Trend Model signal: Risk-on
Direction of last change: Negative (Trading Downgrade)
(Please scroll to the bottom of this post to see how you can get a free subscription to Trend Model updates.)
A downgrade in Trend Model signal strength
Late Friday, CNBC reported that Goldman Sachs downgraded equities to "neutral" over fears of a possible sell-off in the bond market:
Goldman Sachs downgraded equities to "neutral" over the next three months on Friday afternoon, citing the risk of a temporary sell-off in stocks following a sell-off in bonds.My Trend Model also detected a number of signals of global weakness, though the reasoning behind my downgrade were different from Goldman's. Even though the absolute level of the signal remains "risk-on", the weaknesses led to a directional change which amounted to a trading downgrade. As the chart below of real-time (not back-tested) past trading upgrades and downgrades show, they have had a reasonable track of signaling short-term stock market movements.
The firm said the near-term risk/reward profile for stocks was less attractive, even as it reiterated a "strong conviction" that stocks were the best-positioned class over the next year.
Trend Model Trading Upgrades and Downgrades
As the frequency of the signals in the above chart clearly shows, this is a trading signal. The intermediate term outlook remains risk-on. This is most likely an indicator of minor stock market weakness. Long-term investors who are not hyper-focused on every little squiggle in market prices should not panic and sell everything. The long-term outlook remains bullish and there is no bear market in sight (see The "good" stock market mania).
A global growth scare?
The Trend Model is a composite model based on trend-following principles as applied to global equity and commodity prices. The picture that I am seeing is that markets are starting to price in a possible global growth slowdown, which is starting to raise concerns.
I view commodity prices as a key real-time indicator of the Chinese economy. Despite the better PMI releases coming out of China last week, commodity prices are weakening. The chart below of the CRB Index shows that commodity prices violated its 50 day moving average (dma) in early July and they are showing a general topping pattern. Longer term, however, the trend remains positive as the CRB Index is holding up above its 200 dma.
As another confirmation of incipient weakness in China, the price of Chinese iron ore, another key industrial commodity, is slipping:
Another area of concern are European stocks. The chart below of the Euro STOXX 50 shows a similar pattern of violating its 50 dma. While this eurozone zone index remains above its 200 dma, the geopolticial good news that pro-Russian rebels handed over the MH17 black boxes to investigative authorities failed to propel the rally above the key 50 dma line.
The UK`s FTSE 100 fared better than the Euro STOXX 50. It is disappointing, however, that the FTSE 100 did the zigzag around the 50 dma but closed the week just below that key trend indicator.
Indeed, analysis from Jens Nordvig of Nomura indicates that money is coming out of European equities, which would account for their recent weakness.
US stocks have been one of the strongest of the major global equity markets. However, as SPX moved to new all-time highs last week, it is experiencing a minor divergence against the SP 1500 Advance-Decline line:
Taken in isolation, each of these warnings are not very important. When compiled into a mosaic picture, however, all these little warnings are raising concerns about flagging global growth. Indeed, the IMF downgraded the global growth outlook last week on the basis of slowing US and Chinese growth.
Despite the relatively robust results from the US 2Q earnings season so far, results from key capital goods companies like Caterpillar are worrisome (also see CapEx: Still waiting for Godot) as signs of a CapEx rebound are still MIA. CAT reported better than expected EPS but missed on the key revenue metric and went on to guide revenue expectations lower. As well, Gerald Minack recently showed that corporate debt loads are rising, but the extra debt is primarily dividend payouts and share buybacks instead of capital expenditures.
A possible credit induced sell-off?
In addition, I pointed to the negative divergence in US junk bonds last week (see Returning to high school, investment style). Analysts have raised concerns that a sell-off in low liquidity vehicles such as the corporate bond market could spark a stampede out the exit in what amounts to a crowded theatre.
However, Peter Tchir of Brean Capital recently postulated that credit markets are bubbly and nearing the end of the fear-greed cycle, but greed could have a bit more to run:
When I put it all together, risks are rising and a Trend Model downgrade is warranted. Nevertheless, the intermediate term trend for US stocks is still up so it's not time to panic. If recent history is any guide, any pullback is likely to be less than 5%.
My inner investor therefore remains overweight US equities. He is not taking any action but he is keeping an eye on how the situation is developing as he doesn't want to react to every little twist and turn of the market. My inner trader, on the other hand, has sold out of his long equity position and he has taken short positions in stocks.
How to subscribe to Trend Model updates
To subscribe to my posts, which include Trend Model updates, click on one of these links on the sidebar or follow me via Twitter:
Disclosure: Long SPXU, TZA.