Sunday, June 3, 2018

Revealed: The market timers' dirty little secret

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.

What market timers won't tell you
Market timers have a dirty little secret that they won`t tell you, "Bottoms are easy to call, but tops are hard."

Consider the use of the NAAIM exposure index just as a typical example of a contrarian indicator. In the last 10 years, episodes when the NAAIM fell below its Bollinger Band (blue vertical line) have been good trading buy signals. While oversold markets can become more oversold, buy signals have marked periods of low downside risk. On the other hand, sell signals when NAAIM rose above its upper BB have not worked well.

The perspective is totally different from a business viewpoint. What market timers won't tell you that it's the doom and market crash narratives that get the clicks and the views. Mark Hulbert revealed that "bear markets and heightened volatility are good for business" of newsletter writers. In the two years leading up to the January top, stock prices went straight up:
Who needs a market timer during conditions like those? One leading stock-market timer I monitor told me that during the market’s blow-off stage between last November and the late-January peak, he lost 18% of his subscribers. He added that he’d never before experienced a drop in subscribers of similar magnitude — much less over so short a period.

Glenn Neely, editor of the NeoWave market-timing service, said 2016 and 2017 were some of the most difficult he’s experienced in a 30-year career.
With those factors in mind, I analyze some of the scare stories that have come across my desk in the last few weeks and show why they should not be reasons for panic:
  • Eurozone crisis: Italy and Spain
  • A looming junk bond Apocalypse
  • A crowded long position in the equity bull trade 
  • Signs of complacency at the Fed
As the Wall Street adage goes, "Bottoms are events, while tops are processes." Ignore "this will not end well" warnings with no obvious bearish trigger. Don't be fooled by the clickbait stories of doom.

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

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