A Market Timing Report based on the 11-24-2017 Close, published Sunday, November 26th, 2017

I deliver focused comments on market timing once or twice a week.  These are supplemented with daily “Tweets/StockTwits” (see links below).

UPDATE 11-29-2017: Bitcoin Defying Trend Channel on Run Above $10,000

It is what it is.  Sometimes markets that are stretched become even more stretched.  If you must buy now to “get into the market,” then buy higher and lower in a methodical way.  There is inherent risk in  buying a stretched market.  It can snap back based on the next “negative news,” which is often simply an excuse for a market correction.  Compare this chart to where we were just last Saturday (chart #5 below).

Bitcoin defying the channel on panic buying above $10,000.

Now back to this week’s issue…

1.  SP500 Index: We need to pay close attention to year over year quarterly earnings comparisons for the tech sector going into 2018.  Market timing signals may start going off in techland by Q1 of 2018 and I’ll explain why…

Why should we track this closely?  First the facts.  The last quarter (Q3) revisions of earnings growth in the tech sector according to FactSet (link opens the PDF) went from 8.8% to 19.9% due to upward revisions to earnings estimates and upside earnings surprises.  By comparison, FactSet says with 98% of companies reporting, SP500 Index earnings rose a much lower 6.2% in the quarter. Still very good, but tech earnings were far better.

Great is great, but remember that stock prices are sustained by continued earnings, but propelled upward by earnings GROWTH, not the level of earnings.  A constant E deserves a constant P, at least over time.  The market can always get far ahead of earnings growth, but if growth in tech earnings slows into 2018, the comparisons become tough and tech stock prices could come down. 

Here however is the tricky part: What if tech earnings growth slows from 20% to 10% for all of 2018?  That would still allow a gradual rise in tech stock prices.

However, seeing earnings growth rates slide for Q1 could raise investor fears that the slide will turn to the negative, with an earnings recession, even if it does not come until 2019 or later.  This means opportunities may arise for us to buy tech stocks sold off in fear of earnings growth deceleration as our market timing signals fire off.  

When will our first market timing buying opportunity arise in tech stocks?  First, you may still be able to make gains between now and the first whiff of tech earnings growth deceleration.  The risk to those gains will require using profit based mental stops to be sure you preserve a certain profit level on all new tech trades from now to the first sign of “trouble.”

My first choice scenario: The market tries to discount “earnings growth slowing” in tech ahead of time after Q4 2017 earnings based on projections of slower growth in the January earnings reports.  If those reports are above current expectations, the selling could wait until after Q1 2018 earnings in April.

My second choice scenario: The first selling panic on tech earnings growth deceleration could come when earnings are actually released for Q1 2018 in April, when the earnings deceleration is actually confirmed, and particularly if the projections are softer for Q2 2018 and beyond than they are now.  As said, a continuing deceleration will raise the possibility of a tech earnings recession.

Generally, the stock market discounts events early, which is why I’m going with Scenario 1 for now.   “For now” means we need to monitor expectations for tech earnings growth and watch the direction and magnitude of revisions.

The still continued growth of tech earnings, even if halved to 10% into 2018 will allow tech stock prices to rise following the bouts of selling. 

If worse than 5-10% earnings growth, a tech pullback will be far more likely.

Read on though to the biggest current market threat…

First, Fed news for the week…  The Federal Reserve minutes released this week revealed the conflicting feelings from one Fed member to another and even of individual Fed members, including Dr. Yellen.  She wants to raise rates in December as the entire Fed does supposedly, and the CME stats verify the likelihood, but is not sure deflationary pressures are behind us. It is of note that the probability of the Fed Funds Rate being hiked from 1.0-1.25% to 1.25-1.50% is now 91.5% down from 96.7%.

Meanwhile inflation has picked up and even the “transitory inflation” as the Fed considers it, of oil prices is on the upswing as oil makes one new high after another. Oil closed this past week at 58.97 after dipping briefly to retest the $55 area of the prior breakout, a classic market timing move.

I will add back exposure to oil stocks when my signals go green.  I can tell you that some investment firms bought into the oil uptrend early via volatile oil stocks and are now carrying sizeable losses, so I want to demand price strength, before beginning to buy the pullbacks in the stocks.  Oil supply looms over the market and will until China’s and India’s demand (plus “other”) pressures prices upward.  There is also an electricity demand from advancing technology.  Connectivity requires electricity, which requires energy resources.

There is a two sided sharp blade here for Fed tightening. First, if the Fed raises rates now, it could cause the economy to decelerate and bring back deflationary pressures.  If it fails to raise rates and the GOP gets its way with its tax plan, that could create inflation and push the Fed to raise rates and slow the economy.  Yes, inflation could result through this mechanism in economic slowing, or at least a bust after a rush of Trump/GOP tax-cut induced artificial growth.  It’s artificial because it’s based on funny money we don’t have to spend.

The biggest risk to tech stock and all stock prices now is failure of the GOP Tax Plan to pass as delineated HERE.  That bill including repatriation of mucho dollars by large cap US companies at a low tax rate is built into current market prices.  So are the corporate and individual tax cuts.

Any signs of softness in the US economic numbers from this week?  Yes, somewhat, in the PMI numbers from Markit, which showed a slight slowing in the composite number (services and manufacturing) at 54.7 in November vs. 55.3 in October.  The chart shows a topping out, which must be negated by a new high as seen HERE.  I’ll be watching for early signs of economic slowing, which could easily be forestalled by the Trump/GOP tax plan funny money.  

Keep up-to-date during the week at Twitter and StockTwits (links below), where a combined 32,475 people are joining in…

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SP500 Large Cap Index (click chart to enlarge; SPX, SPY):

Brand new breakout high.

Survey Says!  Sentiment of individual investors (AAII.com) showed a Bull minus Bear percentage spread of  +6.48% vs. -5.87% last week or somewhat more Bullish, but not stretched to an extreme.  The market was good for a bounce that took it to new all time highs.  Sentiment is still not at all stretched.  Remember that the press focuses on newsletter writer and institutional sentiment.  The individual investor is just getting warmed up to this Bull market.  There are risks, yes, but it is not over.

2.  U.S. Small Caps: Last week I said, “IF there is a rate breakout this next week, early in the week, I believe small caps will rally further and at least test the prior high.”  Rates were relatively flat and despite that small caps hit a new high, but barely. In any case, small caps have broken the market timing flag to the upside.  We’ll see if it can hold what amount to two days of gains.  If the overall stock market rally is still “real,” small caps will continue to make new highs.

Russell 2000 U.S. Small Cap Index  (click chart to enlarge; IWM, RUT):

Small caps make it over the prior high.

3. Gold: Gold is holding up due to U.S. dollar weakness despite the 10 Year Treasury hanging on above its “Trigger Line.”  The trajectory of the economy and interest rates as they effect the U.S. dollar will define gold’s next market timing move.  For now, there is a rough triangle forming on the daily chart below (lower highs, higher lows) and gold will resolve from this pivot.  Follow the direction of the move out of this triangle, up or down, if you are trading.  I am only looking at the lower triangle whose top is formed by the intraday highs of 10-16 and 11-17-2017.  The base of that triangle is the yellow trend line.

Gold ETF (click chart to enlarge the chart; GLD):

Gold still lingering below the “Trigger Line.”

4. U.S. 10 Year Treasury Note Yield (TNX): What’s the danger in the 10 Year Treasury Yield chart?  The head and shoulders market timing formation could break down.  I’m watching the 2.304% level and do not want to see the 10 Year Yield fall below there.    It is the 11-07-2107 low.  If it does, it means something is off in the recovery process or with the Trump/GOP tax-cut plan.  It means that economic slowing is expected.  It could mean that any further Federal Reserve rate hikes are perceived as possibly dampening the economic recovery and leading to disinflation.

U.S. 10 Year Treasury Note Yield (click chart to enlarge; TNX, IEF, TYX,TLT,TBF):

Rates holding up with slightly higher highs but with an emerging head and shoulders pattern.

5. Bitcoin: I will report at times on some of the market timing extremes in the charts, which may represent buying or selling opportunities.  The trend is up, so we are looking for buying opportunities more than selling, unless you are an active trader.  This is one place you may not want to add exposure as we are very stretched, even beyond the upper channel line as the market timing chart shows.

Now, as usual, we need to review our three market timing signals (below the chart after you review it…)

Stretched above the upper channel line.

Let’s review the three market timing signals together….

MY SIGNAL SUMMARY for a Further U.S. Stock Market Rally:

Stock Signal ON (Small Caps above “Trigger Line”), but now the rally to new highs must be sustained.

Gold Signal OFF (GLD is slightly below the “Trigger line” which is negative for gold, and better for stocks.  Gold prices continue to hinge on economic strength vs. inflation.  The stronger the U.S. economy without significant inflation, the higher rates will go as gold declines.  Besides economic weakening, inflation would be the other out for gold.

Rate Signal ON (10 Year Yield above the “Trigger Line,” good for stocks, not bonds).  Rates were oscillating up and down this week.  We’ll continue to look for even higher interest rates or the recovery comes into question.

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