Sunday, May 6, 2018

Why I am not ready to call a market top

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.

Market top is still ahead
As stock prices chopped around in an indecisive fashion in past few weeks, the traders in my social media feed have become increasingly nervous and bearish. The bull can point to the SPX repeatedly testing its 200 day moving average (dma), which has held as technical support. However, the market's inability to rally despite what has been good earnings news during a Q1 earnings season with solid results is worrisome.

My review of intermediate and long-term technical market conditions, as well as the macro backdrop reveals that no pre-conditions of a bear market are in sight. While there are concerns that the American economy is undergoing the late cycle phase of an expansion, which is typically followed by a bear phase. I am not ready to make the investment call that stock prices have topped out just yet.

Consider, as an example, the Relative Rotation Graph (RRG) as a way of analyzing changes in sector leadership. RRG charts are a way of depicting the changes in leadership in different groups, such as sectors, countries and regions, and market factors. The charts are organized into four quadrants. An idealized group rotation pattern occurs in a clockwise fashion. Leading groups (top right) deteriorate to weakening groups (bottom right), which then rotates to lagging groups (bottom left), which changes to improving groups (top left), and finally completes the cycle by improving to leading groups (top right) again.

The latest RRG chart depicts a stock market with the emerging leadership of late cycle inflation sectors (gold and oil), which is the result of late cycle inflationary pressures, along with interest sensitive sectors (REITs and utilities) as the result of a dovish Fed.

This combination suggests that the market is setting up for one last inflationary blow-off before the Fed steps on the monetary breaks to cool the economy into a bull market killing recession.

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

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