Buy the dip, or sell the dead cat bounce?

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 Asset Allocation Model is an asset allocation model that 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. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can bsoe found here.

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is 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: 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 receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.

Subscribers can access the latest signal in real-time here.

Estimating downside risk

Last week, I highlighted a sell signal from the intermediate-term breadth momentum oscillator (ITBM). The 14-day RSI of ITBM had recycled from an overbought condition, which was a sell signal for the stock market. In the past, ITBM sell signals have resolved with 5-10% drawdowns and the market bottomed with the ITBM RSI fell to an oversold or near oversold condition.

The S&P 500 fell -5.8% since the sell signal and RSI is oversold. Does this indicate a short-term bottom, or is this the start of a major bear leg?

The full post can be found here.

Rethinking the Hindenburg Omen

The ominously named Hindenburg Omen was developed by Jim Miekka to spot major stock market tops. Unfortunately, it has also had a history of crying wolf too many times with false positives. Its inconsistency prompted one commentary to call it a warning to avoid traveling by blimp.

David Keller recently penned an article that analyzed the Hindenburg Omen in detail. He called it a breadth indicator with three specific components:

1. The stock market has to be in an established uptrend;
2. An expansion in both new 52-week highs and lows that indicate indecision; and
3. The market exhibits a price momentum break.

Keller further explained, "A valid Hindenburg Omen signal needs to have multiple signals within a 30-day window to actually register a valid bearish indication."

A chart of the Hindenburg Omen is shown below. The indicator is displayed in the lower panel and a valid signal has a value of 3. History shows that there were 11 such warnings in the last 10 years. Six saw declines (shown in pink). The market continued to advance or the Omen was too late in warning of declines in four instances (grey). One resolved in a sideways choppy market (grey/pink). While these results are marginally useful, this indicator's sell signals don't inspire a high level of confidence.

The Hindenburg Omen has recently flashed a series of sell signals. How should investors react?

The full post can be found here.

Painful enough for a bounce?

Mid-week market update: After this week's brutal sell-offs, the stock market is oversold enough for a bounce. The VIX Index has risen above its upper Bollinger Band, which is an oversold market condition and short-term buy signal.

If the market action in the past year is any guide, the potential for the S&P 500 is the 4720-4750 zone.

The full post can be found here.

Reversals everywhere

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 Asset Allocation Model is an asset allocation model that 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. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can bsoe found here.

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is 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: Bullish*
• Trading model: Neutral*

* 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 those email alerts is shown here.

Subscribers can access the latest signal in real-time here.

Fun with Japanese candlesticks

Last week's market action in the S&P 500 was a classic lesson in the usefulness of Japanese candlesticks. I wrote last weekend that the market was oversold and due for a rebound. The S&P 500 cooperated on Monday by exhibiting a hammer candle, in which the market tanks but rallied to a level equal to or above the open. Hammer candles are indications of capitulation selling and a possible short-term bottom, but the pattern needs to be confirmed by continued strength the next day. The bottom was confirmed Tuesday when the index advanced and regained the 50 dma.

The second candlestick lesson came on Wednesday, when the S&P 500 showed a doji, when the open and closing levels are about the same. Doji candles are signs of indecision and possible reversals but must be confirmed the next day. The S&P 500 duly weakened Thursday and stabilized Friday ahead of the long weekend. All of this is occurring as the S&P 500 forms a triangle, which suggests that a big move is just around the corner.

In short, it was a master class in trading Japanese candlestick patterns. Not all candlesticks resolve in textbook manners, but they did last week.

The full post can be found here.

Fade the value rebound

In the past week, several readers have asked whether it's too late to be buying financials, value, and other cyclical stocks. In reply, I highlighted the recent Mark Hulbert column, "Value stocks now are beating growth by 10 points, but the easy money might be behind us", namely that the value/growth reversal may not necessarily have legs.

I analyzed value’s relative strength back to 1926, courtesy of data from Dartmouth College professor Ken French. On average, a given month’s relative strength persisted for just one month. With holding periods lasting two or more months, value’s performance against growth was only randomly related to what came before...

So if you’re keeping score for these three instances in which value beat growth by as much as it has recently, there’s one case in which value relative strength continued, one in which it reversed itself, and one in which there was no trend one way or the other. Good luck extrapolating that into the future.

Here are some other reasons to fade the value rebound.

The full post can be found here.

A buy signal AND a sell signal

Mid-week market update: In my update last weekend (see Waiting for the sell signal), I observed that the S&P 500 was oversold and due for a relief rally. The market cooperated by printing a hammer candle on Monday, which is a capitulative reversal indicator, and confirmed the reversal with a bullish follow through on Tuesday by recapturing the 50-day moving average. The index finished the move today with a doji candle, which indicates possible indecision.

That was the buy signal. There was also a sell signal.

The full post can be found here.

Waiting for the sell signal

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 Asset Allocation Model is an asset allocation model that 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. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is 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: Bullish*
• Trading model: Bullish*

* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

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

Subscribers can access the latest signal in real-time here.

No sell signal yet

The S&P 500 took fright last week when the December FOMC minutes revealed a hawkish pivot and the stock market sold off. While I have become more cautious in the past few weeks, technical indicators have not flashed any intermediate-term sell signals just yet.

As an example, the NYSE McClellan Summation Index (NYSI) is only recycling from an oversold condition. In the last 20 years, few instances have resolved in a bearish manner (red vertical lines) and most have seen the market advance (black lines).

The market is increasingly vulnerable to a setback, but there is no need to become overly bearish just yet. Traders should wait for a sell signal first.

The full post can be found here.

2022 = Twenty-Twenty, Too?

As 2021 drew to a close, the broadly based Wilshire 5000 flashed a particularly long-term sell signal in the form of a negative 14-month RSI divergence. The last time this happened was in August 2018 (see Market top ahead? My inner investor turns cautious). Stock prices continued to rise for another two months before it hit an air pocket. In the past, a bearish event can take as long as a year. What does this mean for stocks in 2022?

The bond market may fare better in the coming year. The Barclays Aggregate Index unusually fell last year and it has never exhibited two consecutive years of negative returns (warning: n=3).

What does this mean for asset prices? Will 2022 be equity bearish and volatile and become Twenty-Twenty Too?

The full post can be found here.

Why I am cautious

Mid-week market update: As 2022 opens, I have become increasingly cautious about the stock market. The put/call ratio (CPC) is a bit low, indicating rising complacency. Past instances of a combination of a rapidly falling CPC and low CPC have seen the market struggle to advance. While this is not immediately bearish, it is a flag for caution.

Here are some other reasons why I am cautious.

The full post can be found here.

A "penny wise, pound foolish" application of the Trend Model

I received a number of responses to the post on the 2021 report card on my investment models. While most were complimentary, one reader asked me for a more aggressive formulation of the Trend Asset Allocation Model. 

As a reminder, the signals of the Trend Model are out-of-sample signals, but there are no portfolio returns to publish, mainly because I don't know anything about you. I know nothing about your return targets, your risk tolerance and pain thresholds, your tax situation, or even the jurisdiction you are in. If I offered an actual portfolio, it would be a formal prospectus document outlining what to expect.

Instead, the backtested returns are based on a specific formula for constructing a balanced fund portfolio based on Trend Model scores and reasonable risk assumptions of an average investor with a 60% stock/40% bond asset allocation.

• Risk-on: 80% SPY (S&P 500), 20% IEF (7-10 Treasuries)
• Neutral: 60% SPY, 40% IEF
• Risk-off: 40% SPY, 60% IEF

An advisor or portfolio manager could then change the equity allocation by 20% depending on the Trend Model score without Compliance tapping him on the shoulder.

The historical backtest of the Trend Model using this portfolio construction technique yielded excellent results. An investor using this approach could achieve equity-like returns while bearing balanced fund-like risk. Needless to say, this backtest is just a proof of concept. Every investor is different and your mileage will vary.

A reader then asked me to backtest a more aggressive approach to portfolio construction. Instead of a 60% SPY and 40% IEF benchmark, he suggested a 100% equity position, based on 60% SPY and 40% defensive equity substitute for bonds. The defensive portfolio consists of an equal-weighted portfolio of XLV (Healthcare), XLP (Consumer Staples), XLU (Utilities), and XLRE (Real Estate).

The results turned out to be a case of "penny wise, pound foolish".

The full post can be found here.

Don't overstay the party

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 Asset Allocation Model is an asset allocation model that 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. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is 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: Bullish*
• Trading model: Bullish*

* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

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

Subscribers can access the latest signal in real-time here.

Edge towards the exit

Happy New Year! I hope you are enjoying the seasonal rally, but don't get overly complacent about the party that the bulls are throwing. Sufficient warning signs are appearing that it's time to edge towards the exit.

Exhibit A is the relative performance of the top five sectors of the S&P 500. These sectors comprise over three-quarters of index weight and it would be impossible for the S&P 500 to rise or fall without the leadership of a majority of sectors. As the accompanying chart shows, none of the sectors are in a relative uptrend. The most bullish pattern is technology, which is trading sideways compared to the S&P 500.

Once the seasonal strength fades, what happens to the market?

The full post can be found here.

Don't fight the (hawkish) Fed

As the S&P 500 rises to fresh all-time highs, an important risk is lurking in the form of a more hawkish Fed. Inflation is running hot. When the Fed was officially in the transitory camp earlier this year, inflation pressures were concentrated in only a few components such as used cars. Today, price increases are broadening and even core sticky price CPI (red line) is rising strongly. As a consequence, the Fed made its hawkish pivot and signaled that it is on pace to end its QE program by March 2022, even though inflation expectations (black line) remain well-anchored.

The market is now discounting three rate hikes in 2022, with lift-off to begin in March. Here is how the Fed turned hawkish.

The full post can be found here.

Riding the seasonal bull

Mid-week market update: The Santa Claus rally, which begins just after Christmas and ends on the second day of the new year, began with a bang. The S&P 500 surged 1.4% on Monday to kick off the Santa rally and managed to make another marginal closing high today. The bullish impulse has been relentless.

Marketwatch documented a small sample study (n=8) indicating that Santa rallies that began with an advance of 1% or more tended to be strong.

The full post can be found here.

A 2021 report card

The year 2021 is nearly complete and it's time to issue a report card for my three investment models. Going in order of short to long time horizons, these are:

• The Trading Model;
• Trend Asset Allocation Model; and
• The Ultimate Market Timing Model.

All showed strong results.

The full post can be found here.

The anatomy of a Santa rally

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 Asset Allocation Model is an asset allocation model that 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. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is 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: Bullish*
• Trading model: Bullish*

* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

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

Subscribers can access the latest signal in real-time here.

Has Santa come to town?

Will the real Santa Claus rally, which begins on Monday and lasts until the second trading day of January, now begin in earnest? 

I pointed out last week (see A breakout to S&P 4920?) that the S&P 500 was potentially forming an inverse head and shoulders pattern, but head and shoulders patterns are incomplete until the neckline breaks. The market staged a marginal upside breakout through resistance on Thursday. The measured objective of the inverse H&S breakout is about 4920, but that level may be overly ambitious. If the Santa rally has truly begun, one of the tactical indicators that he has returned to the North Pole is whether the VIX Index falls below its lower Bollinger Band, which is an overbought signal to take trading profits.

Here is what else I am watching.

The full post can be found here.

Was the Grinch in the house?

Mid-week market update: I am publishing this note one day early ahead of my holiday hiatus. Regular service will return Sunday with a trading note.

In the Dr. Seuss children's story, "How the Grinch Stole Christmas", the Grinch is a grouchy character who conspired to steal all the Christmas presents from the nearby village. He later has a change of heart and returns all the gifts and participates in the villagers' Christmas celebrations. 

Was the Grinch in the house? It certainly seemed that wau. The Grinch arrived last week in the form of a market pullback accompanied by weak breadth and negative momentum, capped by Omicron shutdown fears and disappointment over delays of Biden's Build Back Better fiscal stimulus program.

Even though the Grinch has stolen the presents, we may be nearing the end of the story. The market printed a Turnaround Tuesday and the S&P 500 regained its 50 dma.

The full post can be found here.

A breakout to S&P 4920?

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 Asset Allocation Model is an asset allocation model that 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. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is 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: Bullish*
• Trading model: Bullish*

* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

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

Subscribers can access the latest signal in real-time here.

Publication schedule next week: There will be no regular strategy publiction next Saturday owing to the seasonal holidays. I will publish a tactical trading comment next Sunday.

A potential inverse H&S

A potential inverse head and shoulders pattern is forming in the S&P 500? The measured upside objective is roughly 4920. Despite the volatility from Friday's quadruple witching, the S&P 500 held support at its 50 dma.

The bulls shouldn't break out the champagne just yet. Strictly speaking, head and shoulders patterns are incomplete until the neckline breaks. If the index can stage an upside breakout above resistance, then traders can declare a risk-on tone to the market. On the other hand, if the S&P 500 were to undercut the "head" at about 4500 and invalidate the inverse head and shoulders pattern, things could get very ugly.

Here are bull and bear cases.

The full post can be found here.

A recession in 2023?

The Fed has spoken by pivoting to a more hawkish trajectory for monetary policy. The FOMC announced that it is doubling the scale of its QE taper, which puts the program on track to end in March. The December median dot-plots show that Fed officials expect three quarter-point rate hikes in 2022 and three quarter-point rate hikes in 2023.

The 10-year Treasury yield is about 1.4% today. All else being equal, the Fed's dot-plot puts monetary policy on track to invert the yield curve some time in 2023. Historically, inverted yield curves precede recessions and recessions are bull market killers.

Is the Fed on course to raise rates until the economy breaks?

The full post can be found here.

Heightened fear + FOMC meeting = ?

Mid-week market update: I don`t have very much to add beyond yesterday`s commentary (see Hawkish expectations). Ahead of the FOMC announcement as of the Tuesday night close, fear levels were elevated.

The full post can be found here.

Hawkish expectations

Ahead of tomorrow's FOMC decision, market expectations are turning bearish. Even as the S&P 500 consolidated sideways, defensive sectors are all starting to show signs of life by rallying through relative performance downtrends.

The full post can be found here.