Sunday, April 29, 2018

How much does 3% matter to stocks?

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: 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.


The 3% question
The US equity market took fright last week when the 10-year Treasury yield rose above 3%. Stock prices recovered when yields retreated. How much should equity investors worry about a 3% 10-year yield?


Rather than focus on any single level, investors would be advised to concentrate on the interaction between stocks and bonds. Consider the P/E ratio. The factors that drive equity prices are:
  • How fast is the E in the P/E ratio likely to grow?
  • What is the outlook for interest rates and how does it affect the E/P ratio?
The full post can be found at our new post here.

Wednesday, April 25, 2018

Is good news now good news, or bad news?

Mid-week market update: What should we make of the stock market now that the 10-year Treasury yield has breached the 3% level? Should we pay attention to the JPM Asset Management historical analysis which stated, "When yields are below 5%, rising rates have historically been associated with rising stock prices"?



Should we pay attention to the latest BAML Fund Manager Survey, which concluded that the median manager is not overly worried until the 10-year yield crosses 3.5%?


Up until now, good (economic) news has translated to good (stock market) news, and bad news has been bad news. At some point, market perception will shift to putting greater weight on the bearish factors behind higher growth because of the expectation of a more hawkish Fed response, over the bullish factors behind better earnings growth.

Is the market at that turning point when good news is bad news, and bad news is good news?

The Q1 GDP report this Friday provides an important litmus test of whether that inflection point has been reached. Supposing that GDP growth comes in at better than expectations. Will stocks rally because of higher growth expectations, or drop because higher growth will pressure the Fed to raise rates at a faster pace? Similarly, what if growth came in at below expectations?

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

Monday, April 23, 2018

Don't miss the eurozone revival!

Remember my post, Opportunity from Brexit turmoil? I suggested on February 22, 2018 that we were seeing a setup for a long trade in UK equities. Brexit political chaos was reaching a crescendo, and there was a chance that we may see another referendum where the Remainers could prevail.

Since then, while there is no news of a second referendum, Business Insider reported that Theresa May may resign if she loses a vote on leaving the customs union after Brexit. The FTSE 100 (top panel) has steadied, and rallied through resistance and a downside gap from early February. In addition, UK equities have turned up relative to global equities (bottom panel) and begun to outperform.



We may be seeing a similar buying opportunity in the eurozone.

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

Sunday, April 22, 2018

Trade war jitters fade, but for how long?

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: 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.


Falling trade tensions = Equity bullish
I have written in these pages before that, in the absence of trade war tensions, the path of least resistance for stock prices is up (see Watch the Fed, not the trade war noise).

From a technical perspective, stock market is well supported by positive divergence from breadth indicators. Both the SPX Advance-Decline Line and the NYSE common stock only A-D Line made all-time highs last week.




From a fundamental viewpoint, equity valuations are not especially demanding when compared to bonds. The market started to get concerned last week when the 10-year yield approached 3%, but some perspective is in order. As the following chart shows, FactSet reported that forward P/E ratio is in the middle of its 5-year range. By contrast, the 10-year yield is near the top of its 5-year range, indicating slightly equities are cheap relative to Treasuries. On a 10-year perspective, however, the forward P/E is above its historical range and so is the 10-year yield. Depending on your time horizon, valuations are either slightly cheap or slightly expensive, but levels are nothing to panic over.


In addition, earnings are continuing to rise. Results from Q1 earnings season have been solid, with above average EPS and sales beat rates. In addition, forward 12-month EPS are rising, indicating positive fundamental momentum.


The bullishness is not just attributable earnings results. Brian Gilmartin at Fundamentalis pointed out that revenue growth and beat statistics are highly encouraging.



What could possibly go wrong?

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

Wednesday, April 18, 2018

The canary in the credit crunch coalmine

Historically, every recession has been accompanied by an equity bear market.


One characteristic of every recession has been a credit crunch. As the economy slows, banks react by tightening their lending criteria, which dries up the availability of credit, and eventually causes a credit crunch. There are a number of ways that investor can monitor the evolution of lending standards.

The most obvious way is to watch the Fed's lending officer survey. The latest data shows that readings remain benign for both corporate and individual borrowers. One disadvantage of the survey is the results only come out quarterly, which is not very timely and amounts to looking in the rear view mirror.


A more timely data series are the Chicago Fed`s Financial Conditions Index, and the St. Louis Fed`s Financial Stress Index. Current conditions show that Stress levels are starting to rise, though the absolute stress levels remain low. Both of these data series are released monthly, which is more timely than the lending officer surveys.


There may be a better real-time way of watching for a credit crunch.

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

Tuesday, April 17, 2018

Time for a pause in the bulls' charge

Mid-week market update: Don't get me wrong, I am still bullish, but the stock market rally appear a little extended in the short run and due for a brief period of consolidation. The SPX broke out from its inverse head and shoulders (IHS) pattern this week, cleared its 50 day moving average (dma), and filled in the gap from March 22. The next upside objective is the IHS objective of 2790-2800, whic coincides with resistance defined by the highs set in late February and March.



In the short run, however, the market looks overbought and may be due for a pause.

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

Sunday, April 15, 2018

Buy gold for the late cycle inflation surge?

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: 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.


Late cycle expansion = Inflationary revival
The missiles have flown, and the bombs dropped. Inflationary pressures are rising. Is this the time for gold to shine?

Notwithstanding the short-term effects of geopolitical tension, consider the longer term inflationary pressures, which are building not just in the US but globally. Ned Davis Research recently pointed out that roughly two-thirds of countries are growing above their long-term potential. Unless these countries can increase their potential through faster labor force or productivity growth, inflationary pressures begin to build, followed by central bank tightening. We could reach recessionary conditions in the next year or so.



This suggests that the economy is undergoing a late cycle expansion characterized by capacity constraints, which would lead to an inflationary revival. Gold prices are currently testing a key resistance level. Should it stage an upside breakout, who know how far they could go.



The macro bull case for gold is easy to make. Gold is an inflation hedge, and inflation momentum is rising.


J C Parets of All Star Charts highlighted a washout in the silver/gold ratio as an indicator of precious metal risk appetite. A rising silver/gold ratio would indicate that animal spirits have taken over the precious metal complex, which would be highly bullish.


Tiho Brkan pointed out that hedge funds are in a crowded short in silver futures, which is bullish for silver, and for gold by implication.


In short, sentiment models indicate that silver prices are poised for a powerful rally. The combination of rising geopolitical tensions, and possible strength in silver prices would  be highly bullish for gold and other inflation hedges.

Does that mean that investors and traders should pile into precious metals in anticipation of a late cycle inflation surge? Not so fast! There are two sides to every story, and the bull case for gold may be too facile to be true.

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

Wednesday, April 11, 2018

A bottoming process

Mid-week market update: As the market bounces around in reaction to the headline of the day, it is important to maintain some perspective and see the underlying trend. Numerous sentiment and technical indicators are pointing towards a bottoming process and a bullish intermediate term outlook. Day-to-day price movements, on the other hand, are hard to predict.

Consider, for example, the positioning of large speculators (read: hedge funds) in the high beta NASDAQ 100 futures and options. Hedgopia reported that large speculators are in a crowded short in NDX.


By contrast, large speculators are in a crowded long in the VIX Index, which tends to move inversely with the stock market.


While Commitment of Traders data analysis tend to work well as a contrarian indicator on an intermediate term time frame, sentiment models can be inexact market timing indicators.

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

Tuesday, April 10, 2018

China's cunning plan to defuse trade tensions and reduce financial tail-risk

About three years ago, I outlined China's plan to extend its infrastructure growth without creating more white elephant projects in China (see China's cunning plan to revive growth). Enter the One Belt, One Road (OBOR) initiative to create infrastructure projects in the region. OBOR projects were to financed by the Asia Infrastructure Investment Bank (AIIB), which many countries had been falling all over themselves to finance. The infrastructure projects were to be led by (surprise) Chinese companies, which would extend their flagging growth.

Fast forward to 2018, The Nikkei Asian Review and The Banker issued a report card of OBOR projects. Here are their main findings:
Project delays After initial fanfare, projects sometimes experience serious delays. In Indonesia, construction on a $6 billion rail line is behind schedule and costs are escalating. Similar problems have plagued projects in Kazakhstan and Bangladesh.

Ballooning deficits Besides Pakistan, concerns about owing unmanageable debts to Beijing have been raised in Sri Lanka, the Maldives and Laos.

Sovereignty concerns In Sri Lanka, China's takeover of a troubled port has raised questions about a loss of sovereignty. And neighboring India
openly rejects the BRI, saying China's projects with neighboring Pakistan infringe on its sovereignty.
None of these problems are big surprises. I had outlined in my 2015 post that Chinese led infrastructure projects tended to see inflated costs, and the geopolitical objective of OBOR was to extend China's influence in the region.

Today, China faces two separate problems. The most immediate issue are rising trade tensions with the United States. The second and more pervasive issue is the growing mountain of debt, which are backed by less productive assets, which elevates financial tail-risk. The China bears' favorite chart exemplifies that problem.


The latest developments indicate that Beijing has developed a cunning plan to defuse both trend tensions and reduce financial tail-risk.

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

Monday, April 9, 2018

Evaluating Jim Paulsen's market warning

I have been a fan of Jim Paulsen for quite some time. The chart below depicts the track record of my major market calls. His work formed the basis for my timely post in May 2015 (see Why I am bearish (and what would change my mind)), which was received with great skepticism at the time.

The track record of my major market calls


This time, though, I believe that Jim Paulsen's warning for the equity market outlined in this Bloomberg article is off the mark. Paulsen's cautionary signal for the stock market is based on his Market Message Indicator, which has rolled over. The indicator is described in the following way:
The gauge takes five different data points into account: how the stock market is performing relative to the bond market, cyclical stocks relative to defensive stocks, corporate bond spreads, the copper-to-gold price ratio, and a U.S. dollar index. The goal is to devise a gauge that acts as a proxy for broad market stress.
I have annotated (in red) in the chart below the subsequent peak in the stock market after this indicator gave a sell signal. This indicator is far from infallible, but the market has weakened the last few times this indicator peaked and rolled over. During the study period that begins in 1980, some sell signals simply did not work, or there were long delays between the sell signal and the actual peak.


Here is what I think Paulsen is missing.

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

Sunday, April 8, 2018

Watch the Fed, not the trade war noise

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: 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.


Fade the trade war jitters
"Fool me once, shame on you. Fool me twice, shame on me." We've seen this movie before on trade. The White House begins the process with tough and inflammatory rhetoric, only to see the threats walked back or watered down later.

Consider the case of the steel and aluminum tariffs, which were levied for national security reasons. The initial announcement shocked the market, but the Trump administration eventually walked back most of their effects by providing exemptions for Canada, Mexico, the EU, Australia, Argentina, Brazil, and South Korea. Um, those exemptions account for over half of American steel imports. What "national security" considerations are we referring to?

The KORUS deal is another example. The agreement was hailed as a great victory by the Trump administration, but the tweaks were only cosmetic in nature. The South Koreans agreed to two concessions. In return for an indefinite exemption from the steel and aluminum tariffs, Seoul agreed to a steel export quota to the US, but the quotas are toothless because they are contrary to WTO rules and could be challenged at anytime. In addition, South Korea doubled the ceiling on American cars that don't conform to Korean standards which could imported into that country. The ceiling increase was meaningless because US automakers were not selling enough cars under the old ceiling. In other words, the KORUS free trade deal was a smoke and mirrors exercise and a face saving out of a potential trade war.

The NAFTA negotiations followed a similar pattern of using bluffs as a tactic, and reacting afterwards. Trump began the process by declaring the free trade agreement "unfair" and "terrible". He then threatened to tear up the treaty. The latest news from Bloomberg indicates that American negotiators are pushing very hard to have an agreement in principle in place by the Peru Summit of the Americas that begin April 13 next week. How much leverage will the American side have if the other negotiators know that Trump wants a deal by next week? Much work needs to be done before an agreement in principle can be made, but watch for more climbdowns and a declaration of "victory" by the White House.

So why worry about a possible trade war with China? Investors worried about equity downside risk should instead focus on the likely direction of monetary policy. New Deal democrat recently outlined a simple recession model which states that whenever the YoY change in the Fed Funds rate rose above the annual change to employment, a recession has followed within a year.


As the Fed normalizes monetary policy, it is on the verge of making a policy error where it tightens into a weakening expansion and crashes the economy. Recessions have invariably translated into equity bear markets in the past. That's why investors should look past the trade war noise and focus on monetary policy.

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

Wednesday, April 4, 2018

The post-FANG market beaters hiding in plain sight

Mid-week market update: It is encouraging that the stock market held up well in the face of bad news on global trade. Global markets adopted a risk-off tone on the news of Chinese trade retaliation, but the SPX managed to hold a key support level and rally through a downtrend line.



Looking over the past few weeks, equity market weakness really started rolling when technology stocks rolled over in March. The carnage was not just confined to Facebook, or Amazon, but to the entire technology sector and globally. The relative performance of European technology stocks (green line) paralleled the relative performance of US technology.



One encouraging sign for the broader market can be found in my risk appetite metrics. High yield bonds (top panel) are not confirming the weakness in stock prices, though momentum (middle panel), and high beta (bottom) panel are struggling.



Notwithstanding the weakness in the technology sector, where can investors find opportunity (or places to hide) in light of the constructive view on the broader equity market?

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

Monday, April 2, 2018

What's the real test? The 200 dma or you?

As the SPX sold off today and tested the 200 day moving average (dma) while exhibiting positive RSI divergences, a Zen-like thought occurred to me. Is the market testing the 200 dma, or is it testing you?



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

Sunday, April 1, 2018

Is this what a regime change looks like?

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: 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.


Tech rollover = Regime change?
Is the stock market undergoing a regime change? The Average Direction Index (ADX) is a trend indicator developed by J.Wells Wilder to measure the strength of a price trend. The higher the ADX level, the strong the trend. The chart below shows the relative performance of technology stocks compared to the market. Even though this sector remains in a relative uptrend, the ADX of the relative performance ratio began to roll over in late 2017. The weakness in trend culminated in the recent carnage of FANG and semiconductor stocks.


The enthusiasm for technology stocks may be overdone, as the sector has exceeded its weight in the SPX index, which last peaked during the NASDAQ Bubble.


There is a fundamental reason for the weakness in this sector. I had written about this possibility last October (see Peak FANG), where I suggested that the regulators would come for the Big Data companies in the next recession. Facebook and Google were the prime targets because they were in the surveillance business, largely because of the creepiness effect of their practices. Of the other FANG names, Amazon is also vulnerable because of their strategy to entice users into their walled garden by learning everything about them in order to sell them goods and services. The latest Facebook episode mane mean that the competitive moats of these companies may be already breached. A prolonged period of market performance may be in store, much in the manner of Microsoft after its anti-trust battle with the Justice Department.

In connection with the failure of FANG and technology leaders, the stock market is also showing signs of weakening. The SPX recently breached an uptrend line, and its ADX has also rolled over.


These developments raise two key questions for investors. If technology leadership is indeed failing, can any other sectors step up to take its place? As well, does the weakness in these high octane and high beta groups the sign of a top for the overall stock market?

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