Sunday, October 7, 2018

A recession in 2020?

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.

The 2020 recession consensus call
In the past few months, there has been a cacophony of voices calling for a recession or significant slowdown in 2020, such as Ben Bernanke (via Bloomberg), and Ray Dalio (via Business Insider). Bloomberg reported that two-thirds of business economists expect a recession by the end of 2020.

To be sure, the American economy is exhibiting behavior consistent with a late cycle expansion. Estimates of the output gap show that both the US and developed economies are running at, or above capacity, which are usually signs that a recession is just around the corner.

How close is the American economy to a recession? I answer that question using the long-leading indicator methodology outlined by New Deal democrat (NDD) in 2015. These indicators are designed to spot a recession about a year in advance, and they are broadly categorized into three groups (my words, not his):
  • The consumer or household sector
  • The corporate sector
  • Monetary conditions
I would add the disclaimer that while the analytical framework comes from NDD, the interpretation of the output is entirely mine.

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

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