Sunday, December 11, 2016

Watch the reaction, not just the Fed

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 mid-week observations at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.

All eyes on the Fed
As market activity starts to wind down for the holiday season, the major event next week will be the FOMC meeting. The Fed's policy move has been well telegraphed and a quarter-point rate hike will be a foregone conclusion. Bond yields have been rising, and so have inflationary expectations, but that's not a surprise. Sometimes the best part of watching a play where you already know the plot is to watch the audience`s reaction.

Even as bond prices got clobbered, equities have soared. Major US indices achieved new record highs last week. At this rate, the SPX may achieve its point and figure target of over 2500 in the not too distant future.

To stay ahead of the markets, here is what I will be watching next week in the wake of the FOMC announcement:
  • What happens to the dot plot? 
  • How will the market react to the Fed's message? Will the current market expectations of about two more rate hikes in 2017 change?
  • How will Donald Trump react to the likely quarter-point rate hike?
Watch the audience, not just the show.

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

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