Sunday, January 19, 2020

Froth everywhere!

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 Asset Allocation 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: Neutral*
* 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.

Will history repeat itself?
Looking to the week ahead, there is no doubt that the stock market is becoming more and more frothy. While I did alert readers to the potential for a melt-up in early December (see Buy signal confirmed: It's a global bull), the magnitude of the price surge has caught me even by surprise.
I remain bullish on an intermediate term basis. The SPX may be undergoing a melt-up in the manner of late 2017. It is unusual to see the index remain above its weekly BB for more than a week, which it did two weeks ago. The melt-up of late 2017 also saw similar episodes of upper weekly BB rides, punctuated by brief pauses marked by “good overbought” conditions on the weekly stochastic. The technical conditions appear similar today, and I am therefore giving the intermediate term bull case the benefit of the doubt.
The melt-up of 2017/18 ended in late January, 2018. Will history repeat itself? As a reminder, here is the latest cover from Barron's.

Today, market conditions are characterized by:
  • Excessively bullish sentiment: While crowded long sentiment readings are warnings of downside risk, they do not act well as timely trading indicators.
  • Waiting for a catalyst: While there has been plenty of good news, there has also been bad news lurking in the background. This brings investors and traders to ponder the question of, "Is the glass half full or half empty?"
  • Overbought markets: But overbought markets can indicate either "good overbought" markets dominated by price momentum, or overbought markets ripe for a reversal.
The full post can be found here.

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