Sunday, February 9, 2020

Where's the sentiment reset?

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: 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.

Is sentiment too bullish?
Mark Hulbert warned about excessively bullish sentiment leading to a market decline in a Marketwatch column on February 1, 2020. At the time, Hulbert wrote that he would like to see bullish sentiment to retreat and the Wall of Worry to rebuild.
It would be a good sign if they rush to the sidelines and then quickly jump onto the bearish bandwagon. In contrast, it would be a bad sign if they stubbornly hold onto their bullishness in the wake of the decline. In that case, contrarians would expect that an even deeper correction would be necessary to rebuild the Wall of Worry that would support a new leg upwards.
The market did fall briefly, but rallied in the face of massive PBOC market support. In a follow-up column last week, Hulbert issued a second warning about excessive bullishness. His Hulbert Stock Newsletter Sentiment Index fell, but rose again into the top 80% of bullishness. Such readings have historically been resolved with subpar returns over a 1-3 month time frame.

The stock market advance appears to be unsustainable on an intermediate term basis, but even Hulbert's analysis shows a return of 0.0% over one month, which is hardly a wildly bearish forecast. The bigger question is, how vulnerable is the market in the short run?

It would be very easy to turn tactically bearish here, but let us turn conventional technical and sentiment analysis on its head. It is entirely possible that we are undergoing a period where sentiment resets briefly, and stock prices rally to even more highs as pictured by my green annotated periods.

How vulnerable is the market? Has sentiment reset sufficiently for the market to make another run at fresh highs?

The full post can be found here.

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