Sunday, April 22, 2018

Trade war jitters fade, but for how long?

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"



My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bullish*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.


Falling trade tensions = Equity bullish
I have written in these pages before that, in the absence of trade war tensions, the path of least resistance for stock prices is up (see Watch the Fed, not the trade war noise).

From a technical perspective, stock market is well supported by positive divergence from breadth indicators. Both the SPX Advance-Decline Line and the NYSE common stock only A-D Line made all-time highs last week.




From a fundamental viewpoint, equity valuations are not especially demanding when compared to bonds. The market started to get concerned last week when the 10-year yield approached 3%, but some perspective is in order. As the following chart shows, FactSet reported that forward P/E ratio is in the middle of its 5-year range. By contrast, the 10-year yield is near the top of its 5-year range, indicating slightly equities are cheap relative to Treasuries. On a 10-year perspective, however, the forward P/E is above its historical range and so is the 10-year yield. Depending on your time horizon, valuations are either slightly cheap or slightly expensive, but levels are nothing to panic over.


In addition, earnings are continuing to rise. Results from Q1 earnings season have been solid, with above average EPS and sales beat rates. In addition, forward 12-month EPS are rising, indicating positive fundamental momentum.


The bullishness is not just attributable earnings results. Brian Gilmartin at Fundamentalis pointed out that revenue growth and beat statistics are highly encouraging.



What could possibly go wrong?

The full post can be found at our new site here.

Wednesday, April 18, 2018

The canary in the credit crunch coalmine

Historically, every recession has been accompanied by an equity bear market.


One characteristic of every recession has been a credit crunch. As the economy slows, banks react by tightening their lending criteria, which dries up the availability of credit, and eventually causes a credit crunch. There are a number of ways that investor can monitor the evolution of lending standards.

The most obvious way is to watch the Fed's lending officer survey. The latest data shows that readings remain benign for both corporate and individual borrowers. One disadvantage of the survey is the results only come out quarterly, which is not very timely and amounts to looking in the rear view mirror.


A more timely data series are the Chicago Fed`s Financial Conditions Index, and the St. Louis Fed`s Financial Stress Index. Current conditions show that Stress levels are starting to rise, though the absolute stress levels remain low. Both of these data series are released monthly, which is more timely than the lending officer surveys.


There may be a better real-time way of watching for a credit crunch.

The full post can be found at our new site here.

Tuesday, April 17, 2018

Time for a pause in the bulls' charge

Mid-week market update: Don't get me wrong, I am still bullish, but the stock market rally appear a little extended in the short run and due for a brief period of consolidation. The SPX broke out from its inverse head and shoulders (IHS) pattern this week, cleared its 50 day moving average (dma), and filled in the gap from March 22. The next upside objective is the IHS objective of 2790-2800, whic coincides with resistance defined by the highs set in late February and March.



In the short run, however, the market looks overbought and may be due for a pause.

The full post can be found at our new site here.

Sunday, April 15, 2018

Buy gold for the late cycle inflation surge?

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"


My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bullish*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.


Late cycle expansion = Inflationary revival
The missiles have flown, and the bombs dropped. Inflationary pressures are rising. Is this the time for gold to shine?

Notwithstanding the short-term effects of geopolitical tension, consider the longer term inflationary pressures, which are building not just in the US but globally. Ned Davis Research recently pointed out that roughly two-thirds of countries are growing above their long-term potential. Unless these countries can increase their potential through faster labor force or productivity growth, inflationary pressures begin to build, followed by central bank tightening. We could reach recessionary conditions in the next year or so.



This suggests that the economy is undergoing a late cycle expansion characterized by capacity constraints, which would lead to an inflationary revival. Gold prices are currently testing a key resistance level. Should it stage an upside breakout, who know how far they could go.



The macro bull case for gold is easy to make. Gold is an inflation hedge, and inflation momentum is rising.


J C Parets of All Star Charts highlighted a washout in the silver/gold ratio as an indicator of precious metal risk appetite. A rising silver/gold ratio would indicate that animal spirits have taken over the precious metal complex, which would be highly bullish.


Tiho Brkan pointed out that hedge funds are in a crowded short in silver futures, which is bullish for silver, and for gold by implication.


In short, sentiment models indicate that silver prices are poised for a powerful rally. The combination of rising geopolitical tensions, and possible strength in silver prices would  be highly bullish for gold and other inflation hedges.

Does that mean that investors and traders should pile into precious metals in anticipation of a late cycle inflation surge? Not so fast! There are two sides to every story, and the bull case for gold may be too facile to be true.

The full post can be found at our new site here.

Wednesday, April 11, 2018

A bottoming process

Mid-week market update: As the market bounces around in reaction to the headline of the day, it is important to maintain some perspective and see the underlying trend. Numerous sentiment and technical indicators are pointing towards a bottoming process and a bullish intermediate term outlook. Day-to-day price movements, on the other hand, are hard to predict.

Consider, for example, the positioning of large speculators (read: hedge funds) in the high beta NASDAQ 100 futures and options. Hedgopia reported that large speculators are in a crowded short in NDX.


By contrast, large speculators are in a crowded long in the VIX Index, which tends to move inversely with the stock market.


While Commitment of Traders data analysis tend to work well as a contrarian indicator on an intermediate term time frame, sentiment models can be inexact market timing indicators.

The full post can be found at our new site here.

Tuesday, April 10, 2018

China's cunning plan to defuse trade tensions and reduce financial tail-risk

About three years ago, I outlined China's plan to extend its infrastructure growth without creating more white elephant projects in China (see China's cunning plan to revive growth). Enter the One Belt, One Road (OBOR) initiative to create infrastructure projects in the region. OBOR projects were to financed by the Asia Infrastructure Investment Bank (AIIB), which many countries had been falling all over themselves to finance. The infrastructure projects were to be led by (surprise) Chinese companies, which would extend their flagging growth.

Fast forward to 2018, The Nikkei Asian Review and The Banker issued a report card of OBOR projects. Here are their main findings:
Project delays After initial fanfare, projects sometimes experience serious delays. In Indonesia, construction on a $6 billion rail line is behind schedule and costs are escalating. Similar problems have plagued projects in Kazakhstan and Bangladesh.

Ballooning deficits Besides Pakistan, concerns about owing unmanageable debts to Beijing have been raised in Sri Lanka, the Maldives and Laos.

Sovereignty concerns In Sri Lanka, China's takeover of a troubled port has raised questions about a loss of sovereignty. And neighboring India
openly rejects the BRI, saying China's projects with neighboring Pakistan infringe on its sovereignty.
None of these problems are big surprises. I had outlined in my 2015 post that Chinese led infrastructure projects tended to see inflated costs, and the geopolitical objective of OBOR was to extend China's influence in the region.

Today, China faces two separate problems. The most immediate issue are rising trade tensions with the United States. The second and more pervasive issue is the growing mountain of debt, which are backed by less productive assets, which elevates financial tail-risk. The China bears' favorite chart exemplifies that problem.


The latest developments indicate that Beijing has developed a cunning plan to defuse both trend tensions and reduce financial tail-risk.

The full post can be found at our new site here.

Monday, April 9, 2018

Evaluating Jim Paulsen's market warning

I have been a fan of Jim Paulsen for quite some time. The chart below depicts the track record of my major market calls. His work formed the basis for my timely post in May 2015 (see Why I am bearish (and what would change my mind)), which was received with great skepticism at the time.

The track record of my major market calls


This time, though, I believe that Jim Paulsen's warning for the equity market outlined in this Bloomberg article is off the mark. Paulsen's cautionary signal for the stock market is based on his Market Message Indicator, which has rolled over. The indicator is described in the following way:
The gauge takes five different data points into account: how the stock market is performing relative to the bond market, cyclical stocks relative to defensive stocks, corporate bond spreads, the copper-to-gold price ratio, and a U.S. dollar index. The goal is to devise a gauge that acts as a proxy for broad market stress.
I have annotated (in red) in the chart below the subsequent peak in the stock market after this indicator gave a sell signal. This indicator is far from infallible, but the market has weakened the last few times this indicator peaked and rolled over. During the study period that begins in 1980, some sell signals simply did not work, or there were long delays between the sell signal and the actual peak.


Here is what I think Paulsen is missing.

The full post can be found at our new site here.

Sunday, April 8, 2018

Watch the Fed, not the trade war noise

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"



My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bullish*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.


Fade the trade war jitters
"Fool me once, shame on you. Fool me twice, shame on me." We've seen this movie before on trade. The White House begins the process with tough and inflammatory rhetoric, only to see the threats walked back or watered down later.

Consider the case of the steel and aluminum tariffs, which were levied for national security reasons. The initial announcement shocked the market, but the Trump administration eventually walked back most of their effects by providing exemptions for Canada, Mexico, the EU, Australia, Argentina, Brazil, and South Korea. Um, those exemptions account for over half of American steel imports. What "national security" considerations are we referring to?

The KORUS deal is another example. The agreement was hailed as a great victory by the Trump administration, but the tweaks were only cosmetic in nature. The South Koreans agreed to two concessions. In return for an indefinite exemption from the steel and aluminum tariffs, Seoul agreed to a steel export quota to the US, but the quotas are toothless because they are contrary to WTO rules and could be challenged at anytime. In addition, South Korea doubled the ceiling on American cars that don't conform to Korean standards which could imported into that country. The ceiling increase was meaningless because US automakers were not selling enough cars under the old ceiling. In other words, the KORUS free trade deal was a smoke and mirrors exercise and a face saving out of a potential trade war.

The NAFTA negotiations followed a similar pattern of using bluffs as a tactic, and reacting afterwards. Trump began the process by declaring the free trade agreement "unfair" and "terrible". He then threatened to tear up the treaty. The latest news from Bloomberg indicates that American negotiators are pushing very hard to have an agreement in principle in place by the Peru Summit of the Americas that begin April 13 next week. How much leverage will the American side have if the other negotiators know that Trump wants a deal by next week? Much work needs to be done before an agreement in principle can be made, but watch for more climbdowns and a declaration of "victory" by the White House.

So why worry about a possible trade war with China? Investors worried about equity downside risk should instead focus on the likely direction of monetary policy. New Deal democrat recently outlined a simple recession model which states that whenever the YoY change in the Fed Funds rate rose above the annual change to employment, a recession has followed within a year.


As the Fed normalizes monetary policy, it is on the verge of making a policy error where it tightens into a weakening expansion and crashes the economy. Recessions have invariably translated into equity bear markets in the past. That's why investors should look past the trade war noise and focus on monetary policy.

The full post can be found at our new site here.

Wednesday, April 4, 2018

The post-FANG market beaters hiding in plain sight

Mid-week market update: It is encouraging that the stock market held up well in the face of bad news on global trade. Global markets adopted a risk-off tone on the news of Chinese trade retaliation, but the SPX managed to hold a key support level and rally through a downtrend line.



Looking over the past few weeks, equity market weakness really started rolling when technology stocks rolled over in March. The carnage was not just confined to Facebook, or Amazon, but to the entire technology sector and globally. The relative performance of European technology stocks (green line) paralleled the relative performance of US technology.



One encouraging sign for the broader market can be found in my risk appetite metrics. High yield bonds (top panel) are not confirming the weakness in stock prices, though momentum (middle panel), and high beta (bottom) panel are struggling.



Notwithstanding the weakness in the technology sector, where can investors find opportunity (or places to hide) in light of the constructive view on the broader equity market?

The full post can be found at our new site here.

Monday, April 2, 2018

What's the real test? The 200 dma or you?

As the SPX sold off today and tested the 200 day moving average (dma) while exhibiting positive RSI divergences, a Zen-like thought occurred to me. Is the market testing the 200 dma, or is it testing you?



The full post can be found at our new site here.

Sunday, April 1, 2018

Is this what a regime change looks like?

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"



My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bullish*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.


Tech rollover = Regime change?
Is the stock market undergoing a regime change? The Average Direction Index (ADX) is a trend indicator developed by J.Wells Wilder to measure the strength of a price trend. The higher the ADX level, the strong the trend. The chart below shows the relative performance of technology stocks compared to the market. Even though this sector remains in a relative uptrend, the ADX of the relative performance ratio began to roll over in late 2017. The weakness in trend culminated in the recent carnage of FANG and semiconductor stocks.


The enthusiasm for technology stocks may be overdone, as the sector has exceeded its weight in the SPX index, which last peaked during the NASDAQ Bubble.


There is a fundamental reason for the weakness in this sector. I had written about this possibility last October (see Peak FANG), where I suggested that the regulators would come for the Big Data companies in the next recession. Facebook and Google were the prime targets because they were in the surveillance business, largely because of the creepiness effect of their practices. Of the other FANG names, Amazon is also vulnerable because of their strategy to entice users into their walled garden by learning everything about them in order to sell them goods and services. The latest Facebook episode mane mean that the competitive moats of these companies may be already breached. A prolonged period of market performance may be in store, much in the manner of Microsoft after its anti-trust battle with the Justice Department.

In connection with the failure of FANG and technology leaders, the stock market is also showing signs of weakening. The SPX recently breached an uptrend line, and its ADX has also rolled over.


These developments raise two key questions for investors. If technology leadership is indeed failing, can any other sectors step up to take its place? As well, does the weakness in these high octane and high beta groups the sign of a top for the overall stock market?

The full post can be found at our new site here.

Wednesday, March 28, 2018

Technicians nervous, fundamentalist shrug

Mid-week market update: Both my social media feed and the my questions this week have a jittery tone. Will the 200 day moving average (dma) hold as the SPX tests this important support level? What sectors or groups could step up to become the next market leaders if technology stocks falter?

Callum Thomas of Topdown Charts highlighted an important bifurcation in sentiment between the technicians and the fundamental analysts. He has been conducting an (unscientific) Twitter poll on a weekly basis since July 2016, and the latest results show a record level of bearishness among technicians, while fundamental analysts have largely shrugged off the recent round of market weakness.


Who is right?

The full post can be found at our new site here.

Tuesday, March 27, 2018

The things you don't see at market bottoms: China edition

It is said that while bottoms are events, but tops are processes. Translated, markets bottom out when panic sets in, and therefore they can be more easily identifiable. By contrast, market tops form when a series of conditions come together, but not necessarily all at the same time. My experience has shown that overly bullish sentiment should be viewed as a condition indicator, and not a market timing tool.

Two months has passed since I last published a post in a series of "things you don't see at market bottoms". That's because market exuberance has significantly moderated. There are, nevertheless, signs of froth in non-US markets. Therefore I am publishing another post in the series. Past editions of this series include:
I reiterate my belief that this is not the top of the market, but investors should be aware of the risks where sentiment is getting increasingly frothy. Much of the froth can be found across the Pacific in China, starting with the China bears' favorite chart.


The full post can be found at our new site here.

Sunday, March 25, 2018

Trade war, Schmade war!

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"



My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bullish*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.


A market triple whammy
Last week, the stock market was hit with a triple whammy of bad news.
  • Negative stories about market and momentum leader Facebook (FB);
  • A moderately more hawkish message from the Federal Reserve; and
  • The prospect of a trade war that could tank the global economy.
As a result, the SPX fell -6.0% for the week. The market is obviously stretched to the downside. The SPX is testing support at its February lows and the 200 day moving average (dma). The VIX Index has risen above its upper Bollinger Band, which is a short-term oversold signal. As well, the CBOE put/call ratio spiked to high levels indicating fear.


Is this enough to signal a short-term bottom? This week, I address the dual macro threats of Fed policy, and the possible effects of a trade war. There are many others who can much analyze FB better than me, and stock specific analysis is outside my scope.

The full post can be found at our new site here.

Wednesday, March 21, 2018

Is the NASDAQ trend still your friend?

Mid-week market update: There have been a number of questions of whether the NASDAQ run is over. Marketwatch reported that Jim Paulsen of Leuthold Group highlighted the vulnerable nature of technology stocks. Paulsen pointed to the Tech/Utilities ratio as a way of showing that Tech is nearly as stretch as it was during the height of the NASDAQ bubble.



Chris Kimble also worried about the recent NASDAQ breakout, which was not followed by the major large cap averages, as well as a negative RSI divergence.


In addition, Kimble highlighted the huge weekly inflow into the NASDAQ 100 ETF (NDX), which could be interpreted as contrarian bearish.



If the NASDAQ falters, what would a loss of Tech leadership mean for overall stock prices?

The full post can be found at our new site here.

Monday, March 19, 2018

FOMC preview: Rising stress edition

The Federal Reserve is widely expected to raise interest rates a quarter-point this week at their FOMC meeting this week. Even though financial conditions remain at benign levels, there are a number of signs that stress levels are rising during the current tightening cycle.



The full post can be found at our new site here.

Sunday, March 18, 2018

When the story changes...

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"



My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Neutral*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.


A change in seasons
Bill McBride of Calculated Risk has had a remarkable record of calling turns in the economy. He correctly warned about the peaking housing bubble before it popped, and he has been consistently bullish since the market bottom in 2009. Recently, he warned that "the story is changing":
But in 2018, the story is changing. We are seeing some economic tailwinds and some headwinds. Although the tax changes are poorly conceived, and mostly benefit high income earners, there should be some short term boost to economic growth. That might lead the Federal Reserve to raise rates a little quicker than anticipated.
He concluded:
I still think the economy will be fine in 2018, but the story is changing.
Bloomberg reported that Morgan Stanley cross-asset strategist Andrew Sheets highlighted a changing environment of weakening Purchasing Manager Indexes (PMIs) and rising inflation. Such regimes shifts have typically led to rising volatility.
Markets have traditionally been well-equipped to handle higher inflation when it comes alongside a pickup in growth, notes Sheets. But it’s the prospect of an inflection point away from the dominant narrative of “synchronized global growth” reflected in rising PMIs, and moribund price pressures that could cause investors angst.

Kevin Muir at Macro Tourist also highlighted NDR analysis that split Fed tightening cycles to fast and slow cycles. If history is any guide, this is the point where stock prices start to flatten out and weaken during a slow tightening cycle.


I agree 100%. Goldilocks is dying, but the probability of a recession in 2018 remains low. Risks and volatility are rising. It is time to review how "the story has changed".

The full post can be found at our new site here.

Wednesday, March 14, 2018

A test of bullish resolve

Mid-week market update: Last weekend, I wrote that while I was intermediate term bullish, I expected some equity market weakness early in the week. The hourly RSI-5 had exceeded 90, which is an extremely overbought reading, which was not sustainable. Even during the January melt-up, such episodes resolved themselves with either a pullback or sideways consolidation. The downside risk is the 50 day moving average (dma) and the gap that was created when the market rallied on March 9, 2018.



Now that the market has declined to test the 50 dma, and the gap is filled, what now?

The full post can be found at our new site here.

Monday, March 12, 2018

The new Fragile Five to avoid

In the wake of my last post about whether USD assets and Treasury paper would remain safe haven and diversifiers in the next global downturn (see Will diversified portfolios be doomed in the next recession), I received a number of questions as to what investors should avoid. There is an obvious answer to that question.


Call them the new Fragile Five.

The full post can be found at our new site here.

Sunday, March 11, 2018

Will diversified portfolios be doomed in the next recession?

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"



My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Neutral*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.


Will Treasuries continue to be diversifiers?
Bloomberg recently reported that Sanford Bernstein declared the 60/40 portfolio to be doomed, because the prices of different asset classes, which were believed to be diversifying, are moving together.



This brings up an interesting point, will bonds do their part to diversify portfolio returns and cushion equity downside risk in the next bear market? In the last crisis, fixed income investments proved to be a poor diversifier as credit spreads blew out, and only Treasuries rallied. In the next bear market, will Treasuries be able to fulfill their role as diversifying investments?

In the wake of widespread worries over the Republicans' latest fiscal experiment with tax cuts during the late phase of an expansion, a number of strategists have voiced concerns about the downward pressure that exploding fiscal deficits would put on the US Dollar. Macquarie pointed out that priming the fiscal pump during a period of low unemployment is highly unusual.


If history is any guide, then the USD is likely to face significant downward pressure in the future as deficits explode upwards.


The FT reported that Vasileiocs Gkionakis of UniCredit came to a similar conclusion.



That got me thinking. A falling USD implies that the market is losing confidence in the value of USD assets. If the greenback is going to be under such pressure, what happens in the next recession?

In the past, USD assets, and Treasury securities in particular, have been the safe haven asset of choice during periods of economic stress. If the USD and USTs lose their safe status, what happens to diversified portfolio returns? Will the decline in their asset values accelerate because bonds, and especially USTs, fall in value along with the price of other risky assets like stocks?

The full post can be found at our new site here.