Sunday, August 14, 2016

Party like it's 1999, or 1995?

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 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 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. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Risk-on*
  • Trading model: Bullish*
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 any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.

How close are we to a market top?
I am used to getting abused for my market views, but the abuse is starting to turn into agreement - and that's a cautionary flag. I haven't always been a bull, here is a summary of my major market calls since January 2015.

When I was cautious in the first half of 2015, I got hate mail (see Why I am bearish (and what would change my mind)). When the market corrected in August/September 2015 and I was constructive on stocks, I got hate mail (see Relax, have a glass of wine and Why this is not the start of a bear market). When I turned bullish in January 2016 at the height of the market panic, a lot of people thought I was an idiot (see Buy! Blood is in the Streets). When I reiterated my bullish views as the market moved sideways in June before the big breakout, there was much skepticism that stock prices could go much higher (see How the SPX can get to 2200 and beyond).

Now that the broad market averages are seeing new all-time highs, market psychology has shifted from skepticism to grudging acceptance of the bull case. This got me worried. Am I becoming consensus and part of the crowd? Does this mean that the market is about top out?

For some perspective on this question, the Dow, SPX and NASDAQ all made simultaneous new highs last Thursday. The last time this happened was December 31, 1999, which was shortly before the ultimate top in March 2000, indicating that the market may be in a high risk zone. On the other hand, Ryan Detrick highlighted analysis showing simultaneous new highs in all three indices tend to be bullish.

Coincidental new highs is reflective of bullish price momentum, Detrick pointed out that the market saw a total of 25 simultaneous new highs in 1995.

So should we party like it's 1995, which was a sustained bull move, or late 1999, which marked a blow-off top?

I believe that the answer depends on the timing of a recession caused bear market, which is a function of the Federal Reserve's reaction to economic and market developments.

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

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