Market Analysis for 2017

Each year I like to do an analysis of different economic indicators to understand the bigger picture of what’s going on in the economy and to help guide my investment decisions. This analysis is meant to be descriptive, rather than predictive in nature as my investment strategy is focused on identifying low-risk investment opportunities with high risk-to-reward ratios. I recently read Anthony Robbins’ book “Money – Master the Game: 7 Simple Steps to Financial Freedom” and found out that Paul Tudor Jones wants at least a 5:1 ratio (Expectation to make $5 for every $1 of risk) which is similar to my strategy (I usually look for 2:1 or 3:1 opportunities) but much more conservative than I expected, but still exciting since it’s a similar framework of one of the best investors in the world. I also will use this analysis to identify imbalances which can be the starting point for scenario-driven planning.

Who influences my investment strategy?

I have a tremendous amount of respect for Dr. Van Tharp and his teachings and analysis. He puts out a monthly report that is always insightful and definitely worth the read. You can find out more about Dr. Tharp and subscribe to his free newsletter at www.iitm.com

I’m also a fan of Ken Long who is very systematic about his investment strategies. He has a YouTube channel (Link here). A lot of his analysis is short-term (Over a few days), but it can easily be extrapolated to longer time-frames.

Overview

Obviously, the big story of 2016 is Donald Trump winning the US presidential election. While initial stock market moves have been positive, it will remain to be seen what policies President Trump will enact and how that will affect the US and World economies and stock markets. I will be watching the US Dollar closely to see how investors are reacting to the various policy changes that will be enacted in the near future.

S&P500

S&P500 Weekly Chart

sp500-weekly

Pretty obvious here that after going sideways for most of 2015 and for the first half of 2016, we’ve broken above resistance at about $2140, retested the level and bounced up. This indicates the market is prepared to continue its uptrend for the time being.

S&P500 Daily Chart

sp500-daily

 The SP500 daily chart shows the recent breakout from resistance and the re-test of the level that finds support. We also see the recent consolidation through December and January, but then another break above that consolidation.

Here’s the System Quality Number (SQN) levels, which gives us a statistical T-score of how the market has been moving recently:

SQN(200) = 1.21 (Bullish)

SQN(100) = 0.948 (Bullish)

Here’s our Average True Range (ATR) values to measure volatility::

ATR(20) = 0.636 (Quiet)

Both the longer term SQN values are showing Bullish trends, and volatility, which is generally low during bullish cycles and high during bearish cycles, confirms this trend.

Nasdaq

Nasdaq Weekly Chart

nasdaq-weekly

Nasdaq Daily Chart

nasdaq-daily

Both the weekly and daily charts for the Nasdaq are following the same pattern as the S&P500. This is typical, but I want to look for any deviation that would indicate that one group of stocks is falling out of favor or are being aggressively bought. But as of right now stocks continue to be a good buy.

Price-to-Earnings (PE) Ratios

pe-ratios

From http://www.multpl.com/

Price to Earnings (PE) ratios help to identify when stocks are becoming overvalued when compared with corporate earnings. After hitting an intermediate bottom in 2011-2012, PE ratios are on the rise again. Of interest, we are at the same levels as several previous peaks, but well below the massive breakouts of 2002 and 2009. This means that over the past 20 years investors are willing to pay more for stocks than before, which means we could still have the stock market move upward for some time yet, but I’ll be watching for stocks to become over-valued over the next 1-3 years.

Inflation/Deflation

inflation-rate

inflation-stocks

 From Dr. Van Tharp’s Newsletter

Inflation is seeing a bit of an uptick in 2016, up to 2.1% but still very much in line with reasonable values. Inflation assets (Oil, Gold, Financial Stocks) provide a secondary way to monitor inflation without being subject to calculation changes and manipulation. These assets saw upticks in 2016, which is consistent with the actual inflation numbers.

US Gross Domestic Product

US Real GDP.png

Gross Domestic Product (GDP) gives an indication of how much a country’s economy is growing. Positive growth is good, but too much growth can indicate a bubble while negative growth indicates a recession.

2016 was on track for the 6th straight year of economic growth, around the 2% range which shows a good rate of growth without being too high. The Economist magazine is predicting 2.3% growth in 2017, and 2.1% in 2018.

Unemployment

unemployment-chart

alternate-unemployment

US Real Income Growth.png

The unemployment rate gives a good indication of the strength of an economy, as when more people have jobs, there is more money to be spent and thus more economic growth. Higher employment rates mean incomes are lower, less money available to be spent, downward pressure on prices, and thus economic contraction.

The US unemployment has continued to drop in 2016, keeping up with the trend from 2010. Interestingly, the Shadow Stats (John Williams website) show no real drop in unemployment since 2010. When we compare this data with real (inflation-adjusted) income growth, aside from 2014, we are not seeing an increase in average incomes. This could mean that either: A) Unemployment has not actually been coming down enough which would create income growth, or B) There are other factors at play causing income growth to stay muted.

US Debt

US Debt.png

This is by far the most interesting data. The US national debt stands at nearly $20 trillion dollars. That’s almost $167,000 of debt per taxpayer. This means at 2% interest, the US government pays $400 billion dollars in interest payments. If interest rates rise to 4%, that means interest payments will rise to $800 billion dollars, which is 25% of the US government’s tax revenue. What that means to me is that the Fed is likely going to keep interest rates low because they cannot afford for them to increase until wages start to increase and thus increase tax revenue.

That said, this is the biggest upcoming risk for the US and World economies. Ray Dalio has a great video on short-term and long-term debt cycles here: http://www.economicprinciples.org/ He discusses that a “deleveraging” happens about every 75-100 years when debt becomes so high it can no longer be serviced. Based on the numbers above, it feels like a deleveraging cycle is close at hand. While it would be hard to predict exactly what will cause that cycle to begin and when I will be watching for the US dollar index to start falling as an indication that confidence the in the US economy has been lost.

US Bonds

10 year Treasuries.png

2016 saw a couple of interest rate hikes, but as discussed previously, I don’t see that continuing to happen until wages start to rise. Interest rates also remain at near historic lows meaning that it has never been cheaper to borrow money.

US Dollar

US Dollar.png

The US Dollar has seen a recent jump over the past 4 months, getting above 1 year resistance levels. Strength in the US Dollar indicates confidence in the US economy, at least in the short term. I’ll be watching for it to continue to increase, but without getting too high that it starts to affect the trade balance.

US Real Estate

us-home-sales

Home Price Index.png

US existing home sales ticked up in 2016 by more than 6%, with another expected jump in 2017. New home starts and sales are also strongly moving higher which isn’t too surprising given historically low interest-rates, low unemployment, and stock markets on the rise.

The House Price Index is back on the rise again after dropping in 2008-2009. Given that interest rates continue to remain low, this will continue to put upward pressure on housing prices.

Something that I will be watching is that as interest rates will not be able to be raised much in the near future due to the US Debt, we may start to see another housing bubble unless credit starts to be restricted. So long as we aren’t seeing families purchase multiple houses (as speculative investments), I don’t think we will see a repeat of 2008. But this will definitely be something I will be keeping an eye on.

Summary

Based on this information, things definitely are looking positive in the mid-term. Stock markets are on the rise, real estate will likely continue to move higher, and interest rates will stay low. However, I’m definitely concerned for the longer-term given that the US Debt continues to be the so-called “elephant in the room”. Perhaps there is a plan to bring the debt-to-taxpayer ratio back in line with reasonable values, but I’m not entirely sure what would be. This will be something I’ll be looking research and perform scenario-based analysis over the next few months.

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