Wednesday, October 17, 2018

Is there any more pop after the drop?

Mid-week market update: Is there any more "pop" after last week's drop? The market certainly had a big rally yesterday, and it is not unusual to see a pause the day after a big move.



Here are the bull and bear cases.

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

Monday, October 15, 2018

Tops are processes: Here's why

I received a ton of comments after yesterday's post (see A correction, or the start of a bear market?), probably because of the tumultuous nature of last week's market action. Readers pointed out a number of buy and sell signals that I had missed in yesterday's post and asked me to comment on them. (Rather than email me directly, I encourage everyone to put their comments in the comments section rather so that the rest of the community can see them.)

The bullish and bearish signals are not necessarily contradictory, as they operate in different time frames. I believe that they reinforce my conviction that the market is undergoing a long-term top. Tops are processes. Stock prices don`t go straight down when the market tops out. The most recent break was just a warning.

Even if you are bearish, I reiterate my view that the markets are too oversold to meltdown from current levels. Rob Hanna of Quantifiable Edges found that market bounces that begin on a Friday tend to be the most reliably bullish.



Here is the other feedback that I received which makes me believe that the US equity market is in the process of making a top.

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

Sunday, October 14, 2018

A correction, or the start of 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. 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 hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.



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 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.


Where's the bottom?
When the market selloff began last Wednesday, Callum Thomas conducted an (unscientific) Twitter poll asking if this is a correction, the start of a bear market, or just market noise. The overwhelming response favored a correction, which is contrarian bearish from a sentiment viewpoint.



Regular readers know that I have become increasingly cautious on the outlook for US equities since August (see 10 or more technical reasons to be cautious on stocks and Red sky in the morning). Now that the major US averages have begun to show signs of technical breakdowns, it is time to ask, "Is this just a correction, or the start of a bear market?"

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

Thursday, October 11, 2018

Things you don't see at market bottoms: Booming confidence edition

The last time I published a post in a series of "things you don't see at market bottoms" based on US based investor enthusiasm was in June. Sufficient signs have emerged again for another edition.

As a reminder, 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.

Past editions of this series include:
I reiterate my belief that excessively bullish sentiment may not signal the top of the equity market, but investors should be aware of the risks of an environment in which sentiment has become increasingly frothy.

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

Wednesday, October 10, 2018

Has the correction bottomed? What`s next?

Mid-week market update: Is the correction over? At least my inner trader had been positioned for market weakness. Subscribers who had been following my inner trader, you know that we issued real-time alerts to buy the market on September 12, 2018 and flipped short on September 21, 2018. (You can subscribe here if you haven't done so).



Where's the bottom?

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

Monday, October 8, 2018

More cracks appear in the New Fragile Five

Recessions serve to unwind the excesses of the past expansion cycle. While the immediate odds of a US recession is still relatively low right now (see A recession in 2020?), and there are few excesses in the economy, the problems are found outside US borders. This time, most of the excessive private debt accumulation has occurred in China, and Canada.

I wrote about the New Fragile Five last March. Loomis Sayles made the case for these countries to be the New Fragile Five, which includes Canada, based on unsustainable real estate bubbles:
Cracks are starting to appear in five highly leveraged economies: Canada, Australia, Norway, Sweden and New Zealand. For several years following the global financial crisis, these five countries all shared a common theme—a multi-year housing boom, fueled by low interest rates, which resulted in very elevated levels of household debt.

This boom is starting to dissipate in all five markets. House prices have largely reversed course, be it slowing appreciation or outright decline. Moreover, this is occurring even as interest rates remain at or near record lows and labor markets continue to be robust. Importantly, this is a correction that many thought could not occur given the otherwise strong economic growth backdrop in these countries. But we take a long-term view of house prices, and began highlighting affordability problems in these markets several years ago.

Signs are growing that those property bubbles are popping.

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

Sunday, October 7, 2018

A recession in 2020?

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 hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.


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 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.


The 2020 recession consensus call
In the past few months, there has been a cacophony of voices calling for a recession or significant slowdown in 2020, such as Ben Bernanke (via Bloomberg), and Ray Dalio (via Business Insider). Bloomberg reported that two-thirds of business economists expect a recession by the end of 2020.

To be sure, the American economy is exhibiting behavior consistent with a late cycle expansion. Estimates of the output gap show that both the US and developed economies are running at, or above capacity, which are usually signs that a recession is just around the corner.


How close is the American economy to a recession? I answer that question using the long-leading indicator methodology outlined by New Deal democrat (NDD) in 2015. These indicators are designed to spot a recession about a year in advance, and they are broadly categorized into three groups (my words, not his):
  • The consumer or household sector
  • The corporate sector
  • Monetary conditions
I would add the disclaimer that while the analytical framework comes from NDD, the interpretation of the output is entirely mine.

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

Wednesday, October 3, 2018

Style and factor analysis reveals the challenges for bulls and bears

Mid-week market update: The Dow has made another record high. Most technical analysts would interpret such a development bullishly as there is nothing more bullish than a stock or index making a new all-time high. However, there is the nagging problem of poor breadth.

In the past few weeks, I have been warning about the precarious technical condition of the stock market. On Monday, I wrote about the narrowing Bollinger Band of the VIX Index, which is a sign of complacency, and the pattern of declining new highs on both NYSE and NASDAQ stocks even as the market advanced to all-time highs (see The calm before the storm?). The negative breadth divergence has gotten so that that it has prompted analysts like SentimenTrader to point out the ominous historical parallels with the Tech Bubble top.


He also highlighted the historical record of poor breadth when the DJIA made a new high.



Rather than obsess endless about the negative breadth divergence, I examined performance market cap, style, or factor, rotation. The analysis yielded some surprising answers, and laid out the challenges for the bulls and bears.

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

Monday, October 1, 2018

The calm before the storm?

Notwithstanding today's NAFTA USMCA driven reflex rally today, one puzzle to this market is the remarkable level of complacency in the face of potential market moving events, such as a trade war.

From a technical perspective, complacency can be seen through the historically low level of weekly Bollinger Band on the VIX Index, which has foreshadowed volatility spikes (h/t Andrew Thrasher). The chart below depicts the 10-year history of this indicator. While the sample size is small (N=5), four of the five past instances have seen market corrections (red vertical lines). The only exception occurred when the stock market had already weakened. When combined with episodes of low levels of NYSE and NASDAQ new highs, which is the case today, the outlook is particularly worrisome.


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

Sunday, September 30, 2018

Quantifying the fallout from a full-scale trade 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 hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.



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 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 complacent market
The latest BAML Fund Manager Survey shows that the biggest tail risk is a trade war, followed by a China slowdown. In reality, both are related because the risk of a China slowdown is heightened by the Sino-American trade war.


At the same time, the US trade deficit is rising, and so are trade tensions.



It is therefore a puzzle why the market has largely been shrugging off the threat of rising protectionism.

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

Wednesday, September 26, 2018

Everyone expects Mr. Bond to die

Mid-week market update: For a change, I thought it was more appropriate to write about bond yields instead of the usual tactical trading commentary about stock prices on this FOMC day.

Increasingly, there has been more and more bearish calls for bond prices (and bullish calls for bond yields) as the Fed continues its rate normalization program. Some analysts have pointed out a nascent inverse head and shoulders formation on the 30-year yield (TYX). With the caveat that head and shoulders formations are never complete until the neckline is broken, a decisive upside breakout in TYX would be bad news for long Treasury prices.



I would argue against an overly bearish view for bonds. At a minimum, bond yields are unlikely to rise as much as expected, and they may actually decline slightly from current levels.

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

Monday, September 24, 2018

When should you buy gold?

Goldbugs got excited recently when the gold stock to gold ratio turned up sharply after the gold price consolidated sideways subsequent to breaking up from a downtrend. Past episodes have been bullish signals for bullion prices.



On the other hand, the front page of Barron's may also be a contrarian magazine cover bearish signal.


What should you do?

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

Sunday, September 23, 2018

FOMC preview: Prepare for the hawkish surprise

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 hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.


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.


Hawkish surprise ahead?
The FOMC is scheduled to meet next week for its September meeting. The market has fully discounted a quarter-point rate hike for the September meeting, and for the upcoming December meeting. Looking ahead to the March 2019 meeting, however, the market isn't fully convinced the Fed will continue its pace of quarter-point rate hikes every three months.


Peering further into the future, the CME's FedWatch tool for the June 2019 meeting shows that the market has only one rate hike penciled in between December and June.


Will the Fed pause as the Fed Funds rates nears neutral? The market thinks so. But I beg to differ for the following reasons:
  • Inflation pressures are rising, which will force the Fed to focus on its price stability mandate.
  • The Fed governors, including Fed Chair Jerome Powell, have shown little interest in pausing. Other key Fed officials have indicated that they are not afraid of inverting the yield curve.
In other words, prepare for a hawkish surprise from the September FOMC statement.

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

Wednesday, September 19, 2018

Surprising conclusions from advanced rotation analysis

Mid-week market update: I have been asked to periodically update my sector leadership analysis as a guide to spot up and coming sector strength. The standard approach is to apply the Relative Rotation Graph (RRG) to the market.

As an explanation, RRG charts are a way of depicting the changes in leadership in different groups, such as sectors, countries or regions, or market factors. The charts are organized into four quadrants. The typical group rotation pattern occurs in a clockwise fashion. Leading groups (top right) deteriorate to weakening groups (bottom right), which then rotates to lagging groups (bottom left), which changes to improving groups (top left), and finally completes the cycle by improving to leading groups (top right) again.

The sector RRG chart shows that Healthcare stocks remain the leading sector. Up and coming sectors are Financial and Industrial stocks, and defensive sector such as Consumer Staples, Utilities, and REITs are starting to lose steam.


However, the recent reclassification of stocks into the newly formed Communication Services sector, which moved high octane names such as Alphabet, Amazon, and Netflix into the sector makes RRG analysis somewhat deceptive. Standard RRG analysis on sectors doesn't tell the entire story. As an alternative, I present a couple of two other ways of rotation analysis for insights for both leadership and market direction.

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

Monday, September 17, 2018

How to watch for signs of another Lehman Crisis

It has been 10 years since the Lehman bankruptcy, which became the trigger for the Great Financial Crisis (GFC). The financial press has been full of retrospective stories of what happened, and discussions from key players.

The GFC was an enormous shock to investor confidence. Ever since that event, many investors have been living with the fear that another tail-risk shock to their portfolios, and they have searched for warning signs that another financial crisis is around the corner.

One of the commonly used indicators to measure financial tail-risk are the financial stress risk indicators produced by the Chicago Fed and St. Louis Fed. Right now, readings are relatively benign, as low and negative numbers indicate low levels of financial stress.


New Deal democrat also monitors the Chicago Fed's National Financial Conditions Leverage Subindex as a more sensitive indicator of systemic stress. The readings of this indicator are also relatively benign (low = low stress).


For investors and traders who demand real-time results, there may be even a better way.

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

Sunday, September 16, 2018

Is China ready for the next downturn?

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 hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.



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 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.


How much runway is left in China's long landing?
The bears have been warning about China's unsustainable debt for years. So far, it has been a "this will not end well" investment story, with no obvious bearish trigger and no time frame for a crisis.



Michael Pettis is one of the few China watchers who have established a time frame for China to resolve its problems. He outlined a scenario four years ago where China would not crash, but experience a "long landing" where growth gradually decelerates. Pettis elaborated on his best case scenario in an email to me (see Michael Pettis on the risks of the long landing scenario):
My "best-case" rebalancing scenario, as I think you know, consists of an upper limit to average GDP growth of 3-4% over the presumed decade of President Xi's administration (2013-23), driven by growth in household income of 5-7% and commensurate growth in household consumption. Although when it comes to China I have been the big, bad bear for so long that perhaps I tend to want to understate my pessimism, I nonetheless always try to remind my clients, sometimes not very loudly if I am in a public forum, that this is not my expected "most likely outcome".
He went on to elaborate that his best guess is the current pace of credit growth was only sustainable until 2017-2018:
My guess (and it is only a guess), is that China can continue the current pace of credit growth for another 3-4 years at most, after which it cannot grow credit fast enough both to roll over what Hyman Minsky suggested was likely to be exponential growth in unrecognized bad debt (and WMP and other shadow banking assets will almost certainly be absorbed into the formal banks), and to provide enough new lending to fund further economic activity. If there is less time, as I think Anne Stevenson might argue, or if Beijing cannot get credit and rebalancing under control before then, I think we can probably assume my "orderly long landing" scenario is less likely.
Here we are, four years later. How is China managing its long landing?

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




Wednesday, September 12, 2018

Short-term bullish, long-term cautious

Mid-week market update: There are a number of signs that the pullback that began in late August has run its course. These conditions makes me short-term bullish, but I remain longer term cautious on equities.

The market's recent action of a correction to test its breakout level turned support is constructive. The index pulled back to form a bull flag, which is a bullish continuation pattern. It staged an upside breakout out of the flag this week, which suggests that the index may be poised for a test of its previous highs.



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

Tuesday, September 11, 2018

Tech as the canary in the coalmine

Technology stocks have been on a tear in the last couple of years. Indeed, both the Tech sector and the Tech heavy NASDAQ 100 has been market leaders.


Tech earnings have surged in this cycle. By contrast, non-Tech earnings appear to be at or near a cyclical peak.


Can it continue?

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

Sunday, September 9, 2018

Red sky in the morning

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 hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.


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 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.


Global slowdown in progress
There is an adage among the nautical set:
Red sky at night, sailor`s delight
Red sky in the morning, sailors take warning
In the global economy, there are signs of a red sky in the morning. Last week, IHS Markit highlighted falling global manufacturing PMI.


Stagnant growth can be attributed to a slowdown in export orders in every major region of the world. In particular, the export order components of the UK, Japan, China, and much of Asia are below 50, indicating negative growth.

The global trade slowdown is confirmed by the OECD, which is a sign that the trade war is starting to bite.



Let's take a tour around the world and see how the global economy is progressing.

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

Wednesday, September 5, 2018

The Dollar tail wagging the market dog

Mid-week market update: Here at Humble Student of the Markets, we believe that investors can gain great insight through the use of inter-market, or cross asset market, analysis. During this period of heightened trade tensions and emerging market stress, it is the US Dollar that is driving risk appetite, and the direction of stock prices.

Indeed, the stock market has weakened whenever the year/year increase in the USD Index has reached 5% or more. If the index were to rally up to about the 96 area this week from Wednesday`s closing level of 95.06, the 5% tripwire will be triggered.


Here are the bull and bear cases.

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