Sunday, November 4, 2018

Was the market swoon made in China?

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: Bearish*
  • 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.

A made in China selloff?
There is a family joke in our household that Santa Claus doesn't live at the North Pole, but in China. That's because everything he bring says "Made in China".

There have been many explanations for the recent market swoon, such as rising rates, earnings disappointment, or earnings growth deceleration from the fading effects of the tax cuts, and so on. John Authers, who is now at Bloomberg, pointed out that the recent sell-off may have been made in China.
Volatility returned to U.S. stocks again Monday afternoon. This is still, I think, largely about forced sellers as speculators such as hedge funds get used to the reality of having to operate with less leverage. But it would be wise to note that there is obviously a Chinese component to this. Since 2016, the more a company was exposed to China, the better it had done. But that has all changed in recent weeks, and those companies are doing worse.

It's starting to look that way. After Trump tweeted about his "good conversation" with Xi Jinping, and Bloomberg reported that he asked his cabinet to draft a possible deal with China (what have they been doing all along?), global markets went full risk-on Thursday night. Stock prices reversed themselves Friday after White House officials denied that there were any cabinet preparations for a trade plan with China. The market partially recovered when Trump contradicted his staff and stated that he thinks the US will reach a trade deal with China.

If the Made in China thesis is correct, investors need to adjust the macro, fundamental, and technical analytical framework from a purely domestic focus to one more global in nature. This week, I explore the underpinnings of this hypothesis, and the steps to take should it be correct.

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

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