Why there is no V

The market has been getting excited by the prospect of a V-shaped recovery. It points to data such as the ISM Manufacturing PMI, which rose from 43.1 in May to 52.6 in June, indicating expansion. The employment index improved from 32.1 to 42.1, and the new orders index increased from 31.8 to 56.4..

While those are positive developments, this is not indicative of a V-shaped rebound. PMIs are designed to measure month-to-month changes. The economy is still in a big hole it's trying to dig out of, and there are signs the recovery is stalling.

The full post can be found here.

Can the bulls breach the island's moat?

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.


The moat around the island
I have been highlighting in these pages the bearish island reversal which formed in mid-July. Although stock prices haven't fallen significantly, the bulls have been unable to breach the gap that defines the island reversal. Conversely, past market advances since the downside break from the island has stalled at resistance at about 3150-3160.

Is there a moat around the island?

The full post can be found here.

Fun with technical analysis on the 4th of July

On this 4th of July Independence Day weekend, let's try a change of pace and indulge in some technical analysis of a different sort. The behavioral finance basis for technical analysis is the wisdom of the crowds.

Francis Galton observed a competition at a local fair in 1906 where about 800 people tried to guess the weight of an ox. To Galton's surprise, the average of all the guesses was 1,197 lbs. The actual weight came in at 1,198 lbs. Other studies have confirmed that a diverse crowd is better at estimates than any single expert.

This adage, "the wisdom of the crowds" is really another formulation of the Efficient Market Hypothesis, in which it is difficult for any single analyst to gain a consistent edge. Technical analysis is one way of listening to the markets, and applying its message to understand what the market is discounting.

With that preface in mind, consider this mystery chart. Would you buy, hold, or sell this security?

The full post can be found here.

A 2020 year

Mid-week market update: It is said that the adage "hindsight is 2020" may have been a garbled warning from a future time traveler. This year is certainly turning up like that.

The SPX fell -20% in Q1 2020, and recovered 20% in Q2. It's been that kind of year. Tactically, the index is backtesting the violation of the rising channel, but the bearish island reversal remains intact, and the market has been unable to breach the moat surround the island at about 3160.

To say that 2020 has been an unusual year is an understatement.

The full post can be found here.

Q2 earnings season preview: Flying blind

As Q2 earnings season is about to begin, it would be useful to assess the level of expectations going into reporting season, and the risks ahead. According to FactSet, forward 12-month EPS estimates have been bottoming and begun to turn up after a massive downdraft.

On the surface, this appears to be a constructive backdrop going into earnings season. While I would normally agree, the current environment is anything but "normal", and there are plenty of risks ahead.

The full post can be found here.

A shallow or deep pullback?

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.


Bearish tripwires
I have been cautious about the equity outlook for several weeks, and the market triggered several bearish tripwires last week. First, the SPX violated a rising trend channel, and fell through its 200 day moving average (dma). Other trend line violations observed were the high beta to low volatility ratio, which is an equity risk appetite indicator, and the NYSE Advance-Decline Volume Line, though the NYSE A-D Line remains in an uptrend.

Is this the beginning of a minor pullback where the market consolidates sideways, or the start of a major correction?

The full post can be found here.

A bleak decade ahead for US equities

Some analysis has recently emerged pointing to a bleak decade for equities, and US equities in particular. Mark Hulbert highlighted a model outlined in the Philosophical Economics blog, entitled "the single greatest predictor of future stock market returns". The model is based on US household allocation to equities and uses the levels as a contrarian indicator.

Notice that the household equity allocation is the flip side of the coin from household cash — sometimes referred to as sideline cash. Higher cash levels are therefore bullish and, sure enough, household cash allocations have risen markedly as equity allocations have fallen. But backtesting has shown that household equity allocation is the better predictor. In fact, according to Ned Davis Research, it is able to explain 77% of the variation in the stock market’s return in all 10-year periods since 1951. I am aware of no other indicator that does as well.

Hulbert continued:

Consider a simple econometric model I constructed from quarterly household equity allocation data since 1951 and the stock market’s subsequent inflation-adjusted total return at each step along the way. Based on the year-end 2019 allocation level, that model projected a 10-year inflation-adjusted return of negative 1.3% annualized.

That -1.3% expected real return was based on year-end 2019 data. Q1 2020 figures are in, and we all know what happened in March, namely the COVID Crash. According to Hulbert, projected annualized real returns improved to a positive 2.3% based on March 31 levels. Fast forward to today, the market has recovered most of its losses, and expected inflation-adjusted returns are undoubtedly negative again.

The news is even worse than that. The projected returns are calculated before fees. If an investor were to create a balanced portfolio consisting of some stocks and bonds. Add in some trading costs and management fees, diversification and frictional costs could easily subtract another 1%-2% from overall returns.

The full post can be found here.

Good news, bad news about a second wave

Mid-week market update: I have some good news, and bad news about a second wave. The bad news is new case counts are rising dramatically in the US. The good news is fatalities are not rising.

Here is some more bad news. Marketwatch reported that Dr. Anthony Fauci, head of infectious diseases at the National Institute of Health, said that "We are still in the middle of the first wave. So before you start talking about what a second wave is, what we'd like to do is get this outbreak under control over the next couple of months."

For investors, this matters for a couple of reasons.

The full post can be found here.

Bearish warnings, but no trigger

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.


Island reversal signal intact
A little over a week ago, the market traced out a bearish island reversal formation after violating a rising trend line. While the bullish island reversal signal in April saw the market advance immediately afterwards, the aftermath of the most recent signal resolved itself in a sideways consolidation, indicating that the bulls still had some life left in them, and they were struggling to maintain control of the tape.

Nevertheless, market internals revealed a number of bearish setups, with no obvious trigger. As an example, there is a divergence between the VIX Index and VVIX, which is the volatility of the VIX. I interpret this to mean that VVIX is not buying the recent fall in the VIX, and it is discounting an increase in volatility, which tends to be inversely correlated with stock prices.

The full post can be found here.

The bears are capitulating

Last week, I discussed the professional career risk challenges in this market (see What professional career risk looks like).

During these unusual periods of severe bifurcation between valuation and macro risk and price momentum, the investment professional is forced to make a decision based on what he believes the dominant investment regime will be in order to minimize career and business risk. This amounts to the classic Keynesian investing beauty contest, where investors do not try to determine the winner based on some investment criteria, but based on what he believes other investors think will be the winner.

I highlighted the differences in thinking between the fast-moving hedge fund manager, Stanley Druckenmiller, and the cautious approach of Jeremy Grantham, whose firm, GMO, reduced its target equity weight from 55% to 25%.

This week, it seems that even Grantham has capitulated and called this market a bubble in a CNBC interview.

“My confidence is rising quite rapidly that this is the fourth ‘Real McCoys’ bubble of my investment career,” Grantham, co-founder of GMO, told CNBC’s Wilfred Frost on Wednesday in an interview which aired on “Closing Bell.” “The great bubbles can go on for a long time and inflict a lot of pain.”

The previous three bubbles Grantham referred to were Japan in 1989, the tech bubble in 2000 and the housing crisis of 2008.

Not only has Jeremy Grantham capitulated and called this market a bubble, but also the latest BoA Global Fund Manager Survey shows signs of capitulation by cautious bears. Even though a record net 78% of survey respondents acknowledged that equities are overvalued, which is the highest reading since the survey began in 1998, their investment outlooks turned less bearish between the May and June survey.

As global stock prices continue to grind upward, managers are giving greater weight to their career risk, and reluctantly turning bullish. The bears are capitulating. How should investors approach this market?

The full post can be found here.

An island reversal update

Mid-week market update: Remember the island reversal? The market gapped down and skidded last Thursday after Wednesday's FOMC meeting, creating an island reversal. It opened down on Friday, but managed to close in the green on the day. And it has rallied back to the bottom of the gap this week.

Have the bearish implications of the island reversal been negated?

The full post can be found here.

China's tough policy choices

The Buttonwood column in The Economist had this to say about the recovery in metal prices (before the most recent risk-off episode):

A pattern in markets is that a lot happens by rote. China’s response to a weak economy is to build; investors’ response to the Fed’s easing is to buy stocks; the algorithms’ response to a weaker dollar is to buy commodities. Higher prices beget higher prices. The sceptics, the too-sooners, note that this also works in reverse. Quite so. But the momentum is now with the believers.

Even as the copper/gold ratio recovers, there are reasons to be skeptical. As a reminder, this ratio is a useful indicator of global cyclicality. Both copper and gold are commodities, and respond to hard asset inflationary pressures. Copper has more industrial uses, and therefore the ratio can be a way of filtering out the hard asset inflation element out of copper prices.

There is a speculative element to the rise in metal prices, too. Buying or selling copper futures is a popular way to express a view about the world economy. Indeed copper can be all about belief, says Max Layton of Citigroup, a bank. Many of the bets laid on it are by trading algorithms, which mechanically respond to financial signals that have worked well in the past. The dollar, which has fallen by 6% against a basket of currencies since March, is usually part of the semaphore. A weaker dollar allows for easier terms of finance in emerging markets. Anything that helps emerging-market economies is generally good for commodity prices. So the algorithms buy.

The complex of price changes becomes self-reinforcing. Higher ore prices bring higher-cost producers back to the market. But their profit margins are then squeezed as their home currency appreciates, because that raises the cost of labour in dollars, in which commodities are priced. To restore margins, prices must go up. Moreover, marginal costs rise when the prices of steel (used for mining parts) and oil (used for energy and chemicals) go up. These higher costs push up prices further, says Mr Layton.

What policy choices does China have to revive its economy?

The full post can be found here.

A major correction, or just a flesh wound?

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: Neutral*

* 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.


Just a flesh wound?
Was the market's -5.9% one-day swoon last Thursday the start of a major correction, or just a flesh wound?

The SPX exhibited an island reversal last week while violating a key rising trend line that went back to the March bottom, which are bearish. On the other hand, it successfully tested its 200 day moving average (dma), and the VIX Index (bottom panel) recycled from above its upper Bollinger Band (BB), which is an oversold reading, to below, which are constructive signs for the bull case.

What's next? The market had been rising steadily so long that it's difficult to ascertain the short or intermediate term trend. The strength of an uptrend is not known until it is tested in a pullback.

The full post can be found here.

What professional career risk looks like

This is a market that defines professional career and business risk. Should investors adopt a momentum approach, or maintain caution in the face of valuation and macro risk?

The stock market has recovered from the COVID-19 crash. The NASDAQ has made a fresh all-time high, and the SPX was briefly positive for 2020. Price momentum has been strong, and broad. Analysis from Topdown Charts shows that 74% of countries are now in bull markets.

On the other hand, the macro outlook and valuations are stretched. The market is trading at a forward P/E ratio of over 21. Even with headline CPI at -0.1%, the Rule of 20 is flashing a warning for the stock market.

The current market environment raises the level of career and business risk for investment managers. Traditional investing approaches would call for prudence in the face of elevated valuation and heightened macro risk. On the other hand, if the strong market breadth were to continue, it would mean an investment environment reminiscent of the go-go days of the dot-com bubble, or the Nifty Fifty era. A defensive posture in the face of a investment bubble risks the loss of clients and damage your career. Adopting a price momentum approach to investing while ignoring valuation also risks the perception of recklessness that can forever stain a career.

What should an investment professional do in the face of such career risk volatility? There are no easy answers. Let's consider how two well-known investors have approached the problem.

The full post can be found here.

Trading sardines, or eating sardines?

Mid-week market update: Experienced investors know the story about the difference between trading sardines and eating sardines. Here is how Seth Klarman recounted the story:

There is the old story about the market craze in sardine trading when the sardines disappeared from their traditional waters in Monterey, California. The commodity traders bid them up and the price of a can of sardines soared. One day a buyer decided to treat himself to an expensive meal and actually opened a can and started eating. He immediately became ill and told the seller the sardines were no good. The seller said, “You don’t understand. These are not eating sardines, they are trading sardines.”‘

Like sardine traders, many financial-market participants are attracted to speculation, never bothering to taste the sardines they are trading. Speculation offers the prospect of instant gratification; why get rich slowly if you can get rich quickly?

Klarman continued:

Speculation involves going along with the crowd, not against it. There is comfort in consensus; those in the majority gain confidence from their very number. Today many financial-market participants, knowingly or unknowingly, have become speculators. They may not even realize that they are playing a “greater-fool game,” buying overvalued securities and expecting—hoping—to find someone, a greater fool, to buy from them at a still higher price.

There is great allure to treating stocks as pieces of paper that you trade. Viewing stocks this way requires neither rigorous analysis nor knowledge of the underlying businesses. Moreover, trading in and of itself can be exciting and, as long as the market is rising, lucrative. But essentially it is speculating, not investing.

In light of the surprising and powerful stock market rally off the March bottom, you have to ask yourself, "Am I looking for trading sardines, or eating sardines?"

The full post can be found here.

Buy the breadth thrust and FOMO stampede?

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: Neutral*

* 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.


Breadth thrusts are bullish
Last week, technical analyst Walter Deemer pointed out that the market had flashed a "breakaway momentum" buy signal. He did qualify the condition, "Supposed to get it near the beginning of a powerful move, not after a 42% advance (altho did have late signals Jul 12 2016 and Nov 20 1950). Definitely not its finest moment..."

As well, Deemer reported on Friday that the market achieved both a Whaley Breadth Thrust and a Whaley Volume Thrust.

Could this be the start of a new bull leg? On one hand, the market's animal spirits are stirring, and breadth thrusts like Deemer's breakaway momentum signal have historically been bullish. There are usually signals of a full-fledged Fear of Missing Out (FOMO) stampede, especially in light of the surprisingly strong May Jobs Report (see May Jobs Report: Back from furlough). If you only believe technical analysis is all that matters, then you should be bullish.

On the other hand, the market is trading at a stratospheric forward P/E of 22.4, and at a 2021 P/E of 19.5. To buy now means adopting the late 1990's go-go mentality that earnings don't matter, and all that matters is price momentum.

Careers were made and severely damaged during the dot-com era. Should traders throw caution to the wind?

The full post can be found here.

What would a Biden Presidency look like?

Joe Biden has officially clinched the Democratic nomination for president, and his odds of winning the Presidency in November have been steadily rising, and he is now at 54% on PredictIt. For the uninitiated, the contract pays off at $1.00 if a candidate wins, so buying the Biden contract at $0.54 implies a 54% of a Biden victory.

The consensus view has the Democrats retaining control of the House. The PredictIt odds of the Democrats gaining control of the Senate has been steadily improving over the past few months, and now shows a slight edge for the Democrats. In the case of a 50-50 divided Senate, the vice-president casts the tie-breaker and the winner of the White House has control.

While this is not meant to be an endorsement of any candidate or political party, it is time to contemplate what a Biden victory might mean for the economy and the markets. If Biden were to win, there is also a decent chance that the Democrats might capture control of both chambers of Congress. How should investors react to that outcome?

The full post can be found here.

May Jobs Report: Back from furlough

I don't usually offer instant reactions to economic news, but the May Jobs Report was a shocker. Non-Farm Payroll gained 2.5 million jobs, compared to an expected loss of -8 million. The Diffusion Index bounced back strongly, indicating breadth in job gains.

This was a positive and highly constructive report for the economy. Before everyone gets overly giddy, the report also highlighted some key risks to the outlook.

The full post can be found here.

Trading the Energizer Bunny rally

Mid-week market update: As regular readers are aware, I have been increasingly cautious about the equity outlook for the past few weeks as the market advanced. This has become the Energizer Bunny rally that keeps going beyond expectations.

Where will it stop? One of the indicators that I have been keeping an eye on is the NYSE McClellan Summation Index (NYSI). In the past, whenever the NYSI has fallen to an oversold extreme of -1000 or less, the indicator has rebounded so that the weekly stochastic bounced from an oversold to an overbought level. We are now overbought on the weekly stochastic.

To be sure, past rebounds have seen the weekly stochastic become even more overbought. These conditions suggests that there may be one or two weeks of more upside on NYSI, this relief rally is running on borrowed time.

The full post can be found here.

Brace for the second waves

As we progressed through the pandemic induced recession, there have been much discussion about a second wave. Second waves appear in many forms, and they can threaten the current consensus expectation of a V-shaped rebound.

Here are some of the second wave risks the market faces.

• A second wave of COVID-19 infections
• A second wave of layoffs and wage cuts
• A second wave of bankruptcies

Finally, investors have to face the risk of permanent economic scarring that impair long-term growth potential. Under that scenario, slower growth rates will persist even after any recovery, and affect asset prices in ways that the market hasn't fully discounted.

The full post can be found here.