Thursday, June 23, 2016

Brexit fallout watch

Well, my Bremain call didn't go so well (see Positioning for a Bremain result). As I write this, the BBC has called the referendum in favor of Leave by a margin of 52-48. GBPUSD is down about 10% and Asian stock markets are down 2-4%.

If you were correctly positioned for this outcome, congratulations, but don`t get overly excited about doing a victory lap as there is going to be market volatility ahead. During these episodes of unexpected market shocks, here is what I am watching for:
  • Technical: Watch for logical areas of technical support
  • Sentiment: Signs of panic and oversold reading that signal a bottom
  • Macro: Either official intervention or policy responses that could rip a short`s face off
The full post can be found at our new site here.







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Wednesday, June 22, 2016

Positioning for a Bremain result

Mid-week market update: Even though the polls show the two sides running neck and neck, my inner trader is positioning for a Remain result in the UK referendum for the following reasons.
  • Polling internals indicate momentum towards Remain;
  • Bookmaker odds overwhelmingly favor Remain over Leave; and
  • Market anxiety is rising - so a "buy the rumor, sell the news" position is not warranted.
This is obviously a speculative trade and much could go wrong. The pollsters totally missed the results of the last UK election. In addition, severe weather in southeast England could affect turnout and therefore skew results.

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







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Tuesday, June 21, 2016

The Brexit Pandora's Box

For my (mainly) American friends, file this under "why you don't understand Europe":

The Vietnam War was a war that scarred the national psyche and dramatically changed the tone of American foreign policy for a generation. If you visit the Vietnam Memorial in Washington DC today, you will find roughly 58,000 names of fallen soldiers from that period. Now imagine if instead of losing 58,000 soldiers, the United States lost 2.5 million during the Vietnam War. For a country like the US of roughly 300 million people, that kind of casualty rate would mean that virtually every household in America would be touched by combat death, whether it's a father, son, brother, uncle, friend or neighbor. Then 25-30 years later, which is roughly the span between the Vietnam War and 9/11, the country got involved in another conflict with a similar death toll.

Imagine the resulting national trauma.

That's what happened to many European countries in the First and Second World Wars - and the losses quoted would be roughly what the equivalent losses are for the US on an equivalent per capita basis on par with many European countries.

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







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Sunday, June 19, 2016

How the S&P 500 can get to 2200 and beyond

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 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 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 bullish 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. Past trading of the trading model has shown turnover rates of about 200% per month.



The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Neutral*
  • Trading model: Bearish*
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 any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


Where's the growth?
My last post (see Why you need to give the bull case a chance) elicited a considerable amount of comment. Most of the pushback I got on the equity bull case amounted to a question of, "Where's the growth coming from?"

I recognize the concerns. As this chart from Factset shows, the equity market has had to endure five consecutive quarters of falling year-over-year EPS growth. How can anyone possibly be bullish under such circumstances?


In this post, I would like to explain my bull case for stocks, with an initial SPX target of 2200 and, depending on the Fed's reaction function, up to 2400-2500.

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








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Thursday, June 16, 2016

Why you need to give the bull case a chance

Maybe it's me, or my imagination? Even before the latest round of market weakness, most of the feedback and sentiment on my social media feed has tended to bear bearish. I saw a fair number of calls for SPX to eventually test its February lows at about 1820, but I haven't seen a lot of forecasts for breakouts to new highs. The recent year-end projection by respected former Value Line research director Sam Eisenstadt of 2220 only represents only modest upside from current levels, but I don't see a lot of enthusiasm for that call.

The WSJ recently call this The Most Pessimistic Bull Market in History, as investors have only embraced it in the most reluctant way:
Instead of chasing growth and profits, investors this year have bought into safety—in a big way. Only two of the 10 top-level sectors which make up the market have reached new highs this year, and they are the antithesis of exuberance: utilities and consumer staples.

This may be merely a failure of imagination. As in 2007, the bubble pushing up the market may be elsewhere. Back then, valuations weren’t outrageous, but excess in credit created unsustainable profits. This time the most obvious froth is in the government-bond markets. German 10-year bunds on Friday yielded a mere €270 a year on a €1 million investment ($1.1 million), enough to fuel your BMW 7-Series a couple of times with enough left over for a currywurst and a beer. Japan’s yields are negative for bonds maturing out to early 2031, while U.S. 10-year Treasurys on Monday closed at a new 52-week low.
Josh Brown also pointed out that stock market investors have become chicken-bulls (my term, not his), as the two most popular ETFs for equity flows have been low-volatility funds, USMV and SPLV:
The popularity of these two ETFs is perfectly emblematic of the mood these days among financial advisors and their clients. And if you know anyone in the ETF business, they’ll tell you that the principal determiners of flows are in this order: 1) recent performance 2) whether or not advisors have been sold on them and 3) recent performance. ETFs do not sell themselves and retail do-it-yourselfers are not the drivers of AUM flows – only advisors can really move the ETF needle. The iShares product probably has an edge on SPLV because it’s based on an MSCI index, which is what many advisors use as a benchmark in their performance reporting.
That's where the "chicken-bull" part comes in:
A collective financial advisor decision was made in the aftermath of August – “Okay, we’ll stay in, but we can’t take the full volatility of the stock market anymore.”

You can only imagine the calls that were coming in – “Is this it? Here we go again!”

To which the advisors’ response was something along the lines of “Don’t worry, I have an idea…” The iShares and PowerShares wholesalers did their work well.

Seeing this fund grow to $12.5 billion, having taken in a third of that in the first four months of this year, tells you everything you need to know about current sentiment. Advisors are tacitly accepting that they must be in US stocks, but because of the angst of their clients, they’re offering them exposure through a vehicle that purports to offer “minimum” volatility.
That's not the sort of investor behavior and psychology that happens at market tops. While a bull case where the SPX rises to 2400-2500 is my base case scenario, it is well within my range of possibilities. Until the investing public starts to get wildly enthusiastic about a 2400-2500 SPX target, it's hard to see how this market tops out - and I will measure the success of this post by the amount of hate mail I get.

Let me make two cases for a 2400-2500 bull market. One is fundamental, the other is technical.

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







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Tuesday, June 14, 2016

The VIX tail wagging the SPX dog

Mid-week market update: What's going on with the VIX Index? The VIX, which measures implied option volatility and a useful measure of "fear", spiked dramatically on Monday. While SPX did fall, the magnitude of the decline didn't match past VIX spikes. It prompted this tweet from Ryan Detrick:


Rob Hanna at Quantifiable Edges also observed that the combination of a VIX spike of this magnitude is unmatched by the shallowness of the fall in stock prices.

As you can see from the chart below, the VIX Index spent the second day above its Bollinger Band (BB), which has marked regions of limited downside risk in the past. On the other hand, the bottom panel shows the 10-day rate of change of the VIX Index, and such events have often foreshadowed further SPX weakness (see vertical lines).



What's going on? My analysis suggests that we are seeing the case of the VIX tail wagging the SPX dog.

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






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Sunday, June 12, 2016

Buy the dip!

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 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 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 bullish 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. Past trading of the trading model has shown turnover rates of about 200% per month.


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 any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


Here comes the June swoon
The market seem to be following the script that I laid out last week (see Get ready for a market of maximum frustration). I wrote that I remained bullish into year-end, but the short-term outlook was corrective. From a very short-term trading perspective, however, the tendency for the market to rise in the face of bad news like the Jobs Report, indicated that stocks needed to move higher before correcting.

The market did climb the proverbial Wall of Worry until mid-week before weakening (see my mid-week comment Adventures in Option-Land). As the market ground higher last week, I could see the bears starting to capitulate and sentiment gauges becoming more bullish, the major indices topped on on Wednesday. The market narrative then changed to focus on the deteriorating macro outlook. Indeed, the Citigroup Economic Surprise Index, which measures whether macro data is beating or missing consensus estimates (gold line in chart), is turning down again.


It's time for stocks to pay the macro piper. However, these indications of weakness are temporary. Once the growth fears clear, stock prices should recover and push to new highs later this year.

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





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Thursday, June 9, 2016

What I learned about Fed policy this week

Rather than indulge in instant analysis, I wanted to give myself a few days to reflect on Janet Yellen's speech on Monday (see full transcript). In doing so, I learned a number of things about Fed policy that I didn't know before:
  • How much does the Fed want to raise before it considers rates to be "normalized"
  • What it means to allow the economy to run a little "hot" because of slack in the labor markets
  • What the hurdles are to next raise rates
  • From Ben Bernanke: The debate over how to implement the Phillips Curve in monetary policy
The full post can be found at our new site here.












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Wednesday, June 8, 2016

Adventures in Option-Land

Mid-week market update: I like to monitor the option market from a sentiment modeling perspective because, unlike surveys which can swing all over the place, the option market is a forum where people are putting real money on the line.

Even as the stock market has been slowly grinding upwards, the option market has been showing signs of skepticism. As the chart below indicates:

  • The market is overbought on RSI-5 and nearing an overbought condition on RSI-14, but...
  • The VIX Index, aka the Fear Index, has been rising for the last few days; and
  • The VIX term structure has also been indicating higher fear levels in the same time frame.


At the same time, standard measures of overbought/oversold and sentiment models, such as the CNN Money Fear and Greed Index, is showing a high level of greed, which is contrarian bearish.



What's going on? Is this just a sign that the stock market is climbing the proverbial Wall of Worry?

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









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Monday, June 6, 2016

Technical analysis meets macro

I present for your consideration the following mystery chart. Would you rate this as a "buy", "hold" or "sell"? Your answer will tell you something about your global macro-economic outlook and the likelihood of an equity bear market in the near future.



See below...



























Any of the recessionistas who ranked the above chart "buy" might want to read this post carefully, including everyone who jumped on the JP Morgan rising recession risk bandwagon and David Rosenberg's abrupt bearish turn.


The full post is available at our new site here.








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Sunday, June 5, 2016

Get ready for a market of maximum frustration

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 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 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 bullish 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. Past trading of the trading model has shown turnover rates of about 200% per month.


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 any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


A June swoon before SPX 2400?
Well, that Jobs Report certainly changed the tone of the market! The massive disappointment of Friday's Employment Report, combined with other weak macro data such as ISM services, is setting up for a choppy market of maximum frustration. I am seeing cross-currents that could be treacherous for both bulls and bears. Here is my market outlook for differing horizons:
  • Medium term (6-12 month time horizon) bullish: The disappointing Employment Report gave the FOMC doves to stay cautious and push out its schedule of interest rate normalization. When combined with a picture of a steadily growing US economy, it gives room for the SPX to reach the 2400-2500 area late this year before the market tops out for this cycle (see my previous posts How the SP 500 could get to 2400 this year and The roadmap to a market top).
  • Short term (1-2 months) bearish: On the other hand, the massive Non-Farm Payroll (NFP) miss, along with weakness in forward EPS, is setting up for a growth scare that is likely to spook the markets.
  • Trading (1 day to 1 week) bullish: The inability for equity prices to fall in the face of bad news suggests that the bears are exhausted. It therefore sets up the market for a rip-your-face-off rally should there be any sign of positive news.
The stage is set, pick your poison. Be careful - even a slight timing mistake could turn a trading profit into a loss.

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



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Friday, June 3, 2016

Should China emulate America? Or the other way around?

For your weekend contemplation: This post isn't about how the American and Chinese economies may converge, but about the potential development path of capital markets and regulatory regimes. CNBC recently reported that Charles Schwab and the Shanghai Advanced Institute of Finance conducted a survey of Chinese stock investors and found out the reason the Chinese all appeared to be punters and gamblers. First and foremost, they didn't start that way and only a small minority were in it for a quick profit:
Having surveyed 450 investors, only 13 percent invest for short-term purposes, such as turning a quick profit or generating enough cash to make a major purchase, while 87 percent invest as a means to improve their standard of living, retire or their children's education, the study found.
But the Chinese market is not very mature and the investor base isn't very sophisticated:
The lack of a mature bond market, long-term products on the market and professional financial advisors were major challenges, the authors explained.

"While the incomes and expectations of China's emerging affluent have risen, China's financial services sector has not kept pace...Unlike upper-middle class investors abroad, most Chinese investors chart their financial futures without assistance from financial service professionals," the authors said.

As a result, Chinese often don't understand the content of their investments and the risks they carry, the study noted, pointing to WMPs as an example. Detailed information isn't always provided to customers and this lack of transparency is intentional since most WMPs are concentrated in China's increasingly troubled industrial sector, the study said.
The combination of the lack of a professional institutional investor base (think Singapore's sovereign wealth fund) and the lack of hard information about the markets, individual investors adopt behavior that looks like gambling.

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






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Wednesday, June 1, 2016

5 technical reasons to be bullish on stocks

Mid-week market update: As the US equity market consolidates its gains near resistance and all-time highs, I remain constructive on stock prices for the following five reasons:
  • Momentum is positive
  • Breadth is positive
  • Bullish support from overseas markets
  • Greed is fading, which is supportive of further gains
  • Overbought conditions are fading (ditto)

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





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Sunday, May 29, 2016

The roadmap to a market top

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 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 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 bullish 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. Past trading of the trading model has shown turnover rates of about 200% per month.


The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Neutral*
  • Trading model: Bearish*
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 any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


Not turning bearish yet
No, my inner investor isn't turning bearish, but I believe it is prudent to be thinking about how a market top develops. The bull market that began in 2009 is getting mature and I am getting starting to watch for signs that a market top is developing. My analytical framework is as follows:
  • Macro-economic analysis: I am grateful for the work by New Deal democrat in his recent post A roadmap to the next recession. This chart from Gene Epstein at Barron's shows the risks to equities should economic growth stall and roll over. While stock prices can fall and correct at any time, the most severe declines have been associated with recessions.


  • Growth and valuation: I think of stocks in terms of the two components of the PE ratio. First, how much is E like to grow? Second, will the P/E ratio expand or contract? The big question in the current environment is the intersection of growing E as the Fed embarks on a tightening cycle. How will stock prices respond as earnings rise, but higher interest rates puts downward pressure on the P/E ratio?
The full post can be found at our new site here.






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Thursday, May 26, 2016

$50 oil! What's next?

As the oil price touched $50, there has been a growing paradigm shift, a sort of "this time is different", consensus forming about the long-term outlook for oil prices. Amy Myers Jaffe of UC Davis recently addressed the 69th CFA Institute Conference and made the following bearish points about the long run trajectory of oil prices:
  • Demand: Global demand growth is set to slow, flatten and perhaps fall as countries start to adopt alternative energy sources. Indeed, Bloomberg recently reported that there are more people employed in renewable energy in China than oil and gas. Similarly, solar power related employment has surpassed employment related to coal and oil and gas combined in the United States.\
  • Supply: The fracking revolution is a revolution. For the first time in history, advances in engineering has allowed us to extract oil and gas from oil bearing rock, which means that any geology that formerly produced oil, such as Pennsylvania, is has the potential to produce oil again. Jaffe did not, however, address the cost question and said in so many words that these are engineering problems, which can be solved over time.
In effect, don`t expect much more upside in the price of oil.

Independent of Jaffe's analysis, Bloomberg Gadfly column by Liam Denning used similar assumptions about oil prices and suggested a strategy by the Big Oil companies is in order:

Like OPEC, they [Big Oil] assumed the value of their reserves of this finite, critical commodity would, more or less, keep rising over time. So a barrel not produced today, even if it cost a lot to find or acquire, is effectively money in the bank. This is why the majors obsess over their reserves replacement ratio, measuring how many new barrels come in to replace the ones they pump out.

Now, the upcoming Saudi Aramco IPO raises one troubling possibility: That the assumption of endlessly rising reserve value may no longer hold true.

A flurry of paradigm-shifting announcements out of Saudi Arabia came soon after a speech in October by BP's chief economist. He posited that the shale boom undercut the notion of peak oil supply, while efforts to curb carbon emissions raised the possibility of peak demand.
Denning went on to suggest that the upcoming partial privatization of up to 5% of Saudi Aramco representing a Saudi strategic shift to produce at any price, rather than to bank the oil in the ground because it is becoming a commodity with diminishing value.
Saudi Arabia's sudden desire to sell shares in its national champion and generally shift the entire economy away from its oil addiction suggests it at least entertains those possibilities. It also provides a rationale to maximize production at any price, rather than risk barrels being left worthless in the ground.
Shale boom + carbon emissions curb = Peak Oil demand. It's time to change the thinking on the management of this resource and sell it as fast as possible because some of those assets will become stranded in the future. Call it the Hot Potato Theory of oil.

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







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Tuesday, May 24, 2016

The correction is (probably) over

Mid-week market update: About two weeks ago, my inner trader turned cautious on the US stock market (see my tweet and subsequent post Tactically taking profits in the commodity and reflation trade). I had cited as reasons the weakness from China, the commodity markets and, later, Europe (see Waiting for the storm to pass), which was based on inter-market and cross-asset analysis. (Though my inner investor remained constructive on stocks.)

Since then, the SPX weakened to test an important technical support at 2040, which represents the neckline of a potential head and shoulders formation. (As all good technicians know, a head and shoulders formation isn't complete until the neckline is broken.) While the market did break 2040 last week on an intra-day basis, neckline support held. In addition, the NASDAQ Composite confirmed the strength today by staging an upside breakout through resistance.


At the time of the bearish trading call, I said that I would turn bullish if:
  • The US stock market got oversold and sentiment models flashed a crowded short reading; o
  • The stock markets improved in Europe or Asia.
Let's consider what has happened since then.

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







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Monday, May 23, 2016

Yield curve: Correlation vs. causation edition

Further to my last post (see Three steps and a stumble?), I would like to clear up some misconceptions about how I interpret the yield curve and its investment implications. Much of the confusion revolves around the idea of correlation vs. causation. Yield curve inversions don't cause anything. Yield curve inversions are a signal (correlation) of certain effects that have important investment implications.

In this post, I will address the following topics:
  • Yield curve and recessions
  • Yield curve and credit conditions
  • Yield curve and equity bear markets
The full post can be found at our new site here.






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Sunday, May 22, 2016

Three steps and a stumble?

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 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 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 bullish 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. Past trading of the trading model has shown turnover rates of about 200% per month.


The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Neutral*
  • Trading model: Bearish*
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 any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


Some good news and bad news
The market action last week played out roughly as I expected. Stock prices were choppy and displayed a series of lower highs and lower lows, though the technically important 2040 support neckline of the head and shoulders pattern did not break decisively (see Waiting for the storm to pass). The short-term trend remains down and key intermediate term indicators has not reach oversold levels, as measured by the NYSE McClellan Oscillator (NYMO) breaching the -80 level and VIX Index moving above its Bollinger Band, which suggests that the current corrective action isn't finished.


There was some good news and bad news as stocks declined...

...specifically, I would like to explore the possibility of the bearish three steps and a stumble scenario, which follows the old trading adage of three Fed tightening moves will tend to lead to a stock market stumble. This scenario is becoming a real possibility as the US economy is still in a fragile state.

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




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Thursday, May 19, 2016

A cautionary tale for quants and systems traders

How would you feel if the average doctor was right 55% of the time? What if a "superstar" doctor, the one whose new patient waiting list stretched out for 1-2 years, was right 60-70% of the time?

That's how thing work in investing. A "good" quantitative factor, or system, is often acceptable if it has a 55% success rate. If you get a 65% success rate, you are a superstar. Some systems have success rates of less than 50%, but the average value of their wins dwarf the average value of their losses.

Finance quants are often said to suffer science envy. They employ scientific techniques to find alpha, but they do it in an environment where the signal-to-noise ratio is very low. Let`s not kid ourselves, we know what day traders, swing traders and system traders really do.


By contrast, the signal-to-noise in the sciences tend to be higher. Viewed in isolation, that can be a cautionary tale for all quant researchers and systems traders who think that they may have found their path to riches.

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Wednesday, May 18, 2016

What's spooking the stock market?

Mid-week market update: No, it isn't just a more hawkish Federal Reserve that's spooking the stock market. Stock prices were been falling before Fedspeak and the latest FOMC minutes sounded a more hawkish tone. The SPX staged a successful test of its 2040 neckline support of its head and shoulders pattern today. In fact, today`s action could be interpreted constructively as it is experiencing a minor positive divergence on RSI-5.



Don`t blame the Fed. Market weakness is a symptom, not the cause of the retreat.

I turned more cautious on the stock market last week because of growing market fears of a slowdown in China (see Tactically taking profits on the commodity and reflation trade). There seems to be a bifurcation starting to occur in the global economy. The US macro picture looks fine as the American economy is motoring along, as evidenced by the latest news of the April rebound in industrial production. Outside the US, the picture looks far less rosy.

The latest BoAML Fund Manager Survey revealed the top two tail-risks on fund managers' minds were Brexit and China, which did not appear as a source of concern in the previous month's survey. It's no wonder that the markets are getting spooked.


Here's how I am preparing myself and how I would watch for the turn upwards, should it come.

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