Sunday, March 18, 2018

When the story changes...

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: Neutral*
  • Trading model: Bullish*
* 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.

A change in seasons
Bill McBride of Calculated Risk has had a remarkable record of calling turns in the economy. He correctly warned about the peaking housing bubble before it popped, and he has been consistently bullish since the market bottom in 2009. Recently, he warned that "the story is changing":
But in 2018, the story is changing. We are seeing some economic tailwinds and some headwinds. Although the tax changes are poorly conceived, and mostly benefit high income earners, there should be some short term boost to economic growth. That might lead the Federal Reserve to raise rates a little quicker than anticipated.
He concluded:
I still think the economy will be fine in 2018, but the story is changing.
Bloomberg reported that Morgan Stanley cross-asset strategist Andrew Sheets highlighted a changing environment of weakening Purchasing Manager Indexes (PMIs) and rising inflation. Such regimes shifts have typically led to rising volatility.
Markets have traditionally been well-equipped to handle higher inflation when it comes alongside a pickup in growth, notes Sheets. But it’s the prospect of an inflection point away from the dominant narrative of “synchronized global growth” reflected in rising PMIs, and moribund price pressures that could cause investors angst.

Kevin Muir at Macro Tourist also highlighted NDR analysis that split Fed tightening cycles to fast and slow cycles. If history is any guide, this is the point where stock prices start to flatten out and weaken during a slow tightening cycle.

I agree 100%. Goldilocks is dying, but the probability of a recession in 2018 remains low. Risks and volatility are rising. It is time to review how "the story has changed".

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

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