A Market Timing Report based on the 5-11-2018 Close, published Saturday, May 12th, 2018…

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

1.  SP500 Index Market Timing (S&P 500 Index®; SPY, SPX): What did the Intel-igent Signal say this week? INTC closed at 54.67 for the week with the breakout at 54.36.  The signal is positive for a continued rally in other words, but cannot reverse from here, so keep following it with me.  The prior Bank of America signal does not look that good as it is barely above the 50 day moving average and rates seem to have eased a bit off 3%.  Higher rates are what banking investors want most.  I have to admit that with inflation rising for another 1-2 quarters, investing in the banks may work here.  Since it will be short lived, it’s a trade though, not a static investment proposition.

What is the truly BIG chart picture?  The Big Picture is this: The SP500 Index is back on trend.  The big picture is that the run up into the end of January was hyper-enthusiasm at work due to the one time “earnings growth benefit” of the tax cuts.

What do I mean?  It’s simple math.  The tax cut gives many corporations, though not all, a big tax break, but it’s a one time adjustment to the earnings capacity of the company, rather than a continued source of growth with one caveat I’ll get to in a moment.  It allows companies to retain and then share more of their earnings, which is very positive, but it does NOT necessarily add to growth of earnings in the subsequent year.  In fact, companies will be reporting a deceleration of earnings due to the loss of the tax cut benefit in earnings GROWTH throughout 2019, unless they invest the new money productively in growing enterprises, which immediately add to earnings, which only some companies will end up doing successfully.  The new enterprises have to immediately spin off cash that can be reinvested in further new enterprises that immediately spin off cash once again to keep the earnings growth ball in the air.

If a company made 10 million in earnings in 2017, let’s say their tax benefit under the Tax Bill was 1 million, so they’ll make 11 million in 2018.  That added 10% earnings growth for 2018 without the company doing anything, but the base earnings for next year assuming zero growth this year will be 11 million, not 10 million, and it must go up due to top and/or bottom line earnings growth for their growth numbers to be better.

Investors pay for current earnings yield for sure, as companies who make lots of money can successfully invest it in new business, in dividends, in debt retirement, and in share buybacks, but investors also pay for growth of earnings and revenue.  They will have to come up with new tricks for 2019 to keep the earnings ball in the air.  They cannot invest the money in enterprises that will take years to show a profit to keep that earnings growth ball levitated.

Going back to the chart, we see that what happened on 2-09, 4-02, and 5-03 was a test of the rising 2017 long term channel base, which is the lower magenta line in the chart below.  What happened is the added premium investors placed on the SP500 Index from the very end of November to January 26th was lost and stocks went into a series of volatile moves each time testing the rising 2017 lower channel line.

NOTHING REALLY HAPPENED!  is my astounding conclusion if you take both the crazy rise of stock prices and their fall into equal account.  Overvaluation of stocks vs. trend went away, but there is no evidence of a “Bear Market” in the making…yet.   There was a “Rate Shock” as I told you back in February, but the markets have readjusted for now and are back on trend. 

The current VIX reading at 12.65, below all useful support levels and below the peaks achieved in Nov. and Dec. 2017, says “it  is likely over.”  If Trump is impeached, because of something we don’t know now, the quiet will be over, but as I said on social media, you cannot protect yourself from the unknown.  If you do that as a plan, you will have lousy results as an investor. Remember, I am not saying here that there are no risks; in fact, I name the number one risk facing the stock markets just below…

As I like to say, when the market changes, I change, because stubborn = dumb.  Bears have things to gripe about including global slowing showing up in China (vs. prior growth rates) and Europe, but it’s not recessionary.  PE ratios could be challenged, but there should be no Big Bear Market as I defined it HERE, until financial conditions deteriorate.

Let’s look at the major threats:

• Trade Wars: As I predicted last week, the market is already quickly forgetting the ongoing process of trade negotiation with China, our NAFTA partners and Europe.  I will call Trump’s bluff on this one and say it will all come down to a negotiated win win series of agreements.  It has to be resolved positively, as everyone realizes selling into a smaller market does not increase opportunity for anyone!

• Recession: Not in the picture, though slower growth moving from China and Europe to the U.S. could be, which would contract PEs (bring prices down) but not cause a “Big Bear” as I just said.  We could be dragged below the 2017 trend however, because our multinationals depend on foreign markets.

• War with North Korea: Not happening apparently any time soon.

• War with Iran: Trump won’t allow it to get to that. He actually hates the idea of money wasting wars and bloodshed more than some other Presidents despite his bluster.  The U.S. will have to watch the current tiff between Israel and Iran however and not let it get out of control.  He’ll renegotiate the nuclear deal somewhat – enough for him to save face and Iran to continue to sell their oil.  He is right that Iran is a regional negative and destructive force that must be contained, be he won’t be easily led into a war with Iran as some say Bolton would like.

• Runaway Inflation: One thing that HAS happened is that the inflation rate has moved up to a point fairly close to the Federal Reserve’s target of 2.0% PCE Index inflation.  This in turn did shock the stock markets via “Rate Shock” as I called it HERE.  But runaway or even more rapidly rising inflation is not likely in near term due to economic slowing in China and Europe. Their slowing puts less pressure on input prices.  In addition, the Federal Reserve learned its lesson under President Jimmy Carter, when rates went up to 15%!!!  They know they cannot allow that to happen again.  They will be proactive on inflation and that is their main focus now, not jobs as it was before.

• Rising Interest Rates: This is the number one threat I see, namely, the Federal Reserve ending or seriously damaging the Bull market.  The Federal Reserve will be reacting to a rising CPI Index for the next quarter or two, before inflation falls again.  I have said several times that current interest rates are contractionary as detailed HERE.  They are probably something stocks can withstand at these slightly elevated levels, but NOT is they continue much higher than the current range to 3.036%.

Under different global circumstances, rates of above 3% would mean nothing, but not in the current context.  So I disagree with Jim Cramer on that as he said the market no longer fears rates above 3%. Look where they are now…back below 3%.  Let’s talk again if they hit 3.5%. 😉

Note the breakout above the triangle and the higher high…and review the signal summary below please.  The next test for the Bulls to the upside will be the top of that key 2017 Channel (ascending orange line).   This maps out to about 2757 for the SPX and about 274.90 for SPY.  Remember the number changes daily as the top of the channel is slanted up.

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

SP500 Index breaks up above the triangle with another higher high..

See what my exposure is at the social media links just below… I raised it a bit more this past week.

Keep up-to-date during the week at Twitter and StockTwits (links below), where a combined 33,466 people are joining in…

Follow Me on Twitter®.  Follow Me on StockTwits®.

Survey Says!  Sentiment of individual investors (AAII.com) showed a Bull minus Bear percentage spread of +7.98% vs. -1.85%.   This does not change my stance on sentiment from last week.  Read what I said HERE (scroll past the SP500 Index chart).

2.  U.S. Small Caps Market Timing (IWM): Small caps are just a bit behind big tech in terms of leadership.  The rising dollar trend should moderate though as the global economy slows and U.S. rates stay relatively low vs. where they would be in a normal world without ridiculously low rates abroad supporting economies that are growing very slowly.  I am continuing to hold my mid cap allocation as noted before, although the outperformance vs. large caps is a bit less than for IWM.  Small caps have more debt than large caps, so the exposure to rising rates is higher for small cap companies pressed to meet their interest rate payments.  Keep an eye on the debt level and the expense line associated with it for individual companies you own of all sizes.

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

Small caps still leading large.

3. Gold Market Timing (GLD): The U.S dollar had a 3 day lull in its rise, so gold caught a break off the prior lows.  This dance will continue unless as I reminded you last week “all heck breaks loose!”

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

Gold rises off its lows just in time.

4. Interest Rate Market Timing – U.S. 10 Year Treasury Note Yield (TNX):  I said 2 weeks ago: “If inflation is still heading up as mentioned, rates should NOT break down below the 2nd green line from the top.”  There was no breach.  There was a bounce.  If inflation is going to rise for 1-2 quarters, rates could rise as well. This could pose problems for stocks as the Federal Reserve would be likely to continue raising rates as its focus is now exclusively on inflation, not jobs.  They would tolerate more inflation if the jobs numbers were bad, but they are not.

First review the rate chart below and THEN I’ll go over signal updates…

That top line was a 12/31/2013 intraday high of 3.036% that I was referencing.  The 4/25/18 high was 3.035%.

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

Rates did not make it through 3% but could as inflation creeps up.

Now let’s review three key market timing signals together…. 

Do not use these signals as a trading plan.  They are rough guidelines.  I currently share my own moves on social media (links above).

MY SIGNAL AND TREND SUMMARY for a Further U.S. Stock Market Rally with GDP Growth and Low Inflation:

Stock Signal GREEN with a Bullish SP500 Index trend.  There is now a higher high and this must NOT reverse.  Last week I said: The SPX must break the triangle shown to the upside to become Bullish again…  It’s done that and gone to a higher high with the VIX collapsing below 13 to 12.65.

Gold Signal  YELLOW with a Neutral Gold Trend.  Same advice: “Now the advice is “Buy the low” if we get back there for more aggressive traders, OR preferably buy when you see the dollar falling for the 2nd or 3rd day.”  We are near a key low now.  If you bought the low, you are already a bit ahead, but watch rates and the U.S. dollar like a hawk!

Remember GLD is being used as an indicator for the ECONOMY here.  A new recent LOW in GLD will turn the signal GREEN. 

Rate Signal  GREEN with a Bullish short term 10 Year Yield Trend but barely this week, as we’re just 0.01 above a key number as discussed above.  Rates fell from the 2014 high of 3.036%, but the TNX is still above the prior breakout level of 2.943%.  If it breaks that level, it becomes Neutral Trend. 

Remember this too is a signal for a “further stock market rally” as it’s being used here.  Remember also “Bullish” for yields is Bearish for bonds and vice versa. There is a twist here though.  This level of the 10 Year Treasury Yield, which is too high for current conditions as explained HERE, will eventually slow the economy in my view (not to mention Gundlach’s view).

Note: I’ve updated my criteria for the equity signal for a further U.S. stock market rally to the following: GREEN = Bullish, YELLOW = Neutral, RED = Bearish.  In other words, the colors tell you whether the signal supports the stock rally or not, while the Bullish, Neutral, and Bearish designations are about the trend. 

Explanation: Note that a RED signal does not mean we should not buy.  A GREEN signal does you cannot sell some exposure.  It depends on what is going on in the economy and how oversold/overbought the market is at a given point whether the Bearish signal is to be sold, sold on the next bounce, etc. and whether a Bullish signal is to be bought or profits should be taken.  YELLOW does not mean the end of the Bull or Bear. It means look for possible entry points within the existing trend, Bull or Bear, but preserve capital if the entry fails.  Our strong intention is to buy low and sell high.  By the way, I will keep showing the prior orange “Trigger lines” in the charts for now as reference points only; they have historical value for us from the post-election period.

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