Sunday, August 12, 2018

Two gifts from the market gods

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.

More market warnings ahead
I received a lot of feedback from my post last week (see Major market top ahead: My inner investor turns cautious), mostly because it represented a major change in investment outlook. I would like to clarify a point that the post did not represent a sell signal for stocks, but the setup for a sell signal.

In the short run, the market gods have given investors two gifts. First, the evolution of the Turkish Tantrum provides investors a glimpse at what a real EM blow-up might look like in the future, especially if China were to undergo a debt crisis.

In addition, the path of least resistance for stock prices is still up for the next few weeks. Any rally therefore represents a second gift from the market gods. Investors can take the opportunity to lighten up their equity holdings in anticipation of long-term market weakness.

There have been plenty of warnings that US equities are topping out, starting with how monetary policy is affecting both Wall Street and Main Street. The latest Turkish inspired sell-off just provides another point of bearish pressure.

Even before Friday`s market blow-up, the fault lines were starkly revealed when the Deputy Prime Minister of Turkey tweeted a complaint about Fed policy.

In light of Friday's above consensus core CPI print, the Fed is likely to stay on their preset course of a quarter point rate hike every three months. Already, the Turkish lira crisis has sparked an upside breakout of the USD Index. If the breakout holds, it will spell trouble in other quarters. In addition to the pressure on other vulnerable EM currencies, a rising USD depresses the Chinese Yuan (CNY) and raise the specter of a currency war.

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

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