Saturday, October 31, 2020

Emerging tail-risk: An invasion of Taiwan

I am not in the habit of peddling conspiracy theories, but this is inadvertently becoming a Halloween tradition. Last Halloween, I wrote about how China could control Taiwan without firing a shot (see Scary Halloween story: How a weak USD could hand China a major victory). This year, a new geopolitical tail-risk is materializing for investors and for global stability. China's People's Daily recently published a “Letter to Taiwan’s Intelligence Organs” warning Taiwanese intelligence agencies against supporting President Tsai Ing-wen’s resistance to China's unification efforts (article in Chinese here, Facebook summary in English here).

People’s Daily on Thursday urged intelligence agencies in Taiwan to stay away from the “fatal track” of seeking Taiwan’s independence, which only leads to self-annihilation and is doomed to fail.

In the released Message to Taiwan’s Intelligence agencies, the Chinese mainland firmly opposed those independence-seeking diehards of the blind to allay their tiger-riding behaviors, and advised them to get a clear understanding of the situation and get back to the correct track, the only correct way of stopping them from dead ends.

“Don’t say I didn’t warn you,” said the message.

The message also reiterated that the Chinese mainland and Taiwan island share the same blood and same culture, and the mainland always welcomes variety of cooperation through different channels and encourages exchanges and dialogues with people of insight in Taiwan.

The warning was little noticed by most Western media. What was ominous was the phrase, "Don't say I didn't warn you" (勿谓言之不预也). Similar language was used by China when it launched military offensives in the past. It used that phrasing when it issued a "surrender or die" ultimatum to the nationalist garrison in Beijing in 1949. it warned American-led forces in Korea not to approach its Yalu River border in 1950; it warned India before attacking in 1962; and it issued a similar warning before the invasion of Vietnam in 1978.



This is not a drill.

The full post can be found here.


Wednesday, October 28, 2020

We're expecting riots...

Mid-week market update: There is an adage that when dentists start to buy, you should be selling. I came upon a tweet by a resident in Los Angeles with a dentist in the Santa Monica area. The dental office is expecting riots next week, regardless of who wins the election.


FBI firearm background checks are surging. Anecdotally, both sides are arming themselves in preparation for civil unrest.




Is this peak fear? It is time to buy the panic?

The full post can be found here.


Monday, October 26, 2020

The momentum vs. seasonality dilemma

I have some good news and bad news. The good news is the option market isn't as concerned about the prospect of a contested election. The chart below shows the history of the term structure of at-the-money implied volatility (IV). The latest readings shows that IV spikes just after Election Day, and deflates slowly afterward. The bad news is it took a -1.9% decline in the S&P 500 to invert the term structure to create this condition.


The full post can be found here.


Sunday, October 25, 2020

How the Election held the market hostage

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 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 those email alerts is shown here.

Subscribers can access the latest signal in real-time here.


The stealth hostage taker
For several months, the market has been gripped by a stealth hostage crisis. The uncertainty of a contested election has gripped the market, and risk premiums have spiked as a result. 

The fever seems to be partially fading. Google searches for "contested election" have fallen dramatically.

I have also been monitoring option market's implied volatility (IV) since late September. For much of this period, IV spiked just after the election, and remained elevated into mid-December and beyond. 



These unusual option market conditions have created confusion among traders, which can lead to erroneous interpretations of market sentiment.

The full post can be found here.

Saturday, October 24, 2020

Buy the cyclical and reflation trade?

The global economy seems to be setting up for a strong recovery. We are seeing a combination of easy monetary policy, slimmed-down supply chains, and a rebound in consumer confidence.


The cyclical and reflation trade is becoming the consensus view. However, there may still be time to board that train. Futures positioning in the reflation trade is rising, but levels are not excessive.


What are the bull and bear cases?

The full post can be found here.


Wednesday, October 21, 2020

The NASDAQ tail wagging the market dog

Mid-week market update: One of the key indicators I have been monitoring for the health of the market is the NASDAQ 100 (NDX), which is a proxy for large-cap technology stocks. So far, the NDX has been testing an important rising relative uptrend.


If the relative uptrend were to decisively break down, it would spell trouble for the overall market.

The full post can be found here.


Monday, October 19, 2020

Does the economy even need more stimulus?

House Speaker Nancy Pelosi has set a Tuesday deadline for an agreement for a coronavirus stimulus package before the election. Recent data begs the question of whether more stimulus is even needed. 

Last Friday's retail sales print was astonishingly strong and beat market expectations. While retail sales statistics are notoriously noisy, September retail sales rose sequentially in all major categories.


In addition, consumer confidence improved in early October despite the expiry of the $600 per week stimulus payments.



The full post can be found here.


Sunday, October 18, 2020

How the US is becoming an emerging 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 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 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: 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 those email alerts is shown here.

Subscribers can access the latest signal in real-time here.


A pre-election stall?
As we approach the November election, the market may be setting up for a pre-election stall. President Trump, otherwise known as "Dow Man", is fond of benchmarking his performance using the stock market. The S&P 500 (SPY) has returned an impressive 64.5% unannualized since Inauguration. Its performance against the long bond (TLT) is less compelling, but it beat bonds by a total of 12.1% over the same period. 



The most disturbing metric is the market's risk perception. The VIX Index is elevated, and trades at a premium to EM VIX. The market is now pricing US risk like an emerging market. Market nervousness is rising, and traders will have to contend with a heightened risk environment until the November 3 election.

The full post can be found here.

Saturday, October 17, 2020

How to trade the election

With the US election just over two weeks away, it's time to look past the election and focus on how the economy and markets are likely to behave. Barry Ritholz correctly advised investors in a recent post to check their political beliefs at the door when analyzing markets. Stock prices have done slightly better under Democratic administrations, but the effect is mostly noise in light of the small sample size.


With that in mind, let's consider the differences in market environment if Trump were to win, compared to a Biden win.

The full post can be found here.


Wednesday, October 14, 2020

Trading the breadth thrust

Mid-week market update:  I discovered an error in my last publication (see A Momentum Renaissance). The market did not achieve a Zweig Breadth Thrust buy signal last Thursday as I previously indicated, though it was very close.

As a reminder, the Zweig Breadth Thrust buy signal is triggered when the ZBT Indicator moves from an oversold to overbought reading within 10 trading days. In my previous publication, I misinterpreted the first day of the window as September 25, it was actually September 24. The ZBT reached an overbought condition in 11 days, not 10, therefore the ZBT buy signal was not triggered. 


I apologize for the error. Nevertheless, several other breadth thrust signals with less strict criteria were recently triggered, and it is worthwhile analyzing how to trade such conditions.

The full post can be found here.


Sunday, October 11, 2020

A Momentum Renaissance?

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: Sell equities*
  • Trend Model signal: Bearish*
  • 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.

Subscribers can access the latest signal in real-time here.


A MoMo revival
Despite my expectations, the market took on a risk-on tone in the past week, and momentum is making a return. The relative performance of price momentum factor ETFs have been strong since their bottom in early September, and most have made new recovery highs.


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The full post can be found here.

Saturday, October 10, 2020

A valuation puzzle: Why are stocks so strong?

One of the investment puzzles of 2020 is the stock market's behavior. In the face of the worst global economic downturn since the Great Depression, why haven't stock prices fallen further? Investors saw a brief panic in February and March, and the S&P 500 has recovered and even made an all-time high in early September. As a consequence, valuations have become more elevated.



One common explanation is the unprecedented level of support from central banks around the world. Interest rates have fallen, and all major central banks have engaged in some form of quantitative easing. Let's revisit the equity valuation question, and determine the future outlook for equity prices.

The full post can be found here.

Wednesday, October 7, 2020

Out of the woods?

Mid-week market update: As President Trump left the hospital and returned to the White House, the message from his doctors was he was doing fine, but he was not "out of the woods". Numerous outside physicians have made the point that COVID-19 is nothing like the flu. Flu symptoms hit the patient and eventually dissipate and go away. COVID-19 patients often have ups and downs in their infection. They may feel fine, but symptoms flare, dissipate, and return. The process can last weeks, even months. Just because Trump reported feels fine now doesn't mean that he won't feel fine by this weekend.

Just like Trump's COVID-19 infection, neither the equity bulls nor bears are out of the woods. Yesterday (Tuesday), Fed Chair Jerome Powell said in a speech that it was time to go big on fiscal stimulus:
The expansion is still far from complete. At this early stage, I would argue that the risks of policy intervention are still asymmetric. Too little support would lead to a weak recovery, creating unnecessary hardship for households and businesses. Over time, household insolvencies and business bankruptcies would rise, harming the productive capacity of the economy, and holding back wage growth. By contrast, the risks of overdoing it seem, for now, to be smaller. Even if policy actions ultimately prove to be greater than needed, they will not go to waste. The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods.
The September FOMC minutes indicated a consensus that fiscal support is forthcoming, and the economy could tank without a rescue package.
Indeed, many participants noted that their economic outlook assumed additional fiscal support and that if future fiscal support was significantly smaller or arrived significantly later than they expected, the pace of the recovery could be slower than anticipated.
Trump tanked the market by tweeting that he was calling off the negotiations for a stimulus package. While he did tweet later that he was in favor of a standalone bill for a $1200 stimulus payment, his chief of staff Mark Meadows confirmed today that stimulus bill negotiations are dead.



The full post can be found here.

Sunday, October 4, 2020

The more things change...

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: Sell equities*
  • Trend Model signal: Bearish*
  • 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.

Subscribers can access the latest signal in real-time here.


Plus ça change...
The market was subjected to an unexpected shock late Thursday when President Trump announced that he had been diagnosed with a COVID-19 infection. What was unusual was the behavior of many market internals - they stayed the same.

Plus ça change, plus c'est la même chose. The more things change, the more they stay the same.

In light of this development, Trump is forced to quarantine and his campaign activities are suspended or curtailed. This creates a headwind for his electoral chances about a month ahead of the election. The betting odds on a Trump victory fell in the betting markets, but the overall Republican odds of a victory was steady as the odds on the Pence contract rose.  Plus ça change, plus c'est la même chose

Equally puzzling was the behavior of risk. Prior to the news, the option market was discounting heightened odds of a disputed election. Average option implied volatility (IV) spiked just ahead of the November 3 election, and they remained elevated until mid-December. The shape of the implied volatility curve stayed the same after the news. Plus ça change, plus c'est la même chose



The technical behavior of the market was also relatively steady. Both the S&P 500 and NASDAQ 100 rallied last week and regained their respective 50 day moving average (dma) levels. Both indices remained range-bound for the week, bounded by a band of upside resistance and downside support.


The full post can be found here.

Saturday, October 3, 2020

Broken Trends: How the world changed

The world is changing, but it changed even before Trump's COVID-19 news.


In the past few weeks, a couple of key macro trends have reversed themselves. The US Dollar, which large speculators had accumulated a crowded short position, stopped falling and began to turn up. In addition, inflation expectations, as measured by the 5x5 year forward, stopped rising and pulled back.


These developments have important implications for investors.

The full post can be found here.