Sunday, July 8, 2018

Trade War Apocalypse, or Sell the rumor, Buy the news?

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.

Bull or Bear?
The first real shots in the Sino-American Trade War were fired last week when the US imposed a series of tariffs on $34b of Chinese goods at 12:01 ET on July 6, 2018, and the Chinese retaliated with tariffs of their own. For investors, the current environment presents a dilemma.

On one hand, the prospect of a protectionist curtain descending around the world is bearish for growth, and for equity prices. On the other hand, the near-term outlook for economic growth and earnings are bright. In the absence of trade tensions, US stock prices should be breaking out to new highs.

The conundrum can be illustrated by the readings of the Fear and Greed Index, which is stuck in neutral and showing no signs of momentum nor direction. Is a Trade War Apocalypse just around the corner, which will collapse the index to new lows; or is this a case of sell the rumor, and buy the news? Arguably, the market's rangebound behavior in 2018 is attributable to the earnings growth vs. trade jitters dilemma.

We examine the bull and bear cases.

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

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