Sunday, August 19, 2018

Could China take the baton if the US growth falters?

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 if I am wrong?
Good investors always examine their assumptions. What if I am wrong? What are  the risks to my forecasts?

I had lunch with a friend where he pushed back on my bear case for a major market top (see Major market top ahead: My inner investor turns cautious and How far can stock prices fall in a bear market?). The macro scenario goes something like this. The Fed is on track to steadily raise rates by a quarter-point every three months. Monetary indicators, such as money supply growth and the yield curve, are on a trajectory to flash recessionary signals by year-end, if not before. The US sneezes and slows into a mild recession, China catches a cold and collapses into a hard landing because of its excess leverage. Global contagion spreads into a global synchronized recession whose magnitude could be as bad as the last financial crisis.

Already, the global outlook is precarious. US equities seem to be the only game left in town as everyone piles into them.

To be sure, the US is the last source of growth left standing. LPL Financial found that while US earnings expectations are still rising, they are flat for non-US developed markets (EAFE), and falling in the emerging markets. Sure, America is leading the world, but if the US slows, what happens then?

My lunch companion's key objection to the bearish scenario is the China linkage. It is unclear whether a slowing American consumer will trigger a significant slowdown in China. Even if Chinese economic growth were to slow, Beijing still has lots of policy levers to cushion a downturn. This is an important question. China remains the big swing factor in global growth. What if China doesn't collapse? The downside risk to my bearish scenario would be very mild by comparison.

If US growth were to falter, could China pick up the baton?

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

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