Sunday, September 24, 2017

The Fed has spoken (and what that means)

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: Neutral*
  • 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 risks to the bond market
The Fed has spoken. Janet Yellen made it clear that the Fed is ready to normalize monetary policy, come hell or high water. This tone to US monetary policy begs the question of how much interest rates can rise.

The Citigroup Economic Surprise Index (ESI), which measures whether high frequency economic releases are beating or missing expectations, has been on a tear for the last few months. In the past, rising ESI values have put upward pressure on bond yields (blue line). How far can they go up this time, and what kind of effects will they have on stock prices?

Moreover, there are a number of indications that the Fed will become increasingly hawkish, and the trajectory of interest rate increases discounted by the market are well below actual Fed actions.

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

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