All good things must come to an end, and I think the latest rally in stocks has just about run out of steam.
Up 12 out of 14 days, and the stock market is starting to reach a point of exhaustion. The S&P 500 (SPY) is now at the top end of a four-month trading range.
In addition, we are now well into a seasonally negative period for stocks, the six months when the total return on indexes is zero. The summer slowdown is upon us, and the declining trading volume is screaming at us loud and clear.
Please note that for the past months, stocks have been rising on small volume and falling on big volume. That is classic late cycle market action and is increasingly making me afraid of my own shadow.
We have just had an onslaught of surprise good news that took us up this high, thus giving us a fabulous short side entry point.
That would include a China trade war temporarily going on hold, the administration's free pass for Iran sanctions busting for the multinational Chinese telecom company ZTE, and Micron Technology's (MU) announcement of a $10 billion share buyback. Good news tends to happen in three's, and on the third one you sell.
So, a shot on the short side is reasonable here. However, doing ANY trade with the Volatility Index (VIX) down here at the $12 handle is a bit of a stretch. But I have only sent out one Trade Alert so far in May, and my traders are starving for fresh red meat.
I am not turning bearish, nor do I expect a recession to strike imminently. That will take place in late 2019 at the earliest. I'm just executing a short-term trade here to keep from being bored to death.
It is all just a matter of numbers. The American labor force is currently growing at 0.5% a year, while productivity is expanding by 1.5%. Add them together and that gives you 2% annual trend growth. Add in a 2% inflation rate and you get a 4% nominal GDP growth rate.
That growth rate means the Fed funds overnight interest rate should be 2.5%, a full 1% above the present 1.5%, so four more 25 basis point Fed rate hikes are a sure thing. It will get to 2.5% in a year.
Similarly, a 4% nominal growth rate historically brings you a 4% 10-year U.S. Treasury bond yield versus the current 3.07%, so we have another year to get to 4% as well.
That means our short strategy in the (TLT) is alive and well, we're just waiting for a better entry point. A 4% Treasury bond targets $98 on the downside in the (TLT), or down another $19 from today's close.
With a price earnings multiple 17X and an assumed earnings per share of $155, that puts the fair value for the S&P 500 of $2,720, or exactly where it is right now.
So the stock market isn't expensive, rich, or euphoric. Nor is it at bargain basement throwing the baby out with the bathwater cheap. It is dead in the middle.
And bull markets never end with fair valuation; they end with valuation upside blowouts. We dallied there at the end of January, but only for a few days. We may not see those high numbers again until the end of 2018.
And here's the bad news. Trading conditions could remain like this for another five months, until the November midterm congressional elections.
Just thought you'd like to know.
