Sunday, July 31, 2016

Get ready for the melt-up

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 bearish 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: 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 brighter tomorrow
No, the "brighter tomorrow" of the title does not refer to the better future promised by American politicians during this election season, but the brighter future for equity prices over the next 6-12 months. It appears that the market bubble scenario that I outlined a few weeks ago is well on its way to becoming a reality (see How to get in on the ground floor of a market bubble). The following factors are combining to create an environment that could see the market melt-up:
  • Positioning: Investors have been caught leaning the wrong way. They are just starting to play catch-up, but sentiment remains overly skeptical.
  • Growth surprise: A US recovery has caught most people off-guard (though I in the minority when I was bullish during the market panic in January, see Buy! Blood is in the streets!).
  • Central bank accommodation: The Federal Reserve has been ultra-cautious in its policy of interest rate normalization, which is an enabling factor for equity price gains.
While I am starting to have concerns about equities on valuation grounds, the market is likely undergoing a blow-off phase where if participants hold their noses and buy, they could enjoy some truly bubbly profits.

The full post can be found here.

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