Sunday, June 4, 2017

Thrust and bust, or lower for longer?

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 the 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 the 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 mid-week observations at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.

A Fed pause ahead?
So far, my base case for the American economy and stock market has been a "thrust and bust" scenario, where the economy continues to grow and overheats, which is then followed by a Fed induced bust. However, the combination of softer macro-economic data, as exemplified by the falling Citigroup Economic Surprise Index...

And an undershoot in inflation expectations has caused the market to re-assess the probability of the "thrust and bust" scenario. In particular, the decline in inflationary expectations has been global in scope, though the US (red line) has stabilized.

Friday's release of the May Jobs Report is a typical example of the weak macro theme. Not only did headline employment miss expectations, employment for previous months was revised downwards. Even though a June rate hike is more or less baked in, the big question is whether the Fed is likely to pause its rate normalization policy in light of disappointing inflation and growth statistics.

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

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