Sunday, July 1, 2018

A looming global recession, or a buying opportunity?

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. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

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 mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.

Non-US weakness = ?
The markets have taken a risk-off tone recently, which raises the perception of a global slowdown. The protectionist measures announced by the Trump administration have not helped matters, and it appears the global economy is becoming increasingly fragile.

Three weeks ago, I asked if global markets could rise if it depended on purely US leadership (see Can America still lead the world?). Since then, US stocks have staged an upside relative breakout against the MSCI All-Country World Index (ACWI). The performance of non-US equities in both the developed countries (EAFE) and emerging market countries (EM) appear challenging.

The following chart from Topdown Charts shows that global breadth is deteriorating. The number of countries whose stock indices are above their 200 day moving averages (dma) has plunged precipitously.

These readings either represent a terrific buying opportunity, or an ominous signal of an impending global recession. The bear case is supported by the deterioration in global economic surprise indices (ESI), which measure whether economic releases are beating or missing expectations. As the following chart shows, global ESIs have been falling. Moreover, the bottom panel shows that the percentage of countries with ESI greater than 0, indicating a balance between positive and negative surprises, are at recessionary lows.

The probability of a global recession is rising rapidly, according to Ned Davis Research.

Is this the beginning of the end? Is the world about to crash into a global slowdown? To answer those questions, I consider the outlook for the three major trading blocs, the US, China, and Europe. During the course of my analysis, I discovered a bullish catalyst hiding in plain sight.

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

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