Sunday, March 31, 2019

Could a unicorn cull tank the economy and market?

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 a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). 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: 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.



Unicorn cull ahead?
As we bid adieu to the Q1 2019, there has been increasing angst about the possibility of a recession, though I have expressed my view that a number of internals cast doubt about the usefulness of the inverted yield curve signal (see How the market could melt up and Why the yield curve panic is a buying opportunity).  Notwithstanding my skepticism, I would like to explore what happens in a recession.

Recessions are cathartic processes that unwind the excesses of the past expansion cycle. The most obvious excess in this cycle has been the rise of Silicon Valley unicorns, private companies with valuations in excess of $1 billion.


The enthusiasm that greeted the Lyft IPO has raised angst among some investors about the herd of unicorns stampeding towards the IPO door, Bloomberg sounded a warning about a possible unicorn IPO mania:
Should these and others make it to the stock exchange, 2019 could prove to be one of the biggest years on record for the amount of money raised in U.S.-listed IPOs. The total will reach $80 billion this year, double the yearly average since 1999, Goldman Sachs Group Inc. predicted in November—an estimate that may prove low. And there’s no arguing that peaks in IPOs have occurred near major tops in the stock market and close to the onset of recessions. Both 1999 and 2007 were unusually strong years for IPOs that were swiftly followed by nasty bear markets in stocks and downturns in the economy.
Could a stampede of unicorns mark a market top, and their subsequent cull sink the American economy?

The full post can be found here.

Wednesday, March 27, 2019

Some clarity from a "show me" week

Mid-week market update: I had characterized this week as a "show me" week for the market, though I had a slight bullish bias (see How the market could melt up). While I remained tactically bullish, a number of unanswered questions remained in light of the yield curve related sell-off that began late last week.

Some of those questions are getting answered. The bulls are still have control of the tape, though the control remains tenuous. The most positive sign is the SPX is holding a resistance turned support zone at about 2800. The market advance last summer was characterized by a series of "good overbought" readings on RSI-5, and pullbacks were halted when RSI-14 reached the neutral zone. The same pattern seems to be occurring today, which is constructive.


The full post can be found here.

Monday, March 25, 2019

Why the yield curve panic is a buying opportunity

There was some confusion from readers in response to my bullish pivot in yesterday's post (see How the market could melt up). Much of the confusion was attributable to the bear porn that has been floating around since last Friday from the inverted yield curve when the 10-year Treasury yield fell below the 3-month.

One example came from Ben Carlson at A Wealth of Common Sense, though Carlson did qualify his analysis that the timing of a stock market pullback has varied:
The timing of these market corrections varies widely. In late 1980 and early 2000, the inverted yield curve signaled a quickly approaching stock market peak. In the other three instances, it was almost two years until stocks broke down.


Troy Bombardia has also weighed in with his own analysis of past inversions.




I beg to differ. The underlying mechanism of this inversion is very different from previous episodes, and that's why I don't think a recession is in the cards.

The full post can be found here.

Sunday, March 24, 2019

How the market could melt-up

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 a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). 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: Sell equities*
  • Trend Model signal: Neutral*
  • Trading model: Bearish*
* 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.



Melt-up ahead?
While this is not my base case scenario, there is a decent chance that the stock market may melt-up in light of the Fed's extraordinarily dovish statement last week. One parallel to the market hiccup of late 2018 would be 1998, when the Fed stepped in to rescue the financial system in the wake of the Russia Crisis.


A melt-up in the current environment would be supported by the combination of loose monetary policy and easy fiscal policy.

The full post can be found here.

Wednesday, March 20, 2019

Sector selection guide for sentiment, momentum and contrarian investors

Mid-week market update: The instant market reaction on FOMC day can often be deceptive. Instead of a general market comment, I will focus instead on analyzing sectors using sentiment, momentum, and contrarian approaches. As a measure of sentiment, John Butters at FactSet recently analyzed sectors by the number of buy, hold, and sell rankings.


The sector with the most buy ratings is Energy, but I am going to set aside Energy and Materials from this analysis as commitments to those sectors amount to a bet on commodity prices, which has historically been inversely correlated to the USD. As the chart below shows, the USD Index has been range bound since November, and so has the relative performance of Materials. The relative performance of Energy to the market has also been range bound for 2019, despite the rally in oil prices.


The full post can be found here.

Monday, March 18, 2019

FOMC preview: Peak dovishness?

The big market moving event this week on this side of the Atlantic is the FOMC meeting, which concludes on Wednesday with a statement, followed by a press conference by Fed chair Jerome Powell. Ahead of that event, let us consider what market expectations are for Fed policy.

The CME's Fedwatch Tool shows that the market does not expect any rate hikes for the remainder of 2019, and a slight chance of a cut by the December meeting.


What about the size of the balance sheet? Callum Thomas conducted an unscientific Twitter poll last week that asked respondents when they expect the Fed to pause quantitative tightening, or QT. The biggest response was Q2, followed by answers in Q3 and Q4 later this year.


As we approach the FOMC meeting, investors have to be prepared for excessively dovish expectations from Fed policy.

The full post can be found here.

Sunday, March 17, 2019

Recession jitters: The new fashion?

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 a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). 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: Sell equities*
  • Trend Model signal: Neutral*
  • Trading model: Bearish*
* 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 recession jitters
I have been warning about the possibility of weakness in Q2 in these pages. Recently, I am seeing more and more evidence of recession jitters come across my desk. The respected UCLA Anderson Forecast issued a statement last week stating that economic growth is likely to slow in 2019 to 1.7% and to near recessionary conditions in 2020:
In his outlook for the national economy, UCLA Anderson senior economist David Shulman notes that while the global economy started out strong in 2018, signs of its weakening will likely be everywhere by year’s end. “The weakness is being amplified by the protectionist policies being employed by the Trump administration and the uncertainties associated with Brexit,” he writes. “This economic weakness has triggered a major contraction in global interest rates, making it difficult for the Fed to conduct its normalization policy, and has put a lid on long-term interest rates.

“After growing at a 3.1 percent clip on a fourth-quarter-to-fourth-quarter basis in 2018, growth will slow to 1.7 percent in 2019 to a near-recession pace of 1.1 percent in 2020,” Shulman adds. “However, by mid-2021, growth is forecast to be around 2 percent.” Payroll employment growth will decline from its monthly record of 220,000 to about 160,000 per month in 2019 and a negligible 20,000 per month in 2020, with actual declines occurring at the end of that year. In this environment, the unemployment rate will initially decline from 3.9 percent in January to 3.6 percent later in the year and then gradually rise to 4.2 percent in early 2021.
Antonio Fatas, the Portuguese Council Chaired Professor of European Studies and Professor of Economics at INSEAD, rhetorically asked in a blog post if low unemployment is sustainable. In other words, this is as good as it gets for unemployment and the economy? Past turns in the unemployment rate have been followed by recession.


The full post can be found here.

Thursday, March 14, 2019

The secret of crytocurrencies revealed!

For the longest time, I never "got" crytocurrencies. I never bought into the idea of an urgent need for a currency that is outside the control of the "authorities", or how you ascribe value to something that had no cash flow. If it has no cash flow, then how do you calculate a DCF value? Here is the perspective from Morningstar:
As with copper ingots, seashells, peacock feathers, and gold before it, cryptocurrency is a medium of exchange, rather than something that creates wealth on its own. It can be used to purchase cash--but it does not earn it. Try as you wish, your bitcoin receipt won't trigger dividend checks, any more than will a sheaf of peacock feathers or a mountain's worth of copper.

Assessing cryptocurrencies by calculating the value of their future payments is therefore a dead end. If cyber coins can be appraised, even tentatively, another approach must be found.

That cryptocurrencies do not generate cash does not mean that they lack worth. Seashells and peacock feathers don't go very far these days, but throughout history and across societies, gold has reliably been prized. So, too, have been rare gems.
How do you keep it safe? One of the functions of a bank, which exists within the formal financial system, is to keep you money safer than stuffing it under the mattress. Banks are there to mitigate situations of the apocryphal story of the Bitcoin pioneer who put a token $100 into BTC during its early days. Several years later, he realized he was a millionaire but he lost his password.

This also brings up the issue of the role of money and banking in managing a medium of exchange that functions as a store of value.



The full post can be found here.

Wednesday, March 13, 2019

From oversold to overbought to...

Mid-week market update: In my last post, I suggested that the stock market is headed for a corrective period, though a short-term bounce was possible this week because of its oversold condition (see Correction ahead: Momentum is dying). The market has staged a remarkable recovery this week by surging to test a key resistance level and readings are now overbought.



The key question then becomes, "Is the correction thesis dead?"

The full post can be found here.

Sunday, March 10, 2019

Correction ahead: Momentum is dying

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 a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). 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: Sell equities*
  • Trend Model signal: Neutral*
  • Trading model: Bearish*
* 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.



Momentum is dying
I have been cautious on the near-term equity market outlook for several weeks (see Here comes the growth scare and Still bullish, but time to reduce risk). I reiterate my point for being bullish and bearish over different time frames. While I believe stock prices will be higher by year-end, investors should be prepared for some turbulence over the next few months.

We are now seeing definitive technical evidence of a softer market in the near-term. Momentum is dying, and across a variety of dimensions. One key technique that I use to monitor momentum is the behavior of different moving averages. If the shorter moving average starts to roll over while the longer moving average continues to rise, that's a sign of fading price momentum.

The chart below depicts the weekly S&P 500 chart, with a MACD histogram on the bottom panel. Note how MACD, while still strongly positive, is starting to roll over. I find that the weekly chart is useful for intermediate term price moves while filtering out the noise from daily fluctuations.



In the past, such episodes have resolved themselves with either a sideways consolidation or market downdraft. I expect that the most likely outcome is a correction that will last 1-3 months, followed by a resumption of the bull market.

The full post can be found here.

Wednesday, March 6, 2019

Consolidation or correction?

Mid-week market update: I have been cautious about the US equity market outlook for some time, and the market seems to be finally rolling over this week. The SPX violated an uptrend while failing to rally through resistance.



In the short rim, stock prices are likely to experience difficulty advancing. However, such episodes of trend line breaches can either resolve themselves through a sideways consolidation or a correction. What is the more likely scenario?

The full post can be found here.

Monday, March 4, 2019

An EM warning

For several months, the BAML Fund Manager Survey shows that global institutions have been piling into emerging market equities.


The purchase of EM equities has been a smart move, as they have been leading the market upwards. However, their time in a leadership role may be coming to an end owing to a series of disappointments. EM started to top out against the MSCI All-Country World Index (ACWI) in early February, and relative performance has been rolling over ever since.



The full post can be found here.

Sunday, March 3, 2019

The boom of 2021

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 a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). 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: Sell equities*
  • Trend Model signal: Neutral*
  • Trading model: Bearish*
* 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.



The Great MMT Experiment of 2021
As I watched last week`s CNBC interview with Stephanie Kelton, I became increasingly convinced that 2021 could see a great experiment in MMT. In that case, the market hiccup of late 1998 could serve as a template for the recent hiccup of late 2018. In that case, the best is yet to come!


Stephanie Kelton is one of the leading academic proponents of Modern Monetary Theory (MMT). I wrote about MMT before, so I won't repeat myself (see Peering into 2020 and beyond). MMT postulates that a government which borrows in its own currency is only constrained by the inflationary effects of excessive debt, and until it hits that point, a government does not have to worry about deficits (for further background, see this Barron's interview with Stephanie Kelton).

There are a number of myths about MMT. It does not mean that deficits doesn't matter, deficits don't matter until the bond market decides it matters. There is no free lunch. It does not mean that government doesn't have to tax. Taxes are and remain a tool of fiscal policy. It is not Keynesian economics. Keynes believed that governments should try run deficits in bad times and surpluses in good times. MMT says that debt, by itself, is not a constraining factor.

With that introduction, I can sketch out a scenario in which MMT becomes the dominant ideology after the 2020 election, which could unleash a powerful fiscal stimulus on the American economy for the following reasons:
  • The rise of millennial political power;
  • A growing acceptance of government debt; and
  • Stimulus will occur, regardless of who wins the 2020 election.
Fiscal stimulus will be reflationary and equity bullish. I have no idea if the implementation of MMT will be a boon, or if Kelton will become the Arthur Laffer of the Left. The bill will be payable much later. In the meantime, investors should be prepared to party. If the results were to turn out to be catastrophic, investors can then opportunistically position themselves to profit from the cleanup.

The full post can be found here.