Sunday, February 11, 2018

Five reasons to not to worry (plus 2 concerns)

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. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

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 receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.

The Bob Farrell Rule #4 correction
Volatility has certainly returned to the financial markets as the Dow experience two 1,000 point downdrafts in a single week. The long awaited correction arrived as stock prices retreated 10% from an all-time high in just under two weeks. Over at Bloomberg, there were six separate and distinct explanations for the correction. I prefer a far simpler reason. Stock prices went up too far and too fast. Call it the Bob Farrell Rule #4 correction: “When prices go parabolic, they go up much further than you expect, but they don’t correct by going sideways.”

As the market cratered last week, subscriber mood began on an air of cautious optimism, which turned to concern, and finally panic. By the end of the week, I was getting questions like, "I know that the market is oversold, but could it go further like 1987, 1929, or 2008?"

Relax, most of the concerns raised are red herrings. Here are what I am not worried about:
  • Equity valuation,
  • Macro outlook,
  • Equity fundamentals,
  • Investor sentiment, and
  • Market technical picture, otherwise known as the "animal spirits"..
Here are a couple of areas where I have some concerns:
  • The inflation outlook and Federal Reserve policy, and
  • Possible changes in White House policy, such as trade and immigration.
The full post can be found at our new site here.

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