Sunday, November 5, 2017

Bull or bear?: It depends on your time horizon

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: Bullish*
  • 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.

Tops are processes
It is said that while market bottoms are events, which are sparked by emotional panic selling, tops are processes, which are the result of a series of connected episodes that depress prices. In the past few months, I have adopted the belief that the market is undergoing a topping process. Consequently, I become increasingly cautious about the stock market, though I do not believe that the ultimate top has been seen yet.

Here is what we know about the market on an intermediate term time frame:
  • Positive momentum: The market has been supported by strong price, fundamental, and macro-economic momentum. Most macro models show that the risk of recession is low or nonexistent.
  • Valuation: Valuation is stretched.
  • Sentiment: Sentiment has been frothy, which is contrarian bearish.
  • Technical: The pre-conditions for an intermediate or long-term top are not yet in place.
  • Short-term outlook: Much depends on the fate of the GOP tax bill and the market's evaluation of other sources of risk, such as the Middle East.
Under these conditions, an investor could be either bullish or bearish and be correctly positioned. It just depends on the investment time horizon.

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

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