Thursday, January 18, 2018

Trump's one-year report card

As we approach the one-year anniversary of Donald Trump's first year in office, I am seeing numerous commentaries assessing his first year in office (see FiveThirtyEight, The Economist and BBC) . About a year ago, I laid out my criteria for his success (see Forget politics! Here are the 5 key macro indicators of Trump's political fortunes) using the criteria that Newt Gingrich specified in a New York Times interview:
“Ultimately this is about governing,” said former House Speaker Newt Gingrich, who has advised Mr. Trump. “There are two things he’s got to do between now and 2020: He has to keep America safe and create a lot of jobs. That’s what he promised in his speech. If he does those two things, everything else is noise.”

“The average American isn’t paying attention to this stuff,” he added. “They are going to look around in late 2019 and early 2020 and ask themselves if they are doing better. If the answer’s yes, they are going to say, ‘Cool, give me some more.’”
As Trump has "kept America safe", because, like it or not, mass shootings such as the one in Las Vegas doesn't politically count as a terrorist incident. From a strictly economics viewpoint to judge whether he "created a lot of jobs", I used the Bloomberg Intelligence economic criteria to judge Trump on his economic record.

Despite all of the outrage of the anti-Trumpers, Trump`s economic record has been quite good in the past year.

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

Wednesday, January 17, 2018

How far can this momentum rally run?

Mid-week market update: How far can this momentum rally run? Already, the momentum frenzy is exceeding the pace set during the height of the Tech Bubble.


The WSJ recently published an article about the dominance of price momentum: "The Momentum Game Has Returned to the Stock Market".
Forget fundamentals: Momentum is back in the stock market. For the first time since the 2008 financial crisis a simple strategy of buying the stocks that had already gone up the most delivered a remarkable outperformance last year. Is it a sign of excess or the start of a new bull run?

Momentum is a formal way to capture two old Wall Street dictums: The trend is your friend until the end, and let your winners run. It can be measured over any period from microseconds to years, but investment strategies typically look for three-, six- or 12-month trends.
The article went on to lay out the bull and bear cases for momentum, and, by implication, the latest bull run:
There are two prevalent explanations for momentum, and today the choice will make you more or less worried about the power of the trend.

The bearish explanation is that investors put far too much weight on the past, and buy what has gone up without properly assessing whether that is likely to continue. Momentum is created by this blind buying, and pulls prices further and further away from where they should be, until they snap back and crush those chasing gains.

The bullish explanation is that it takes time for investors to price in a new environment.

On this view prices rose as investors slowly woke up to the unexpected global economic strength and slowly came to believe in higher profits. Perhaps company analysts still haven’t included U.S. corporate tax cuts in their profit forecasts due to their complexity, which could mean still more good news to come as the earnings season brings tax guidance from CFOs.
Certainly, a number of sentiment indicators are looking stretched. Bloomberg reported that the prices of call options are extremely expensive relative to the price of put option protection.



Strategist Jim Paulsen, who had been very bullish, sounded a word of caution in a recent CNBC interview:
The stock market has incredible price momentum and broad participation but the challenges are "truly increasing," widely followed strategist Jim Paulsen told CNBC on Tuesday.

In fact, he called the optimism of late "really overwhelming."

"It's so striking because we haven't had it in the entire recovery. The wall of worry was probably the cornerstone of this bull market. … That is gone," the chief investment officer at the Lethold Group said in an interview with "Power Lunch."

"That opens you up to the bear's bite," he added.
Is the combination of a pause in stock prices Tuesday and the carnage in crytpocurrencies* represent a warning that the momentum run is nearing an end? If so, does that mean the stock market is destined to suffer a near-term correction?

* Sorry, the cryptos aren't tanking, that's just a dead-cat bounce in the value of the fiat paper currencies.


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

Sunday, January 14, 2018

Bubbleology 101: How to spot the top in a market melt-up

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. 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: 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 will also receive email notices of any changes in my trading portfolio.


Come over to the Dark Side
I have a confession to make. I've gone over to the Dark Side. Valuation doesn't matter. Excessively bullish sentiment doesn't matter. Overbought readings don't matter. The only thing matters is the Melt-Up (see Embrace the blow-off, but with a stop-loss discipline and Jeremy Grantham's call for a market melt-up).


If the market is indeed undergoing a blow-off rally, then investors should be mindful of Bob Farrell's Rule #4: "Parabolic markets go up further than you think, but they don't correct by going sideways."

Nevertheless, there are a number of simple techniques of spotting the top in a parabolic move.

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

Wednesday, January 10, 2018

Can the melt-up continue?

Mid-week market update: The week began on a bullish note this week as the melt-up theme dominated early in the week (see Jeremy Grantham`s call for a possible melt-up, and my own views published last November: Embrace the blow-off, but with a stop loss discipline). On Monday, the market rose for a fifth consecutive day, which flashed a First Five Day (FFD) buy signal. Ryan Detrick at LPL Financial detailed the historical evidence of this momentum effect for the remainder of the year.


In addition, analysis from Jeff Hirsch of Almanac Trader showing a shorter positive momentum effects of the FFD for the remainder of January, shown as JB in the table below (January Barometer). Since 1950, whenever the first five days was positive, the rest of January went on to be positive 86% of the time, with an average return of 2.6% and median return of 2.1% for the remainder of the month (N=29).


The market celebrated with another win on Tuesday, making its winning streak an astounding six consecutive days. The risk-on rally came to a screeching halt when China reported was considering slowing down or halting its purchases of Treasury paper. The initial reaction saw the yield on 10-year Treasury note spiked and a steepening of the yield curve, though both ended the day roughly unchanged. At the same time, the stock market took a risk-off tone. Here is the Bloomberg report:
Senior government officials in Beijing reviewing the nation’s foreign-exchange holdings have recommended slowing or halting purchases of U.S. Treasuries, according to people familiar with the matter. The news comes as global debt markets were already selling off amid signs that central banks are starting to step back after years of bond-buying stimulus. Yields on 10-year Treasuries rose for a fifth day, touching the highest since March.
Arguably, the response from Beijing was a warning shot to the Trump administration over the prospect of a trade war (see Could a Trump trade war spark a bear market?).
China holds the world’s largest foreign-exchange reserves, at $3.1 trillion, and regularly assesses its strategy for investing them. It isn’t clear whether the officials’ recommendations have been adopted. The market for U.S. government bonds is becoming less attractive relative to other assets, and trade tensions with the U.S. may provide a reason to slow or stop buying American debt, the thinking of these officials goes, according to the people, who asked not to be named as they aren’t allowed to discuss the matter publicly.
Is this the end of the momentum rally?

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

Monday, January 8, 2018

Things you don't see at market bottoms: Retail stampede 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.

I have stated that while I don't believe that the stock market has made its final cyclical top, we are in the late stages of a bull market (see Five steps, where's the stumble?). Nevertheless, psychology is getting a little frothy, which represent the pre-condition for a major top. This is just another post in a series of "things you don't see at market bottoms". 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. Jeremy Grantham of GMO recently penned an essay calling for a market melt-up. Investors should also remember Bob Farrell’s Rule #4: “When markets go parabolic, they rise further than you think, but they don’t correct by going sideways."

As a result, I am publishing another edition of "things you don't see at market bottoms", as exemplified by the mood captured by this recent magazine ad.


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

Sunday, January 7, 2018

Could a Trump trade war spark a bear market?

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. 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: 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 will also receive email notices of any changes in my trading portfolio.


Staying ahead of the curve
It is gratifying to be ahead of the curve and anticipate the changes in the market narrative. The two themes du jour are Jeremy Grantham's call for a market melt-up (see Embrace the blow-off, but with a stop-loss discipline), and concerns about rising inflation, which I have been writing about endlessly (as an example, see Five steps, where's the stumble?).

What's next?

How about the risk of rising protectionism? The news site Axios reported that 2018 will bring “full Trump”, with a dramatic change in policy tone after the legislative tax cut victory:
Trump keeps asking for tariffs — on steel and aluminum, in particular. He wants a trade war, and has for many years. His economic and diplomatic advisers persuaded him to delay trade actions in 2017.
  • Those advisers recognize that the day of reckoning will come in 2018, regardless of whether economic adviser Gary Cohn and Secretary of State Rex Tillerson — who advocated restraint — stay or go.
  • Cohn and Treasury Secretary Steve Mnuchin successfully persuaded Trump not to do anything rash while tax reform was being negotiated.
  • Trump also saw the advantage of trying to use that as leverage with China to get help on North Korea. He said yesterday in an interview with the N.Y Times: "China's hurting us very badly on trade, but I have been soft on China because the only thing more important to me than trade is war. O.K.?"
  • And he tweeted yesterday, in response to Chinese ships secretly delivering oil to North Korea: "Caught RED HANDED - very disappointed that China is allowing oil to go into North Korea. There will never be a friendly solution to the North Korea problem if this continues to happen!"

The Washington Post also reported that the Trump Administration is close to imposing trade sanctions on China in January:
The Trump administration is setting the stage to unveil tough new trade penalties against China early next year, moving closer to an oft-promised crackdown that some U.S. business executives fear will ignite a costly battle.

Several corporate officials and analysts closely tracking trade policy said that President Trump is expected to take concrete actions on a range of disputes involving China within weeks.

Trump is due by the end of January to render his first decision in response to petitions from U.S. companies seeking tariffs or import quotas on Chinese solar panels and washing machines manufactured in China and its neighbors.
The Trump Administration’s newly unveiled National Security Strategy reframes the China relationship in an adversarial fashion. As a result, the latest anticipated pivot on trade policy is therefore not an unexpected development, though the scale of the reaction is likely to surprise the market:
White House action is due on a separate Commerce Department probe triggered by worries about the national security impact of rising imports of Chinese steel and aluminum.

“Their intent is to bring shock and awe,” said Scott Kennedy, an expert on Chinese trade at the Center for Strategic and International Studies. “They’re not kidding around.”
My base-case scenario calls for an equity market melt-up, supported by a combination of fundamental growth momentum and technical price momentum. It would end with aggressive Federal Reserve action to cool an overheated economy. In other words, an equity bear market would begin with a classic Fed-induced slowdown.

What if the economic slowdown is not caused by monetary policy but by trade policy? What would happen if the growth outlook slowed because of a trade war? What would be the damage, both to the economy and stock prices?

While I am not forecasting a trade war-induced bear market, good investors engage in scenario modeling in order to be prepared for different possibilities. I explore the ramifications of a trade war as an exercise in investor preparation.

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

Wednesday, January 3, 2018

A frothy rally, but...

Mid-week market update: The stock market began the year by roaring out of the gate. This was not a big surprise. Rob Hanna at Quantifiable Edges tweeted on New Year's Eve that the market has rallied strongly when it closed at a 10-day low at the end of the year.


Though the sample size is small (N=4), past episodes has been stock prices advance for a minimum of four consecutive days before pausing.


Hanna followed that tweet with a post which observed that positive momentum on the first day of the year usually leads to follow through for the next two days (which would be tomorrow, or Thursday).



Another bullish seasonal sign come from Jeff Hirsch of Trader`s Almanac.
The first indicator to register a reading in January is the Santa Claus Rally. The seven-trading day period begins on the open on December 22 and ends with the close of trading on January 3. Normally, the SP 500 posts an average gain of 1.3%. The failure of stocks to rally during this time tends to precede bear markets or times when stocks could be purchased at lower prices later in the year.
The SPX returned 1.1% during the seven-day period, which is positive but below average. This is a preliminary sign which should be enough to get traders and investors excited about 2018.

What happens now? Can equities continue to rise after these seasonal tailwinds?

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

Sunday, December 31, 2017

My 2017 report card

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. 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: 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 will also receive email notices of any changes in my trading portfolio.


Marking my 2017 calls to market
As 2017 draws to an end, it's time to mark my 2017 forecasts to market. Overall, the stock market in 2017 was remarkable. What if I told you that you could have had returns with a Sharpe Ratio of 3.2, using the 3-month T-Bill as the risk-free rate? As it turns out, you could have achieved that with a simple buy-and-hold long position in the SPX, whose Sharpe ratio is the second highest in its history in the last 59 years (via Vincent Deluard of NDR).



Indeed, US equities rose steadily in 2017. The drawdown was only 3% in the year, which is a feat that was last achieved in 1995.


With that in mind, I review my inner investor and inner trader calls of 2017. My inner investor gave himself a grade of B+, and my inner trader gave himself an C+ for the year.

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

Wednesday, December 27, 2017

What you should and shouldn't worry about in 2018

The end of December is filled with analyst forecasts for the following year. I would like to take this time to debunk some of the doomster myths about the stock market, and to outline some of the true risks that I worry about in the year to come.

One of the major myths that have been trotted out is the relationship between the Fed's balance sheet and stock prices. While this chart appears impressive, it is an illustration of the adage about correlation does not equal causality.


Instead, investors could be much better served to focus on earnings, with does have a direct causal effect on stock prices. Forward 12-month EPS is coincident with stock prices, and they are rising.


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

Sunday, December 24, 2017

A sector review reveals animal spirits at work

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. 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: 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 will also receive email notices of any changes in my trading portfolio.


Here comes the animal spirits
Josh Brown composed an insightful post last week entitled, Trump's Singular Accomplishment:
I mean this without a trace of sarcasm, not being a fan of the President’s or pretty much anything he stands for…

Donald Trump’s singular accomplishment, in my view, is the ignition of Animal Spirits in the stock market and the real economy. Small business confidence measures shot up from the week of his inauguration and have remained elevated ever since. PE multiples expanded throughout the course of the year, which was not solely due to his tax policy – it was also about his swagger and I-don’t-give-a-f**k persona.
Indeed, the animal spirits in the stock market began to run wild starting in September, when the weekly RSI became overbought and stayed overbought. My former Merrill colleague Walter Murphy called this a "good overbought" condition, where the market continues to advance while remaining overbought. Since 1990, there have been two episodes when the market flashed a series of overbought readings. One lasted 10 months, the other lasted 14 months. In both instances, stock prices were significantly higher afterwards.


LPL Research quantified the "good overbought" effect on market returns using data that went back to 1950. They found that past episodes of weekly RSI above 80 has been bullish for equity returns, though the sample size is still low (N=13). The table below from LPL, which I edited and annotated, shows that the excess return from the price momentum effect fades out after six months. The incremental return from six to twelve months when when weekly RSI > 80 is not significantly different from the "at any time" returns.


This week, I review the sector leadership of the stock market. The analysis reveals a late cycle market characterized by price momentum leadership, and expectations of increased capital expenditures, as well as emerging leadership from inflation hedge sectors.

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

Wednesday, December 20, 2017

An update on gold (but not frankincense or myrrh)

Mid-week market update: There is not much that can be said about the stock market that I have not already said. The small cap seasonal Santa Claus rally that I wrote about appears to be proceeding as expected, though the tape is thin and most professionals have shut down their books for the year.



Next week is Christmas. It is said that the three kings visited the infant Christ with gifts of gold, frankincense and myrrh. While there is no active and liquid market for the latter two gifts, gold is still traded and an update on the outlook for gold would be timely.

Gold is getting intriguing. Analysis from Nautilus Research indicates that we are entering a period of positive seasonality for gold.


At the same time, gold stocks are testing a key relative downtrend line. Should it rally further, it would be a signal of possible further future strength.


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

Sunday, December 17, 2017

Five steps, where's the 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 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. 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: 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 will also receive email notices of any changes in my trading portfolio.


What happened to 3 steps and a stumble?
As expected, the Federal Reserve raised rates by a quarter point last week and re-affirmed its dot-plot projection of three more quarter-point hikes next year. What happened to "three steps and a stumble"?

The old Wall Street trader's adage of "three steps and a stumble" refers to the stock market's reaction to Fed rate hike cycles. At first, stock prices don't react to the Fed raising rates, but eventually the market succumbs to the economic cooling effects of monetary policy, and a bear market usually begins after three rate hikes. Hence, "three and a stumble". The chart below from Ned Davis Research shows the effects of this rule on the Dow. Historically, the DJIA has declined a median of -17.9% from sell signals to NDR market bottoms.



Historically, the sell signals have been fairly prescient, though sometime early. This expansion cycle has been unusual in that the Fed began raising rates two years ago. We have seen five consecutive quarter-point rate hikes, so where's the stumble?

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

Wednesday, December 13, 2017

Do you believe in Santa Claus?

Mid-week market update: You can tell a lot about market psychology by the way it reacts to events. News overnight of the victory by Democrat Doug Jones over the troubled Republican candidate Roy Moore in the Alabama senate race was judged to be market unfriendly, as it meant that the GOP would have its Senate majority shrink by one vote to 51-49. ES fell immediately, but eventually recovered to roughly even the next morning at 8:30 before the release of CPI.

The near term message from the market is "stock prices don't want to go down".

Rob Hanna of Quantifiable Edges observed that this week, which is December OpEx, is one of the most bullish weeks of the year. Moreover, positive seasonality extends past this Friday for another two weeks.


Do you believe in Santa Claus?

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

Tuesday, December 12, 2017

China: A 19th Party Congress postscript

A decent interval has passed since China's 19th Party Congress (see Beware the expiry of the 19th Party Congress put option), and it's time to check in again on China to see how things are progressing. For the China bears, the overhang in debt looms large.



The worries are especially acute in light of International Monetary Fund's publication of the results of its financial stability assessment of China. In connection with that review, the IMF issued the following warning about three sources of vulnerability:
  • Excessive debt: In particular, concerns were raised over the rapid buildup of debt to keep non-viable zombie companies alive.
  • Growth of shadow banking: The growth of the shadow banking system makes it more difficult to monitor and control the risks in the financial system.
  • Moral hazard: The IMF also raised concerns over "moral hazard and excessive risk taking" because of the belief that the government will bail out troubled state-owned enterprises (SOEs) and local government financing vehicles (LGFV).
The concerns raised by the IMF echoes the writings of Winston Yung at McKinsey, who penned an article called "This is what keeps Chief Risk Officers in Chinese Banks awake at night".
  • Economic downturn leads to the emergence of credit risk
  • Risk management cannot keep up with constantly changing business models: 
  • Asset liability mismatch
  • Significant risk from off balance sheet activities
The full post can be found at our new site here.

Sunday, December 10, 2017

Here comes the blow-off!

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. 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: Bullish*
  • 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 mid-week observations at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


Party on!
Friday's November Jobs Report highlighted a number of important bullish data points for the stock market in the weeks ahead. The headline non-farm payroll release came in ahead of expectations, while average hourly earnings missed. At the margin, tame wage pressure which will restrain the Fed from becoming overly aggressive in raising rates.

As well, Thursday's release of initial jobless claims also underlined the remarkable inverse correlation between initial claims (inverted scale) and stock prices. So far, the continuing improvement in initial claims is supportive of higher equity prices.


In his latest update of high frequency economic data, New Deal democrat painted a bright picture for the near term, and an improving long term outlook:
The nowcast and the near term forecast remain very positive, with only relatively strong oil prices juxtaposed with relatively weak commodity prices as flies in the ointment. The longer term forecast, which I briefly downgraded to neutral, is weakly positive again.
Throw in the anticipated corporate tax cuts, it is difficult to contain our short-term enthusiasm. This week, I review my Recession Watch indicators and find that the current snapshot of recession risk is receding, though there are still some key risks on the horizon (also see Things you don't see at market bottoms: Rational exuberance edition).

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

Wednesday, December 6, 2017

Duel of the market studies

Mid-week market update: Swing and day traders are often fond of studies that show an edge under certain market conditions. But what happens when two different studies disagree?

On one hand, Rob Hanna at Quantifiable Edges published a study yesterday that signaled a likely bullish outcome for stock prices. Yesterday (Tuesday) would have day 1 of that study.


On the other hand, I had identified a hanging man candle on Friday. While hanging man formations are thought of as bearish reversals, further studies showed that they don't necessarily resolve themselves in a bearish fashion unless there is a bearish follow-through the next day.



When the market opened up strongly on Monday, I had given up on Friday's hanging man, but the market astonishingly closed in the red to flash a bearish confirmation. My own historical study indicates that these episodes tend to be short-term bearish, and bottom out between day 3 and 4, which translates to either this Thursday or Friday.


How can we resolve this apparent contradiction in market studies?

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

Tuesday, December 5, 2017

How worried should you be about an elevated Shiller P/E?

In my discussions with investors, the Cyclically Adjusted P/E (CAPE), or Shiller P/E, has come up numerous times as a risk for the U.S. stock market. The current reading of 32x is only exceeded by the peak during the NASDAQ Bubble, and it is higher than the levels seen before the Crash of 1929. Does this mean that the risk of a substantial stock market drawdown in the near future is rising?


I studied the question in the context of some of the criticisms of the Shiller P/E and made a number of adjustments to the calculation. I found that the answer is the same. The U.S. equity market is expensive, but Shiller P/E does not work well as a short-term market timing technique. However, I have found that the combination of valuation and price momentum can provide clear warning signs that the market is about to enter a bear market.

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

Sunday, December 3, 2017

Brace for more a volatile 2018

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. 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: 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 will also receive email notices of any changes in my trading portfolio.


Volatility ahead
Equity market volatility, as measured by the VIX Index, has been extraordinarily low by historical standards.



Last week's events is setting the stage for greater market volatility in 2018, which stems from the following three sources:
  • Political uncertainty
  • Fiscal policy
  • Monetary policy
Let's examine each, one at a time.

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

Wednesday, November 29, 2017

What's next for the tax cut bull?

Mid-week market update: It was clear from yesterday's market action that the equity bull depends entirely on the success of the Republican tax cut bill. The market rallied on the news that the tax cut bill had made it out of Senate Budget Committee. It manage to shrug off the news of a possible government shutdown, and a North Korean ICBM test, which was later determined to have a range to reach the entire Continental United States.

The combination of the market enthusiasm yesterday and the strength in the Goldman Sachs high tax basket indicates that the market is discounting the passage of the bill.



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

Monday, November 27, 2017

Things you don't see at market bottoms: Rational exuberance 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.

I have stated that while I don't believe that the stock market has made its final cyclical top, we are in the late stages of a bull market (see Risks are rising, but THE TOP is still ahead and Nearing the terminal phase of this equity bull). Nevertheless, psychology is getting a little frothy, which represent the pre-condition for a major top. This is just another post in a series of "things you don't see at market bottoms". Past editions of this series include:
As a result, I am publishing another edition of "things you don't see at market bottoms".

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