Sunday, August 21, 2016

The market's hidden message for the economy, rates and stock prices

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 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.

The message from inter-market analysis
I have always believed in listening to the markets. Technical analysis is useful as it can be a way of discerning the market's hidden message, especially when performing inter-market analysis, otherwise known as cross-asset analysis.

I have found point and figure charts to be particularly useful tools because they filter out a lot of the price noise, especially when markets trade sideways in a tight range as they have recently. As an example, my recent post that featured a SPX weekly point and figure chart got a lot of attention (see Be patient). Since I performed that analysis, not much has changed. The latest weekly chart pattern remains unambiguously bullish on an intermediate term basis. It also tells the bullish story of powerful price momentum, TINA (There Is No Alternative) and FOMO (Fear Of Missing Out), all rolled into one.

I reviewed my charts using this technique in order to get a fresh point of view and what I found astonished me. Over and over again, I was getting a lot of chart patterns like this from a single market sector.

Bullish or bearish? The charted instrument is in a well-defined uptrend, but there is overhead resistance nearby. While I interpreted it bullishly, I wanted to be sure. A Twitter poll showed that the crowd agreed with me.

This results of this analytical approach was in effect a hidden message from Mr. Market. More importantly, the message has crucial medium term implications for the economy, interest rates, stock prices, and the likely trajectory of Fed policy.

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

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