Sunday, October 15, 2017

Market melt-up and crash?

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: Bullish*
  • 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.

The challenges of a late cycle bull
I have been making the point that the American economy is in the late stages of an expansion. This presents some investment challenges as an inflection point may be near. As the chart below shows, while every equity downdraft has not signaled a recession, every recession has seen an equity bear.

The question is, "How far away are we from a recession?" I try to answer that question this week by focusing on three components of the economy using the leading indicators in my Recession Watch Monitor:
  • The household sector;
  • The corporate sector; and
  • Monetary conditions.
Further, I analyze the nowcast of the economy and the market outlook from both macro and technical viewpoints. The market may be setting for a scenario where stock prices melt-up, followed by a market crash of unknown magnitude.

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

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