Wednesday, March 29, 2017

Is the correction over?

Mid-week market update: On Monday, the major market averages successfully tested their 50 day moving averages (dma) and bounced. Does this mean that the correction is over?

Not so fast. There are several indications that the market still has unresolved business on the downside for Monday's test to be a durable bottom. First of all the SPX remains in a short-term downtrend, and the breach of that downtrend line is the first test of this rally.



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

Tuesday, March 28, 2017

A passive index fund built to outperform?

A long time reader sent me this Seeking Alpha article entitled "Monish Pabrai Has Created An Index Fund Built To Outperform", which described a "passive index fund" built using the following three investment themes deployed in three portfolio buckets:
  • Share buybacks: Companies that are buying back their own shares
  • Selected value manager holdings: The holdings of 22 selected value managers, based on their 13F filings
  • Spin-offs: Companies that were recently spun off from their parent
It's difficult to have a detailed opinion on the pros and cons of this fund. That's because the article only described what this "index fund" would hold, it did not describe the portfolio construction method, or how much of each stock it would hold. So it`s impossible to understand the risk profile of the fund, the size of its factor exposures, as well as its sector and industry exposures.

All the marketing hype aside, this investing approach is really a re-packaged form of factor investing, otherwise known as "smart beta". Therefore investors who buy into such a vehicle should expect similar kinds of results as "smart beta", though in a multi-factor format.

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

Sunday, March 26, 2017

Could "animal spirits" rescue the Trump rally?

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 the 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: 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 will also receive email notices of any changes in my trading portfolio.


A shift in tone
Well, that shift in tone came out of nowhere! It seems that as the focus shifted from "tax cuts" to "Obamacare", the stock market began to lose steam and retreated.


Before the bulls get overly discouraged, Main Street's enthusiasm for the Trump agenda may spur enough growth to keep the Trump rally going. Megan Greene recently highlighted this now familiar chart of the large gap between soft (expectations) and hard (reported) data.


I had also raised the same question just after Inauguration Day (see Could "animal spirits" spark a market blow-off?

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

Wednesday, March 22, 2017

Three bottom spotting techniques for traders

Mid-week market update: Regular readers will know that I have been tactically cautious on the market for several weeks, but can the blogosphere please stop now with details of how many days it has been without a 1% decline?


The market fell -1.2% on Tuesday with no obvious catalyst. Despite today's weak rally attempt, Urban Carmel pointed out that the market normally sees downside follow-through after 1% declines after calm periods.


Within that context, I offer the following three approaches to spotting a possible market bottom, with no preconceived notions about either the length or depth of the correction.

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

Monday, March 20, 2017

China's revival and what it means

I was reviewing RRG charts on the weekend (click here for a primer on RRG charting) using different dimensions to slice and dice the market. When I analyzed the regional and country leadership, I was surprised to see that the dominant leadership were all China related (note that these ETFs are all denominated in USD, which accounts for currency effects).


From a global and inter-market perspective, this is bullish for the global reflation trade.

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

Sunday, March 19, 2017

Rate hikes ≠ The Apocalypse

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 the 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: 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 will also receive email notices of any changes in my trading portfolio.


Pundits vs. the bond market
As expected, the FOMC delivered a rate hike last week, From the bond market`s perspective, you would have thought that the Fed cut rates. The stock market rallied, and bond yields fell.



From the viewpoint of some of the pundits, I thought that the Apocalypse was at hand. David Rosenberg warned that "There have been 13 Fed rate hike cycles in the post-WWII era, and 10 landed the economy in recession".

Not to be outdone, Bill Gross said that "Our highly levered financial system is like a truckload of nitro-glycerin on a bumpy road".

What's going on? Who is right, the bond market, or the pundits?

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

Friday, March 17, 2017

Sell St Patrick's day?

I hope that you are enjoying the stock market rally this week. My inner trader covered his short positions last week and stepped aside to await a better short re-entry point. St. Patrick's Day may be it.

Ryan Detrick pointed out that St. Patrick's Day is one of the most positive days of the year, though as of the time of this writing, the market has been flat.


As well, Rob Hanna at Quantifiable Edges highlighted March option expiry week (OpEx) is one of the most consistently bullish OpEx weeks of the year. As I will show later, OpEx+1 week tends to mean revert and see market weakness.


The latest readings from Index Indicators show that the market is rolling over after flashing a short-term overbought reading.



In addition, a number of broad based indices had violated their uptrends, which is setting up the market up for a period of correction or consolidation.



Risk appetite, as measured by the junk bond market, is flashing a minor negative divergence.



When I put these conditions together with my own study of OpEx week, it adds up to a tactical sell signal on the stock market.

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

Wednesday, March 15, 2017

3 steps and a stumble: Bull and bear case

Mid-week market update: It was no surprise that the Fed raised rates, as they had spent the last month widely telegraphing their intentions. This morning's release of February CPI tells the story. Headline CPI is near a 5-year high. Though core CPI (ex-food and energy) edged down, the latest reading of 2.2% is above the Fed's 2% targeted inflation rate.



The big surprise was the dot plot, which the market anticipated would edge upwards. Instead it remained mostly unchanged for 2017, though rate expectations were nudged up for next year.




Since this is the third rate hike for the Federal Reserve, the key question for equity investors is whether they should be concerned about the traders' adage of "three steps and a stumble" (via MTA):
Similar to Zweig's Fed policy indicator and in line with the desire to measure when the Federal Reserve is tightening credit, Edson Gould, a legendary technical analyst from the 1930s through the 1970s, developed a simple rule about Federal Reserve policy that has an excellent record of foretelling a stock market decline. The rules states that "whenever the Federal Reserve raises either the federal funds target rate, margin requirements, or reserve requirements three consecutive times without a decline, the stock market is likely to suffer a substantial, perhaps serious, setback" (Schade, 2004). This simple rule is still relevants. Although it tends to lead a market top, it is something that should not be disregarded.
Here are the bull and bear cases under "three steps and a stumble". In particular, the current economic cycle is elongated and shallow compared to past recoveries, and therefore it would be premature to worry about Fed actions to cool down the economy just yet.

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

Monday, March 13, 2017

To BAT or not to BAT? Trump`s tax reform dilemma

As the market awaits the FOMC decision and statement this week, there are a number of other critical market moving events to watch for. The Trump White House is expected to release its "skinny budget" this week, which may contain some broad outlines of the tax reform package. In addition, Angela Merkel's White House visit Tuesday could bring important news on the trade front.

Donald Trump came into office promising a series of tax cuts and offshore cash repatriation incentives for Wall Street. But tax cuts have to be offset with either revenue increases or spending cuts. Trump adviser Gary Cohn recently stated on CNBC that the White House is aiming for to be revenue-neutral over a 10-year period. As this chart from Morgan Stanley shows, this level of fiscal stimulus is highly unusual at this point of the economic expansion.



The main strategy for paying for the many of the proposed tax cuts is the imposition of a Border Adjustment Tax (BAT), which will penalize imports while encouraging exports. The BAT proposal, however, is likely to run into a number of major objections from America's largest trading partners.

Those objections have come from Canada, which is America's biggest customer, and from Germany, the sixth largest (chart via CNN Money).



Last week, Canadian prime minister Justin Trudeau spoke at a Houston energy conference and cautioned that a BAT would be bad for all parties (via Bloomberg):
A levy on goods imported to the U.S. would damage business on both sides of the northern border and could impede the growth of energy, automobile and steel industries that benefit from bilateral cooperation, Trudeau said at a press conference in Houston.

“A border adjustment tax would be bad not just for Canada but for the United States as well,” the prime minister told reporters Friday. “No two countries in the world have the close friendship, alliance, relationship and level of economic integration that Canada and the U.S. have.”
German chancellor Merkel is expected to be far less diplomatic than Trudeau.

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

Sunday, March 12, 2017

A toppy market, but not THE TOP

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 the 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: 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 will also receive email notices of any changes in my trading portfolio.


Valuation and sentiment vs. momentum
Last week, I wrote about signs of stretched stock market valuation (see  Why I am cautious on the market). Last Wednesday, I warned about excessively bullish sentiment, which suggests that stock prices are likely to pull back (see A sentimental warning for bulls and bears).

Despite these red flags, I would caution that both valuation and sentiment models are notoriously bad at timing market tops. Expensive markets can get more expensive, and stock prices don`t necessarily go down if investors get into a crowded long. These models serve the highlight the risks to a market.

Here is another take on valuation. Taking a very long term 30-year view, Urban Carmel observed that the SPX goes up and down in fits and starts after adjusting for inflation. The key to achieving superior long-term returns is to buy when valuations are low, which is not the case today.


Michael Batnick at Irrelevant Investor showed that the Cyclically Adjusted PE ratio (CAPE) is elevated when compared to its own history.


But average CAPE has been rising over time.


If valuation doesn't work for short term market timing, what should investors do? In the intermediate term, a focus on fundamental and macro momentum in addition to factors like valuation and sentiment. Current conditions can more useful for market timing. Using this framework, it suggests that risks are rising, but there is no need to panic just yet.

The market is looking toppy, but this is not "the top".

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

Wednesday, March 8, 2017

A sentimental warning for bulls and bears

Mid-week market update: Recently, there have been numerous data points indicating excessive bullishness from different segments of the market:
  • Retail investors are all-in
  • Institutional investor bullish sentiment is off the charts
  • Cash is at a two-decade low in global investor portfolios
  • RIA sentiment are at bullish extremes
  • Hedge funds are in a crowded long in equities
These giddy sentiment readings are comforting to the bear camp (chart via Business Insider) and it will be difficult for stock prices to advance under such conditions. When everyone is bullish, who is left to buy?


However, I would warn the bears that they should not go overboard and short the market with both hands. In the past, euphoric sentiment has not a good indicator for pinpointing market tops.

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

Monday, March 6, 2017

A track record update

I have had a number of subscribers ask me to extend the chart of my longer term calls, which had only gone back two years. The chart below shows the highlights of my posts back to 2013, which are intended for investors with a 6-24 month time horizon. I haven't been always right. On occasion, I was early, late, or simply mistaken.


Here is the links to the past posts shown in the above chart.

A correction, not a bear June 2013
A buy signal from the option market September 2013
Are stocks tumbling too far too fast? January 2014
Global growth scare = Trend Model downgrade July 2014
Onwards and upwards August 2014
3 reasons to get more cautious on stocks September 2014
Getting close to a bottom, but not yet October 2014
Why I am bearish (and what would change my mind) May 2015
Relax, have a glass of wine August 2015
Why this is not the start of a bear market September 2015
The reason why the bulls should be cautious about a January hangover December 2015
Buy! Blood is in the Streets January 2016
Super Tuesday special: How President Trump could spark a market blow-off March 2016
How the S+P 500 can get to 2200 and beyond June 2016


In addition, these are the buy and sell calls of the trading model, which are designed for traders with a 1-2 week time horizon. Again, I haven't been always right. The most recent failure occurred when the trading model got caught long (and wrong) in the correction in late 2015.


Judge for yourself.

Sunday, March 5, 2017

Why I am cautious on the market

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 the 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: 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 will also receive email notices of any changes in my trading portfolio.


An over-valued and frothy market
As the major market indices hit new all time highs, I have become increasingly cautious on the short-term outlook. I view the stock market through the following lenses, and all of them are showing either a neutral to bearish outlook:
  • Valuation
  • Interest rates outlook
  • Growth
  • Psychology
The one wildcard continues to be political developments from Washington. A recent AAII survey indicated that roughly 75% of respondents cited politics as affecting their investment decisions:
This week’s Sentiment Survey special question asked AAII members what factors are most influencing their six-month outlook for stocks. Nearly three-quarters of respondents (73%) cited national politics, particularly President Donald Trump’s polices and what actions Congress may take. Tax reform was mentioned by many (20% of respondents), followed by regulatory reform and uncertainty over what legislation will actually be passed. Just under 23% of all respondents listed the ongoing rally and the prevailing stock valuations, with several of these respondents expressing concerns about the level of valuations or that a drop could be forthcoming. Monetary policy was cited by 8% of all respondents, followed by corporate earnings growth (7%) and investor sentiment (7%). Some respondents listed more than one factor.
Any changes in the path of fiscal or trade policy have the potential to create further market volatility.

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

Thursday, March 2, 2017

A frothy, over-extended stock market

I just wanted to follow up to yesterday's post (see Don't relax yet, the week isn't over). One of the key developments that I had been watching has been the recent hawkish evolution in Fedspeak. Last night, uber-dove Lael Brainard gave an extraordinarily hawkish speech. She started with the following remarks:
The economy appears to be at a transition. We are closing in on full employment, inflation is moving gradually toward our target, foreign growth is on more solid footing, and risks to the outlook are as close to balanced as they have been in some time. Assuming continued progress, it will likely be appropriate soon to remove additional accommodation, continuing on a gradual path.
As a reminder, Brainard had been the Federal Reserve governor who, if given 10 reasons to raise rates and one reason to wait, she would focus on the single reason as a way of mitigating systemic risk. The last paragraph of her speech concluded, not so much with a discussion of whether to raise rates, but what to do with the Fed's balance sheet after the rate normalization process had begun:
To conclude, recent developments suggest that the macro economy may be at a transition. With full employment within reach, signs of progress on our inflation mandate, and a favorable shift in the balance of risks at home and abroad, it will likely be appropriate for the Committee to continue gradually removing monetary accommodation. As the federal funds rate continues to move higher toward its expected longer-run level, a transition in balance sheet policy will also be warranted. These transitions in the economy and monetary policy are positive reflections of the fact that the economy is gradually drawing closer to our policy goals. How the Committee should adjust the size and composition of the balance sheet to accomplish its goals and what level the balance sheet should be in normal times are important subjects that I look forward to discussing with my colleagues.
When a dove like Brainard sounds this hawkish, there is little doubt about whether the Fed will raise rates at its March meeting.


What about Buffett's bullish comments?
In a recent CNBC interview, legendary investor Warren Buffett stated that stocks are on the cheap side, but that assessment would change if rates were to rise:
Billionaire investor Warren Buffett told CNBC on Monday U.S. stock prices are "on the cheap side" with interest rates at current levels...

"We are not in a bubble territory" in the stock market, he said on "Squawk Box." If rates were to spike, however, then the stock market would be more expensive, he added.
It looks like the Fed is about to raise start a rate hike cycle. So what now?

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

Wednesday, March 1, 2017

Don't relax yet, the week isn't over

Mid-week market update: Boy, was I wrong. Two weeks ago, I wrote Why the SP 500 won't get to 2400 (in this rally). Despite today's market strength, stock prices may be restrained by a case of round number-itis as the Dow crosses the 21,000 mark and the SPX tests the 2,400 level.

In addition, the market's reaction to President Trump's speech to Congress was at odds to the reaction from Street strategists. While the market went full risk-on in the wake of the Trump speech, this Bloomberg summary of strategist comments made it clear that the speech was long on themes and short on details. Perhaps stocks are rallying because Trump did not go off script and sounded statesmanlike and presidential. How long the market remains patient with his lack of the specifics on tax reform, which is Wall Street's major focus, remains an open question.

In the meantime, the SPX has broken above its trend line and appears to be staging an upside blow-off. When animal spirits start to stampede like this, you never know when the rally will end.



Does this mean it's time to jump back on the bullish bandwagon? Not so fast. The week isn't over and there are a couple of other major developments (other than the Trump speech) that warrant consideration.

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