Sunday, August 26, 2018

10 or more technical reasons to be cautious on 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 hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

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.

What I am cautious on stocks
I continue to get resistance to my recent bearish calls (see Major market top ahead: My inner investor turns cautious), and that was even before the major indices broke out to fresh record highs. To reiterate, the cautiousness was triggered by both technical and macro considerations. Most importantly, the Wilshire 5000 is exhibiting a negative divergence on the the monthly chart, which has foreshadowed important market tops in the past.

As well, a number of my Recession Watch long leading indicators are rolling over. While the current snapshot forecast for the next 12 months remains neutral, at the current pace of deterioration, they would become sufficiently negative to flash a recession warning later this year. This would indicate that a recession would occur in Q4 2019. As stock prices tend to be forward looking, the combination of bearish technical readings and weakness in long leading indicators suggest that a market top is forming about now.

In addition to the bearish technical indicators I cited three weeks ago, a number of other warnings have appeared indicating intermediate term cautiousness for equity investors.

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

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