Sunday, June 25, 2017

Long live the reflation trade!

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.

The global bull keeps on charging
Despite my recent negativity (see Risks are rising, but THE TOP is still ahead and Things you don't see at market bottoms, 23-Jun-2017 edition), I am not ready to throw in the towel on this equity bull market.

From a long-term perspective, the reflation trade is still alive, and growth is global in scope. As the 20-year monthly chart below of the Dow Jones Global Index (DJW) shows, the last two tops were preceded by negative RSI divergences. So far, DJW is barely overbought and has not even had the opportunity to exhibit a negative RSI divergence. This suggests that global equities can continue to grind higher, and the ultimate top is, at a minimum, several months away.

The tactical outlooks suggests that there may be some near-term weakness ahead. Drilling down to the weekly chart, DJW has shown a pattern of flashing double RSI overbought sell signals. In the past, the index has achieved a first RSI peak overbought reading (dark vertical line) which was followed by a second RSI peak (red vertical line). DJW has recently shown the same double overbought peak pattern, and, if history is any guide, the market is likely to stage a minor pullback.

I interpret these technical conditions as being in favor of the global reflation trade, though some minor pause may be necessary. This scenario is consistent with current macro and fundamental readings that are supportive of a reflationary driven equity advance..

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

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