Sunday, August 6, 2017

Will overheating spoil the market rally?

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

A late cycle market
Bloomberg recently published an article, Why a little economic overheating won't spoil the market rally, that featured the views of Nomura strategist Kevin Gaynor:
The “Goldilocks” rally still has juice.

That perfect environment to sustain broad market gains -- when global growth is fast enough to lift corporate profits, but tame enough to keep inflation muted -- should be in effect for at least another 12 months, according to Kevin Gaynor, the head of international economics at Nomura Holdings Inc.

As the business cycle reaches its climax, European stocks, high-yield bonds and emerging-market credit have the potential to catch up with valuations notched in the halcyon days before the 2008 financial crisis, he said.

“We could get a more extended market rally,” Gaynor said in an interview. “When labor markets are tight and economic growth operates above trend, you see corporate profitability dropping, and that’s one reason to get bearish. For now, we aren’t seeing that type of margin pressure.”
I agree 100%. The nowcast shows that initial jobless claims, which has shown a remarkable inverse correlation with stock prices, is pointing to a robust economy.

For investors and traders, the trick is to spot the turning point. Here are the bull and bear cases for stock prices.

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

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