Sunday, September 2, 2018

The macro risks that keep me awake at night

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 hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

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.

What keeps me up at night
Last week, I outlined the technical reasons for my cautious investment outlook (see 10 or more technical reasons to be cautious on stocks), and I promised that I would write about the macro and fundamental headwinds facing the economy and the stock market. These concerns fall into three main categories:
  • The Fed's monetary policy;
  • Trade policy; and
  • Policy fallout from the midterm elections.
The combination of these factors have the potential to really tank economic growth. The latest Fathom Consulting forecast shows recession risk is rising dramatically.

Equally important is the analysis of New Deal democrat, who monitors economic statistics by splitting them into coincident, short leading, and long leading indicators. NDD reported that his set of long leading indicators have turned negative for the second time in three weeks. While he allowed that the data can be noisy, he is not sounding the recession alarm just yet.
[I]n the last month three of the long leading indicators have deteriorated enough to change from positive to neutral or neutral to negative, and a fourth is less than 0.1% away. The sole remaining positives are the Chicago Fed Adjusted Financial Conditions Index and Leverage subindex, and real estate loans. Corporate bonds remain neutral. Several weeks ago they were joined by the yield curve. Treasuries, refinance applications, mortgage rates, and real M2 all remain negative, plus purchase mortgage applications for the third week in a row, and joined for the first time this week by real M1...

I will require two events before this translates into a "recession watch" for over 12 months later: (1) The weekly reports must remain negative consistently for at least one full month, and (2) they must be reflected in a reliable monthly measure where available.
The full post can be found at our new site here.

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