Something for everyone

Mid-week market update: The Presidential Debate last night was painful to watch. After the debate, different broadcasters conducted instant polls of who won the debate. The CNN poll showed that 60% believed that Biden had won, and 29% thought that Trump had won. The Fox poll showed that 60% thought Trump had won, and 39% thought Biden had won.

Lol! There was something for everyone.

In reality, the debate probably didn't change many minds, and the market's perception of electoral risk was also largely unchanged. My own survey of SPY's at-the-money option implied volatility shows that while implied volatility had fallen, the shape of the curve is unchanged. The early November election spike is still there, and risk remains elevated until mid-December.

For equity traders focused on market direction, there is also something for both bulls and bears.

The full post can be found here.

Fun with CoT data

There was some excitement last week when SentimenTrader wrote about the massive aggregate short by large speculators and CTA trend followers in equity futures. Conventional contrarian analysis would be bearish, but this is a lesson for traders and investors to look beneath the surface before jumping to conclusions.

The full post can be found here.

Time to de-risk

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 Asset Allocation 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 a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). 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: Sell 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.

Subscribers can access the latest signal in real-time here.


Time to be cautious

This is an out-of-sample application of my Asset Allocation Trend Model signals to a model portfolio. If the Trend Model is bullish, the model portfolio will take a 80% position in SPY (stocks) and 20% position in IEF (bonds), neutral at 60% SPY and 40% IEF, and bearish at 40% SPY and 60% IEF. As the chart shows, the model portfolio has been able to achieve equity-like returns over the test period with balance fund-like risk.

The Trend Model's signal was upgraded to neutral from bearish on May 15, 2020 and it has remained in neutral ever since. Recent developments have caused it to turn more cautious. Here is why.

The full post can be found here.

How to spot the next market bottom

RealMoney columnist Helene Meisler asked rhetorically in an article where her readers thought we are in the equity sentiment cycle. She concluded that the market is in the "subtle warning" phase, though she would allow that the "overt warning" phase was also possible.

I agree. This retreat is acting like the start of a major pullback. The S&P 500 recently violated its 50 day moving average (dma). Past major pullbacks that began with 50 dma breaks were marked by the percent of S&P 500 bullish on point and figure charts plunging below 50%. To be sure, this does not assure us of a significant downturn, though it represents a sufficient though not necessary condition for one.

Two weeks ago, I discussed the magnitude of market weakness (see How far can the market fall?), with the caveat that those were not targets, but estimates of downside potential. This week, I outline some techniques on how to spot a market bottom.

The full post can be found here.

The tone is still risk-off

Mid-week market update: I have some good news and bad news. The good news is the performance of the NASDAQ 100,  the market leadership, has stabilized. The relative performance of the NASDAQ 100 against the S&P 500 successfully tested a rising relative trend line, and the relative uptrend is still intact.

The bad news is the NDX rally failed at the 50 day moving average, and the rest of the market is maintaining a risk-off tone.

The full post can be found here.

Election jitters are rising

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 Asset Allocation 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 a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). 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: Sell 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.

Subscribers can access the latest signal in real-time here.


More election volatility

While I am not a volatility trader, my recent calls on the evolution of volatility have been on the mark. Three weeks ago, I raised the possibility of a volatility storm (see Volmageddon, or market melt-up?) owing to rising election jitters. I concluded "I would estimate a two-thirds probability of a correction, and one-third probability of a melt-up, but I am keeping an open mind as to the ultimate outcome". Two weeks ago, I turned more definitive about rising volatility and called for a volatility storm (see Brace for the volatility storm).

The rising election induced volatility theme has become increasingly mainstream in the financial press. Bloomberg highlighted that the one and three month spread in the MOVE Index, which measures bond market volatility, is spiking.

Marketwatch also reported that analysis from BNP Paribas shows that the implied equity market volatility over the election window is sky high compared to past realized returns of election results. 

In addition, all these option readings were taken before the news about the death of Supreme Court Justice Ruth Bader Ginsburg. Should the election results be contested and wind up in the Supreme Court, the odds of a 4-4 deadlocked decision just rose with Ginburg's death, in which case the lower court's decision would stand. This raises the odds of judicial and constitutional chaos. Imagine different states with wildly inconsistent decisions on balloting. The Supreme Court nomination fight also raises the political resolve of both sides in Congress. Don't expect any stimulus bill before the election, and even a Continuing Resolution to fund the federal government beyond September 30 is in jeopardy. Watch for implied volatility to rise in the coming week.

It seems that the bears have taken control of the tape, based on a combination of election uncertainty and a reversal of excessive bullish retail positioning on Big Tech stocks.

The full post can be found here.

A healthy rotation into cyclical stocks?

There is growing evidence that the stock market is undergoing a rotation from large cap technology to cyclical and reflation stocks. Exhibit A is the market action of the tech heavy NASDAQ 100, which violated a key rising channel and also violated its 50 day moving average (dma). By contrast, the broader S&P 500 is testing its 50 dma and only exhibited a minor break.

Even as the S&P 500 and NASDAQ 100 struggled, Material stocks have been making new all-time highs, and its performance against the S&P 500 has decisively turned up.

The full post can be found here.

Time to sound the all-clear?

Mid-week market update: Is time to sound the all-clear? The market staged a relief rally after last week's weakness. Is the stock market ready to resume its uptrend?

A rally to new highs from these levels is unlikely. Last week's pullback inflicted significant technical damage that, at a minimum, a period of sideways consolidation and base building will be necessary before the bulls can take control of the tape again. The S&P 500 violated a rising trend line that stretched back to April. As well, the 8 day moving average (dma) fell through the 21 dma, which is a bearish crossover. Repairing the damage will take time.

The full post can be found here.

Some questions for the Fed

As the FOMC conducts its two-day meeting after its big reveal of its shift in monetary policy, Fed watcher Tim Duy thinks that we won't get much more in the way of details from the Fed after this meeting:

The odds favor the Fed maintains the status quo at this week’s meeting. It does not appear to have a consensus on enhancing forward guidance nor do I suspect FOMC participants feel pressure to force a consensus on that topic just yet. The general improvement in the data likely removes that pressure. The Fed will likely remain content to use the new strategy as justification for maintaining the current near zero rate path. Powell will continue to lean heavily on downside risks to the economy to entrench expectations that the Fed will stick to that path. The dovish risk this week is that the Fed does surprise with either more specific guidance or an alteration of the asset purchase program to favor longer term bonds. I don’t see a lot of risk for a hawkish outcome unless it was something unintentional in the press conference.

As the Citi Inflation Surprise Index edges up for the US, but remain muted for the other major regions, I have some important questions about the Fed's new "average inflation target" policy.

The full post can be found here.

The bears take control, but for how long?

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 Asset Allocation 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 a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). 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: Sell 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.

Subscribers can access the latest signal in real-time here.


A sentiment buy signal?

As last week's market action demonstrated, the bulls just can't seem to catch a break. Even though the market was short-term oversold, rally attempts have been rather anemic. More worrisome is the behavior of the NASDAQ 100 (NDX), which had been the market leadership. The NDX convincingly breached a rising channel, and it is now testing its 50 day moving average (dma). While its relative uptrend against the S&P 500 remains intact, the relative performance of semiconductor stocks, which had also been a source of technology related market strength, also violated a rising trend line.

One bullish ray of hope came from Mark Hulbert, who pointed out that newsletter writer sentiment had plunged precipitously, which is contrarian bullish.

Consider the average recommended equity exposure level among a subset of short-term stock-market timers that I monitor on a daily basis. (This is what’s measured by my Hulbert Stock Newsletter Sentiment Index, or HSNSI.) This average currently stands at 30.1%, which means that the average timer now has 70% of his equity trading portfolio out of the market.

Just three weeks, ago, in contrast, the HSNSI stood at 65.9%. As you can see from the chart below, the HSNSI’s recent plunge rivals what happened during the February-March waterfall decline. That’s amazing, since the market’s early September sell-off — scary as it was — is child’s play by comparison. In contrast to a 34% plunge in the earlier downturn, the S&P 500 SPX, +0.05% from Sep. 2 to Sep. 8 lost less than 7%.

Hulbert concluded, "So long as the market timers on balance remain lukewarm about the stock market, sentiment for the next few weeks favors higher prices."

Could this be the reprieve that the bullish traders need?

The full post can be found here.

How far can the market fall?

Macro Charts recently observed that S&P 500 DSI is turning down from an overbought extreme. Historically, that has led to either sharp corrections or a prolonged period of choppiness.

In light of these conditions, I have been asked about downside equity risk. Is this the start of a significant downdraft? How far can stocks fall from current levels?

I answer these question in the context of secular leadership change. The Big Three market leadership themes in the latest bull cycle has been US over global stocks, large cap growth over value, and large caps over small caps. Transitions from bull to bear phase act to cleanse the excesses of the previous cycle. Until we see definitive signs of leadership changes, it may be too early to call a market top just yet.

From that perspective, we can see that the relative performance of US against global stocks is consolidating sideways after an uptrend; growth beating value, but pulling back; and small caps still lagging large caps after a brief episode of better relative performance.

The full post can be found here.

The story of two trend breaks

Mid-week market update: While it may seem like the Apocalypse for people trading the momentum FANG+ stocks, this is not the Apocalypse. Sure, the market has violated its rising trend line, but this trend break is nothing like the COVID Crash experienced earlier this year.

Before the bears get all excited, there are several key differences between the current trend break and the February trend break. While the NYSE McClellan Summation Index (NYSI) warned of deteriorating breadth in both cases, net NYSE highs have not broken down in the manner of February 2020.

The full post can be found here.

The 5 key macro indicators of Trump’s political fortunes (revisited)

Labor Day is the traditional kickoff of presidential election campaigns. Before that, only die-hard political pundits and devotees pay attention to the election. It is with that in mind we revisit the economic criteria for Trump's political fortunes that I outlined just after his inauguration (see Forget politics! Here are the 5 key macro indicators of Trump’s political fortunes). I followed up a year later with an interim report card (see Trump's one year report card).

While Trump likes to measure his performance by the stock market, the stock market isn't the economy, and the economy isn't the stock market. Historically, the market has shown itself be neutral towards Republicans and Democrats in the White House.

Instead, I offer the Newt Gingrich criteria, which he laid out in a NYT interview just after Trump's inauguration:

“Ultimately this is about governing,” said former House Speaker Newt Gingrich, who has advised Mr. Trump. “There are two things he’s got to do between now and 2020: He has to keep America safe and create a lot of jobs. That’s what he promised in his speech. If he does those two things, everything else is noise.”

“The average American isn’t paying attention to this stuff,” he added. “They are going to look around in late 2019 and early 2020 and ask themselves if they are doing better. If the answer’s yes, they are going to say, ‘Cool, give me some more.’”

The Newt Gingrich criteria is a variation of Ronald Reagan's "are you better off than you were four years ago" campaign slogan. The economy is one of Trump's perceived strengths. In survey after survey, voters consistently trust Trump than Biden on the ability to deal with the economy.

The full post can be found here.

Brace for the volatility storm

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 Asset Allocation 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 a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). 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: Sell 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.

Subscribers can access the latest signal in real-time here.


Why Are VIX and SPX Moving Together?
Something odd is happening in the equity option market.

• Until the market sold off last Thursday, the VIX and SPX had been rising together. The 10-day correlation of the VIX and SPX spiked to over 0.7, which is highly unusual as the two indices tend to be negatively correlated with each other (top panel).
• The rise in implied volatility, as measured by the VIX Index, was not matched by rising realized volatility. The second panel in the chart below shows the width of the SPX Bollinger Band as a proxy for implied volatility, which has been tame.
• Until the market sold off last Thursday, the term structure of the VIX was steeply upwards sloping. The spread between 9-day, 1-month, and 3-month implied volatility was uniformly high by historical standards.
• The SKEW Index, which measures the price of hedging tail-risk, was also elevated.

Equally puzzling is the disconnect between stock and bond implied volatility. While stock volatility has surged, bond market volatility remains tame. What's going on?

Historically, high correlations between SPX and VIX have usually led to market sell-offs. Under a minority of circumstances, they have also signaled market melt-ups. How can we explain these unusual conditions in the option market?

The full post can be found here.

How the Fed's Policy Review got an incomplete grade

It has been over a week since Jerome Powell's virtual Jackson Hole speech in which he laid out the Fed's revised its updates to its Statement on Longer-Run Goals and Monetary Policy Strategy after a long and extensive internal review. There were two changes. one was a shift towards an "average inflation targeting" regime, where the Fed "seeks to achieve inflation that averages 2 percent over time". The other was an emphasis on to target low unemployment. Instead of minimizing “deviations from the maximum" employment, it will minimize “shortfalls of employment from its maximum level.”

The results of the review were much like a student handing in a term paper after much effort, but the assignment is incomplete, and leaves many questions unanswered.

• How will the Fed calculate the average inflation rate? In other words, what decision rules will the Fed adopt to raise interest rates?
• How credible is the 2% inflation target? How does the Fed expect to raise the inflation rate, when it was unable to do so for many years? Is it because its lab partner, fiscal policy, failed to work on the assignment?
• How will the Fed manage the bond market's expectations? If the average inflation target of 2% is credible, how far above 2% will the 10-year Treasury yield be, and what will that do to the economy and stock prices?

On the last point, I had a discussion with a reader about the implications for the bond market in the wake of Powell's speech. Wouldn't a credible 2% average inflation target translate into a substantial surge in bond yields? How far above 2% does the 10-year Treasury have to trade? What does that mean for equity valuations?

Supposing that you knew for certain that inflation will average 2% over the next 10 years, you would certainly demand a Treasury yield of over 2%, say 2.5%. The 10-year yield needs to rise by at least 1.8%. What would that do to the economy, and the stock market?

Forward P/E ratios are stratospheric compared to their own history, but some investors have justified the high multiple by pointing to low rates. TINA, or There Is No Alternative. Valuations are reasonable based on equity risk premium (ERP), which is some variation of E/P - interest rates. Here is the Q2 2020 ERP calculation of Antonio Fatas, professor of economics at INSEAD. While the stock market appears reasonably priced based on ERP today, raising rates by 1.8% (everything else being equal) would make stocks far less attractive compared to fixed income alternatives.

Something doesn't add up. The Fed's review appears incomplete. There are too many unanswered questions.

The full post can be found here.

Growth stocks wobbles

Mid-week market update: One of the defining characteristics of the current bull run is the dominance of US large cap growth stocks. Joe Wiesenthal wrote about the problem of the effect of the "superstar companies" on the economy in a Twitter thread and in a Bloomberg commentary. The "superstar companies" have few employees, and therefore high labor productivity.

But if labor productivity is all that matters, and you don't need any workers, where is the demand going to come from?

If you think that the key thing is demand, and that demand drives investment, driving productivity, then it's not about declaring some tech companies winners and declaring everyone else as zombies that should die, it's about fostering income equality to drive spending.

Something nobody ever seems to point out is how it's interesting that productivity growth is historically quite low, even though we have an economy that's dominated by some of the most productive companies in human history. Maybe more ultra-productive companies aren't the answer?

While Big Tech and large cap growth are still red hot, more cracks are showing up in the growth stock armor. The chart below shows an unexpected divergence in relative performance between large cap and small cap growth (top panel). If we were to benchmark US large and small cap stocks against global stocks, as measured by the MSCI All-Country World Index (ACWI), we can see that large cap growth remains in a relative uptrend against ACWI (middle panel), but the relative performance of small caps and small cap growth have flattened in the past few months.

While these are not immediate bearish signals, they represent "under the hood" warnings of pending trouble in US equities.

The full post can be found here.