Wednesday, May 29, 2019

Some all-weather industries to consider

Mid-week market update: The headlines look dire, and so does the market action. Relative performance analysis shows that defensive sectors have become the leadership, but as the October to December selloff shows, they are coincidental indicators and offer no predictive power as to future market direction.



What should you do? Today, I look through the market turmoil and offer some suggestions of industry groups that appear to stand up well independent of their beta characteristics. These group have the potential to be the leaders in the next upturn.

The full post can be found here.

Monday, May 27, 2019

From a trade war to a cold war?

This is the second part of a two part series on the unusual market pattern that we have been undergoing (see part one, Peak fear or Cold War 2.0). While the market may have discounted a substantial amount of the first-order effects of a trade war, the tail-risk of the loss of business confidence in a full-blown trade war is difficult to measure. In addition, the US and China may be on the verge of Cold War 2.0, which would disrupt and bifurcate technology platforms and supply chains.


Cold War 2.0?
The Economist recently devoted a special report to how a trade war is becoming a Cold War 2.0:
Fighting over trade is not the half of it. The United States and China are contesting every domain, from semiconductors to submarines and from blockbuster films to lunar exploration. The two superpowers used to seek a win-win world. Today winning seems to involve the other lot’s defeat—a collapse that permanently subordinates China to the American order; or a humbled America that retreats from the western Pacific. It is a new kind of cold war that could leave no winners at all.
This development was not a surprise. I had warned about the risk of a Cold War 2.0 in January 2018 when the US unveiled its National Security Strategy that defined China as a "strategic competitor" (see Sleepwalking towards a possible trade war). In retrospect, that publication of the NSS document was probably as historically important as Winston Churchill's "iron curtain" speech in 1946 that marked the start of the Cold War with the Soviet Union.

Viewed in that context, these trade talks represent only an initial skirmish in a globalized competition between two political and economic systems. While my base case scenario calls for a brief truce to be achieved probably in late 2019, the onset of Cold War 2.0 represents a tectonic shift in global trade and investment flows that will have multi-decade long investment implications.

The full post can be found here.

Sunday, May 26, 2019

Peak fear, or Cold War 2.0?

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: 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.



An unusual market
Ever since Trump's weekend tweet cratered the trade talks three weeks ago, the stock market has behaved in an unusual way.



First, it is unusual in that this trade tension induced pullback has been very shallow. Stock prices are less than 5% from their all-time highs despite the heightened trade tension. In addition, the market has been trading in an unusual way. The chart below depicts the returns of the market since the above Trump tweets. While the index (black line) is down -4.1% since that day, the open-to-close return, which shows the returns during the day (blue line), was actually a positive 1.7% during this period. The spread is an astounding -5.8%. During this period, the market had reacted negatively to overnight and weekend news, while strengthening during daytime trading hours.



This is the part one of a two part publication, designed to address the following questions:
  1. What are the fundamental, macro, and technical factors that are supporting market prices during normal market hours?
  2. How do we talk about the elephant in the room, namely the risk of a trade war, and how it might turn into Cold War 2.0?
The full post can be found here.

Wednesday, May 22, 2019

Range-bound, with a bullish lean

Mid-week market update: It appears that the stock market is may be range-bound until Trump and Xi meet in Japan in late June. A high level of uncertainty is the order of the day, with short-term direction will be determined by the latest news or tweet.

As the chart below shows, the range is defined by a level of 2800 on the downside, and 2895-2900 on the upside. From a technical perspective, direction cannot be determined until either an upside or downside breakout is achieved.



There is some hope for the bulls. The market is forming a nascent inverse head and shoulders formation, with a measured target of 2980 on an upside breakout. As good technicians know, head and shoulders formations are not complete until the neckline breaks. The current pattern can only be interpreted as a setup that may fail.

The presence of unfilled gaps both above and below current levels do not give any hint on likely direction. However, the market is giving a number of bullish clues from a technical perspective.

The full post can be found here.

Monday, May 20, 2019

Imminent war with Iran?

The headlines look ominous. The US has dispatched a carrier task force to the Persian Gulf, and a second one is due to arrive soon. The State Department ordered the evacuation of all non-essential personnel from Iraq:
The U.S. State Department has ordered the departure of non-essential U.S. Government employees from Iraq, both at the U.S. Embassy in Baghdad and the U.S. Consulate in Erbil. Normal visa services at both posts will be temporarily suspended. The U.S. government has limited ability to provide emergency services to U.S. citizens in Iraq.
We had a threatening Presidential tweet over the weekend.


Reuters reported that Exxon Mobil is evacuating foreign staff from an Iraqi oilfield near Basra:
Exxon Mobil has evacuated all of its foreign staff, around 60 people, from Iraq’s West Qurna 1 oilfield and is flying them out to Dubai, a senior Iraqi official and three other sources told Reuters on Saturday.
Though it was said to be a purely precautionary measure:
Production at the oilfield was not affected by the evacuation and work is continuing normally, overseen by Iraqi engineers, said the chief of Iraq’s state-owned South Oil Company which owns the oil field, Ihsan Abdul Jabbar. He added that production remains at 440,000 barrels per day (bpd).
Is the US about to attack Iran? Should you buy tail-risk insurance?

The full post can be found here.

Sunday, May 19, 2019

Tariff Man vs. Dow Man

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.



Trump's two personas
Trump's two personas are on a collision course with each other. On one hand, he likes to style himself as Tariff Man, because he believes the US has had a raw deal from its trading partners. The list of offenders starts with China, but it is numerous. Tariffs are the best tool to address that imbalance. On the other hand, Trump the Dow Man loves a booming stock market, which he tracks obsessively, and views it as a form of validation of the success of his administration.

As trade jitters rose, the stock market has become nervous and sold off. Markets hate trade wars, and they hate uncertainty. While Tariff Man and Dow Man can coexist when trade tensions are low, we will reach some tipping point where Trump has to choose.

Jason Furman raised a number of insightful points in a recent Twitter thread.
It would be rational to escalate the trade war with China if the short-run cost for the U.S. economy are outweighed by the long-run benefits of a more favorable trade agreement.

This is not a priori bad economics, it is a numerical cost-benefit question.

I have seen many quantification of the SR [short run] cost (usually something like 0.5pp hit to GDP growth if the tariffs are expanded and sustained).

But I have seen no quantification of the benefit of plausible or best-case Chinese concessions relative to what they have already conceded.

The LR [long run] benefits conditional on a favorable resolution is just one input into a view on the strategy, you would also need to know how the trade war changes the probability of a favorable resolution. But we should be able to take a stab at quantifying the LR benefits.

In theory equity markets are doing this sort of present value calculation—we lose upfront but this strategy raises the chances we get more IP protections, soybean sales, etc. And they seem to be saying that the potential LR benefits don’t outweigh the SR costs.

This is consistent with my hunch that there would be only a very small macro difference for the U.S. economy between China’s last offer and our latest demand. But I wish I had more than a hunch. Anyone seen anything better?
In other words, would the price of a trade war be worthwhile? We have a reasonable idea of what the costs are, but has anyone calculated the net benefits under varying assumptions and scenarios? In particular, has anyone in the Trump administration done a cost-benefit analysis?

If not, will Trump the Tariff Man or Trump the Dow Man gain the upper hand in the crunch? What are the bull and bear cases?

The full post can be found here.

Wednesday, May 15, 2019

Bottoming

Mid-week market update: There are numerous signs that the US equity market is making a short-term tradable bottom. Firstly, the market is washed out and oversold. While oversold markets can become more oversold, we saw some bullish triggers in the form of positive divergences on the hourly SPX chart.

Even as the index fell, both the 5 and 14 hour RSI made higher lows and higher highs. In addition, the VIX Index failed to make a higher high even as prices declined. Possible upside targets are the three gaps left open in the last few days.



The full post can be found here.

Monday, May 13, 2019

Assessing the trade stalemate scenario

I wrote yesterday (see Why investors should look through trade tensions):
Calculated in economic terms, China would “lose” a trade war, but when calculated in political cost, America would lose as Trump does not have the same pain threshold as Xi.
Based on that analysis, I concluded that it was in the interests of both sides to conclude a trade deal, or at least a truce, before the pain became too great. In addition, the shallow nature of last week's downdraft led me to believe that the market consensus was the latest trade impasse is temporary, and an agreement would be forthcoming in the near future.

I then conducted an informal and unscientific Twitter poll on the weekend, and the results astonished me. The poll was done on Saturday and Sunday, and a clear majority believes that it will take 10+ months to conclude a US-China trade deal, or it will never be done.


In view of this poll result, it is time to explore the stalemate scenario. What might happen if negotiations became drawn out, or if the trade war escalates?


The full post can be found here.

Sunday, May 12, 2019

Why investors should look through the trade tensions

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.



Looking through a trade war
Josh Brown made an astute comment last week that all investors should keep in mind.


Here is why I think investors should look through the effects of any trade tensions.

The full post can be found here.

Wednesday, May 8, 2019

Some lessons on trading market surprises

Mid-week market update: When the news of the Trump tweets broke, I wrote:
When it comes to unexpected news, my tactical inclination is to stand aside and let the market tell the story, and then reassess once the dust is settled.
In a very short time, the market has gone to a full-blown panic.


The breadth of the decline has been astounding, and it is unusual to see this level of correlation in a sell-off, especially when the SPX is only -2.1% off its all-time highs as of Tuesday's highs. This kind of behavior is evidence of a panicked stampede.


That said, the dust is starting to settle on this trade related downdraft. It is time to assess the situation.

The full post can be found here.

Monday, May 6, 2019

How to navigate Trump's trade gambit

President Trump surprised the market on Sunday with a tweeted threat:



Notwithstanding his misunderstanding that tariffs are not paid by the Chinese, but American importers, this tweet sounds like an effort to put pressure on China, just as Vice Premier Liu He is scheduled to arrive in Washington on Wednesday with a large (100+) trade delegation for detailed discussions. News reports indicate that both sides have given significant ground, and a deal may have been possible by Friday.

In response to Trump's tweeted threat, the WSJ reported that the Chinese may reconsider making their trip to Washington because "China shouldn't negotiate with a gun pointed at its head". CNBC subsequently report indicated that the Chinese are preparing to visit Washington, but with the delegation size will be reduced, the timing of the visit is not known, and it is unclear whether Vice Premium Liu He will be in the group.
A Chinese delegation will come to the U.S. this week for trade talks after President Donald Trump upended negotiations by threatening new tariffs on Sunday, according to sources familiar with the matter.

One of the sources briefed on the status of talks said the Chinese would send a smaller delegation than the 100-person group originally planned. It is unclear whether Vice Premier Liu He would still helm this smaller group, an important detail if the team were traveling to Washington with an eye toward sealing a deal. Two senior administration officials described Liu as "the closer", since he had been given authority to negotiate on President Xi Jinping's behalf.

The team from Beijing was set to start talks with American negotiators on Wednesday as the world's two largest economies push for a trade agreement. It is unclear whether the talks will still start Wednesday.
Another encouraging sign was the report that Chinese media censored Trump's tweets, which could be interpreted as a signal that Beijing did not want to unnecessarily escalate the conflict. The front pages of the two major Chinese news portals had no mention of Trump's threats.


US tariffs are already higher than most developed market economies. If implemented, the new levels would be higher than most EM economies, and have a devastating effect on global trade.



I spent Sunday responding to emails and social media inquiries about how to react to this news. In many ways, it was more exciting than watching the latest episode of the Game of Thrones.

The full post can be found here.

Sunday, May 5, 2019

Green shoots, rotten roots?

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.



Are the green shoots turning brown?
Just when you think the global economy is starting to spring green shoots, the skies have darkened and some of those shoots may be turning brown. In the US, ISM Manufacturing fell and missed expectations. And that's not all. Analysis from Nordea Markets concluded that the internals are pointing to further weakness.


In China, both the official PMI, which is tilted towards larger SOEs, and the Caixin PMI, which measures SMEs, fell and missed expectations. These readings have cast doubt on the longevity of Beijing's stimulus driven rebound.


On the other hand, the Non-Farm Payroll report came in ahead of expectations. In Europe, the PMIs for peripheral countries like Italy and Greece are outperforming Germany. In addition, exports from Korea and Taiwan, which are highly globally sensitive, have rebounded indicating recovery.


What's going on? How do we interpret these cross-currents?

The full post can be found here.

Wednesday, May 1, 2019

A resilient advance

Mid-week market update: It is always a challenge to make a technical market comment on an FOMC announcement day. Market signals are unreliable. The initial market reaction can be deceptive, and any move reversed the next day after some somber second thought. In addition, today is May Day, and a number of foreign markets are closed, which deprive traders of additional signals from overseas.

With those caveats, I can make a general observation that the advance off the Christmas Eve low has been remarkable and resilient. A historical analysis from Steve Deppe shows that years that have begun with four consecutive monthly advances since 1950 have resolved bullishly, with only one single exception (N=14).


Oddstats also pointed out that 2019 was the fifth best start to the year.


If these small samples of history are any guide, the stock market should be considerably higher by year-end, unless you believe this is a repeat of 1971, based on Steve Deppe's analysis, or 1987, based on Oddstats' data.

The full post can be found here.