Thursday, March 24, 2011

Back to the asset inflation trade

A week after the Inflation Deflation Timer Model moved from an "inflation" to a "neutral" reading, largely because commodity prices have rallied sufficiently for the model to return to an "inflation" reading.

As a reminder, the Timer Model relies on commodity prices as a barometer of global growth and asset inflationary expectations. Mark Thomas posted this chart at Economist's View that confirms our hypothesis.

These trend-following models have the unfortunate problem of occasional signals that whipsaw. Nevertheless, I must therefore respect the discipline of a well-defined investment process and re-orient the model portfolio to inflation hedge and growth vehicles, such as resource and emerging markets stocks.

Could this signal be a fake-out?
Deep down, I have some misgivings that this signal is a fake-out and a return to the risk trade is a just a product of reflex rally from a deeply oversold condition. The confirming indicators that generated the "neutral" reading last week remain in a neutral condition (see my previous comment here). Simply put, I believe that too much technical damage has been done for the markets to roar back to new highs.

As an example, the price of Dr. Copper has broke down from an uptrend and appears to actually be in a downtrend.

Similarly, the ratio of US Consumer Discretionary to Consumer Staple stocks as a measure of risk aversion also indicates that the relative uptrend remains broken.

Despite my personal reservations, I have found that the Timer Model's signals have in the past been better than my own opinion. Therefore I have opted to rely on the discipline of Timer Model instead. Were any additional risks were to arise, the risk control parameters of the model also allow me to define and limit portfolio risk.

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