bond yield fell about 3 basis points, signaling the May high might have been an intermediate term peak. It’s currently at 2.93%. The 2 year yield might beat the 10 year to the 3% mark at the current rate. The 2 year yield fell about a half a basis point, meaning the curve flattened sharply. The 2 year yield is now at 2.57% which means the difference between the 2 rates is only 37 basis points. If the curve keeps inverting more than one basis point per day, we’ll see an inversion in the summer.

Conclusion

Stocks look great, but the yield curve is signaling tougher times are ahead. If the curve inverts, it means you need to activate your action plan which you should be formulating now. One example of this plan could be to raise the cash portion of your portfolio to 20%. That’s something to consider doing early next year. Obviously, you need to tailor that advice to your personal situation.