How to trade the US election

Mid-week market update: There isn't much to say about the short-term stock market outlook, other than to acknowledge that a strong reflex rally is underway. As the markets are reacting in a highly emotional way, I have little to add other than to say that the market will be volatile. If you did jump on the buy signal issued on Monday night (see Hitting the Brexit trifecta), you might consider scaling out of your long positions as prices rise, especially as SPX rallies to test the underside of its 50 day moving average.

Brian Gilmartin pointed out that both the bond market and gold are not retracing the Brexit panic move the way stock prices are, which is a worrisome sign. I interpret these conditions as a bottoming process, where the market will bounce around in a range and re-test the lows before it can mount a sustainable rally.


Trading the US election
Now that the Brexit has been "fixed", I turn to ways of trading the US presidential election this year. The last polls show that Hillary Clinton well ahead of Donald Trump and the Iowa Electronic Markets indicates that HRC has about a 70% chance of winning.

The analysis from FiveThirtyEight show similar levels of probability:

I have a couple of suggested trades to take advantage of either Clinton or Trump winning. As Clinton is currently in the lead, I will frame these trades as a "long" Clinton trade, but if you want to be "long" Trump, then all you have to do is put on the reverse trade by shorting instead of buying.

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









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Hitting the Brexit trifecta

As I pointed out yesterday (see Brexit: LTCM or Lehman?), my Trifecta Bottom Spotting Model, which has shown an uncanny record of spotting short-term market bottoms. This model flashed an "exacta" buy signal as of Friday's close and it has now flashed a "trifecta" signal based on Monday's close.

The model is based on the following three components. An exacta signal occurs if two of the components are triggered within a week of each other and a trifecta signal occurs if all three are triggered:

1. VIX term structure is inverted: When the ratio of 1-month VIX (VIX) and 3-month VIX is above one, it indicates a high level of market fear.
2. TRIN above 2: When TRIN is over 2, it is an indication of indiscriminate forced selling by either risk managers or margin clerks - and often marks a capitulation bottom.
3. Intermediate term overbought/oversold: When the intermediate term OBOS is below 0.5, the stock market is oversold and stretched to the downside.

The chart below shows the past signals of this model in the last three years, with exacta signals in blue and trifecta signals in red.

The US equity market is setting up for a short-term face ripper of a rally very soon.

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

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Brexit: LTCM or Lehman?

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 to look for changes in 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 bullish 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. Past trading of the trading 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: 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 any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


What now?
In the wake of the Brexit referendum surprise, I sensed that a lot of investment professionals were in shock and didn't know how to react to the market turmoil. I have found that having the proper analytical framework focuses the mind. I found one tweet by the FT`s Gillian Tett particularly useful for investors.

That's the critical question: Does Brexit represent a Lehman moment or LTCM moment for investors? In the former case, investors should de-risk portfolios and sell equities down to a minimum weighting in order to avoid severe losses. In the latter, investors have been handed a golden opportunity to buy stocks, Blink and the correction will be gone.

For traders, it's entirely a different story, which I will also address in this post.

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








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Brexit fallout watch

Well, my Bremain call didn't go so well (see Positioning for a Bremain result). As I write this, the BBC has called the referendum in favor of Leave by a margin of 52-48. GBPUSD is down about 10% and Asian stock markets are down 2-4%.

If you were correctly positioned for this outcome, congratulations, but don`t get overly excited about doing a victory lap as there is going to be market volatility ahead. During these episodes of unexpected market shocks, here is what I am watching for:

• Technical: Watch for logical areas of technical support
• Sentiment: Signs of panic and oversold reading that signal a bottom
• Macro: Either official intervention or policy responses that could rip a short`s face off

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

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Positioning for a Bremain result

Mid-week market update: Even though the polls show the two sides running neck and neck, my inner trader is positioning for a Remain result in the UK referendum for the following reasons.

• Polling internals indicate momentum towards Remain;
• Bookmaker odds overwhelmingly favor Remain over Leave; and
• Market anxiety is rising - so a "buy the rumor, sell the news" position is not warranted.

This is obviously a speculative trade and much could go wrong. The pollsters totally missed the results of the last UK election. In addition, severe weather in southeast England could affect turnout and therefore skew results.

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

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The Brexit Pandora's Box

For my (mainly) American friends, file this under "why you don't understand Europe":

The Vietnam War was a war that scarred the national psyche and dramatically changed the tone of American foreign policy for a generation. If you visit the Vietnam Memorial in Washington DC today, you will find roughly 58,000 names of fallen soldiers from that period. Now imagine if instead of losing 58,000 soldiers, the United States lost 2.5 million during the Vietnam War. For a country like the US of roughly 300 million people, that kind of casualty rate would mean that virtually every household in America would be touched by combat death, whether it's a father, son, brother, uncle, friend or neighbor. Then 25-30 years later, which is roughly the span between the Vietnam War and 9/11, the country got involved in another conflict with a similar death toll.

Imagine the resulting national trauma.

That's what happened to many European countries in the First and Second World Wars - and the losses quoted would be roughly what the equivalent losses are for the US on an equivalent per capita basis on par with many European countries.

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







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How the S&P 500 can get to 2200 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 to look for changes in 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 bullish 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. Past trading of the trading 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: 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 any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


Where's the growth?
My last post (see Why you need to give the bull case a chance) elicited a considerable amount of comment. Most of the pushback I got on the equity bull case amounted to a question of, "Where's the growth coming from?"

I recognize the concerns. As this chart from Factset shows, the equity market has had to endure five consecutive quarters of falling year-over-year EPS growth. How can anyone possibly be bullish under such circumstances?

In this post, I would like to explain my bull case for stocks, with an initial SPX target of 2200 and, depending on the Fed's reaction function, up to 2400-2500.

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








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Why you need to give the bull case a chance

Maybe it's me, or my imagination? Even before the latest round of market weakness, most of the feedback and sentiment on my social media feed has tended to bear bearish. I saw a fair number of calls for SPX to eventually test its February lows at about 1820, but I haven't seen a lot of forecasts for breakouts to new highs. The recent year-end projection by respected former Value Line research director Sam Eisenstadt of 2220 only represents only modest upside from current levels, but I don't see a lot of enthusiasm for that call.

The WSJ recently call this The Most Pessimistic Bull Market in History, as investors have only embraced it in the most reluctant way:

Instead of chasing growth and profits, investors this year have bought into safety—in a big way. Only two of the 10 top-level sectors which make up the market have reached new highs this year, and they are the antithesis of exuberance: utilities and consumer staples.

This may be merely a failure of imagination. As in 2007, the bubble pushing up the market may be elsewhere. Back then, valuations weren’t outrageous, but excess in credit created unsustainable profits. This time the most obvious froth is in the government-bond markets. German 10-year bunds on Friday yielded a mere €270 a year on a €1 million investment ($1.1 million), enough to fuel your BMW 7-Series a couple of times with enough left over for a currywurst and a beer. Japan’s yields are negative for bonds maturing out to early 2031, while U.S. 10-year Treasurys on Monday closed at a new 52-week low.

Josh Brown also pointed out that stock market investors have become chicken-bulls (my term, not his), as the two most popular ETFs for equity flows have been low-volatility funds, USMV and SPLV:

The popularity of these two ETFs is perfectly emblematic of the mood these days among financial advisors and their clients. And if you know anyone in the ETF business, they’ll tell you that the principal determiners of flows are in this order: 1) recent performance 2) whether or not advisors have been sold on them and 3) recent performance. ETFs do not sell themselves and retail do-it-yourselfers are not the drivers of AUM flows – only advisors can really move the ETF needle. The iShares product probably has an edge on SPLV because it’s based on an MSCI index, which is what many advisors use as a benchmark in their performance reporting.

That's where the "chicken-bull" part comes in:

A collective financial advisor decision was made in the aftermath of August – “Okay, we’ll stay in, but we can’t take the full volatility of the stock market anymore.”

You can only imagine the calls that were coming in – “Is this it? Here we go again!”

To which the advisors’ response was something along the lines of “Don’t worry, I have an idea…” The iShares and PowerShares wholesalers did their work well.

Seeing this fund grow to $12.5 billion, having taken in a third of that in the first four months of this year, tells you everything you need to know about current sentiment. Advisors are tacitly accepting that they must be in US stocks, but because of the angst of their clients, they’re offering them exposure through a vehicle that purports to offer “minimum” volatility.

That's not the sort of investor behavior and psychology that happens at market tops. While a bull case where the SPX rises to 2400-2500 is my base case scenario, it is well within my range of possibilities. Until the investing public starts to get wildly enthusiastic about a 2400-2500 SPX target, it's hard to see how this market tops out - and I will measure the success of this post by the amount of hate mail I get.

Let me make two cases for a 2400-2500 bull market. One is fundamental, the other is technical.

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







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The VIX tail wagging the SPX dog

Mid-week market update: What's going on with the VIX Index? The VIX, which measures implied option volatility and a useful measure of "fear", spiked dramatically on Monday. While SPX did fall, the magnitude of the decline didn't match past VIX spikes. It prompted this tweet from Ryan Detrick:

Rob Hanna at Quantifiable Edges also observed that the combination of a VIX spike of this magnitude is unmatched by the shallowness of the fall in stock prices.

As you can see from the chart below, the VIX Index spent the second day above its Bollinger Band (BB), which has marked regions of limited downside risk in the past. On the other hand, the bottom panel shows the 10-day rate of change of the VIX Index, and such events have often foreshadowed further SPX weakness (see vertical lines).

What's going on? My analysis suggests that we are seeing the case of the VIX tail wagging the SPX dog.

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






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Buy the dip!

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 to look for changes in 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 bullish 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. Past trading of the trading 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: 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 any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


Here comes the June swoon
The market seem to be following the script that I laid out last week (see Get ready for a market of maximum frustration). I wrote that I remained bullish into year-end, but the short-term outlook was corrective. From a very short-term trading perspective, however, the tendency for the market to rise in the face of bad news like the Jobs Report, indicated that stocks needed to move higher before correcting.

The market did climb the proverbial Wall of Worry until mid-week before weakening (see my mid-week comment Adventures in Option-Land). As the market ground higher last week, I could see the bears starting to capitulate and sentiment gauges becoming more bullish, the major indices topped on on Wednesday. The market narrative then changed to focus on the deteriorating macro outlook. Indeed, the Citigroup Economic Surprise Index, which measures whether macro data is beating or missing consensus estimates (gold line in chart), is turning down again.

It's time for stocks to pay the macro piper. However, these indications of weakness are temporary. Once the growth fears clear, stock prices should recover and push to new highs later this year.

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





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What I learned about Fed policy this week

Rather than indulge in instant analysis, I wanted to give myself a few days to reflect on Janet Yellen's speech on Monday (see full transcript). In doing so, I learned a number of things about Fed policy that I didn't know before:

• How much does the Fed want to raise before it considers rates to be "normalized"
• What it means to allow the economy to run a little "hot" because of slack in the labor markets
• What the hurdles are to next raise rates
• From Ben Bernanke: The debate over how to implement the Phillips Curve in monetary policy

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












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Adventures in Option-Land

Mid-week market update: I like to monitor the option market from a sentiment modeling perspective because, unlike surveys which can swing all over the place, the option market is a forum where people are putting real money on the line.

Even as the stock market has been slowly grinding upwards, the option market has been showing signs of skepticism. As the chart below indicates:

• The market is overbought on RSI-5 and nearing an overbought condition on RSI-14, but...
• The VIX Index, aka the Fear Index, has been rising for the last few days; and
• The VIX term structure has also been indicating higher fear levels in the same time frame.

At the same time, standard measures of overbought/oversold and sentiment models, such as the CNN Money Fear and Greed Index, is showing a high level of greed, which is contrarian bearish.

What's going on? Is this just a sign that the stock market is climbing the proverbial Wall of Worry?

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

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Technical analysis meets macro

I present for your consideration the following mystery chart. Would you rate this as a "buy", "hold" or "sell"? Your answer will tell you something about your global macro-economic outlook and the likelihood of an equity bear market in the near future.

See below...



























Any of the recessionistas who ranked the above chart "buy" might want to read this post carefully, including everyone who jumped on the JP Morgan rising recession risk bandwagon and David Rosenberg's abrupt bearish turn.

The full post is available at our new site here.








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Get ready for a market of maximum frustration

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 to look for changes in 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 bullish 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. Past trading of the trading 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: 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 any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


A June swoon before SPX 2400?
Well, that Jobs Report certainly changed the tone of the market! The massive disappointment of Friday's Employment Report, combined with other weak macro data such as ISM services, is setting up for a choppy market of maximum frustration. I am seeing cross-currents that could be treacherous for both bulls and bears. Here is my market outlook for differing horizons:

• Medium term (6-12 month time horizon) bullish: The disappointing Employment Report gave the FOMC doves to stay cautious and push out its schedule of interest rate normalization. When combined with a picture of a steadily growing US economy, it gives room for the SPX to reach the 2400-2500 area late this year before the market tops out for this cycle (see my previous posts How the SP 500 could get to 2400 this year and The roadmap to a market top).
• Short term (1-2 months) bearish: On the other hand, the massive Non-Farm Payroll (NFP) miss, along with weakness in forward EPS, is setting up for a growth scare that is likely to spook the markets.
• Trading (1 day to 1 week) bullish: The inability for equity prices to fall in the face of bad news suggests that the bears are exhausted. It therefore sets up the market for a rip-your-face-off rally should there be any sign of positive news.

The stage is set, pick your poison. Be careful - even a slight timing mistake could turn a trading profit into a loss.

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

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Should China emulate America? Or the other way around?

For your weekend contemplation: This post isn't about how the American and Chinese economies may converge, but about the potential development path of capital markets and regulatory regimes. CNBC recently reported that Charles Schwab and the Shanghai Advanced Institute of Finance conducted a survey of Chinese stock investors and found out the reason the Chinese all appeared to be punters and gamblers. First and foremost, they didn't start that way and only a small minority were in it for a quick profit:

Having surveyed 450 investors, only 13 percent invest for short-term purposes, such as turning a quick profit or generating enough cash to make a major purchase, while 87 percent invest as a means to improve their standard of living, retire or their children's education, the study found.

But the Chinese market is not very mature and the investor base isn't very sophisticated:

The lack of a mature bond market, long-term products on the market and professional financial advisors were major challenges, the authors explained.

"While the incomes and expectations of China's emerging affluent have risen, China's financial services sector has not kept pace...Unlike upper-middle class investors abroad, most Chinese investors chart their financial futures without assistance from financial service professionals," the authors said.

As a result, Chinese often don't understand the content of their investments and the risks they carry, the study noted, pointing to WMPs as an example. Detailed information isn't always provided to customers and this lack of transparency is intentional since most WMPs are concentrated in China's increasingly troubled industrial sector, the study said.

The combination of the lack of a professional institutional investor base (think Singapore's sovereign wealth fund) and the lack of hard information about the markets, individual investors adopt behavior that looks like gambling.

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






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5 technical reasons to be bullish on stocks

Mid-week market update: As the US equity market consolidates its gains near resistance and all-time highs, I remain constructive on stock prices for the following five reasons:

• Momentum is positive
• Breadth is positive
• Bullish support from overseas markets
• Greed is fading, which is supportive of further gains
• Overbought conditions are fading (ditto)

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





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