Sunday, April 17, 2016

My roadmap for 2016 and beyond

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 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 seeks to answer the question, "Is the trend getting better (bullish) or worse (bearish)?" 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 this 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: Risk-on*
  • 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 any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.

A roadmap, not a forecast
There has been a number of new subscribers who have come onto the site and I thought that it would be useful for me to review my outlook for the remainder of 2016 and into early 2017. I would characterize it as a roadmap, rather than a forecast, as there are far too many moving parts for this to be an actual forecast.

My base case scenario calls for the US equity market to form a cyclical top in 2016. The market is likely to rise and make marginal new highs this year, led by late cycle sectors such as capital goods and resource extraction. As inflationary pressures become evident, the Fed will respond with a series of rate hikes, which have the potential to push the American economy into recession. With European growth still fragile and Chinese growth decelerating and beset by a debt overhang, such Fed actions could drag there rest of the world into recession as well. Risky assets such as stocks would not behave well in such an environment and a major downleg in stock prices is well within the realm of possibility.

An analysis based on the Morningstar median stock fair value estimate, which shows the market to be trading at about fair value, is consistent with my roadmap. On one hand, the lack of gross under-valuation is unlikely to see stock prices rally significantly for the rest of this year. On the other hand, past history has shown that the market has been able to advance even under adverse conditions of over-valuation. Therefore a scenario of modest market gains, followed by a loss of macro momentum from changes in Fed policy, is well within the realm of possibility.

Let me expand on those points.

The full post is available at our new site here.

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