3 steps and a stumble: Bull and bear case

Mid-week market update: It was no surprise that the Fed raised rates, as they had spent the last month widely telegraphing their intentions. This morning's release of February CPI tells the story. Headline CPI is near a 5-year high. Though core CPI (ex-food and energy) edged down, the latest reading of 2.2% is above the Fed's 2% targeted inflation rate.

The big surprise was the dot plot, which the market anticipated would edge upwards. Instead it remained mostly unchanged for 2017, though rate expectations were nudged up for next year.

Since this is the third rate hike for the Federal Reserve, the key question for equity investors is whether they should be concerned about the traders' adage of "three steps and a stumble" (via MTA):

Similar to Zweig's Fed policy indicator and in line with the desire to measure when the Federal Reserve is tightening credit, Edson Gould, a legendary technical analyst from the 1930s through the 1970s, developed a simple rule about Federal Reserve policy that has an excellent record of foretelling a stock market decline. The rules states that "whenever the Federal Reserve raises either the federal funds target rate, margin requirements, or reserve requirements three consecutive times without a decline, the stock market is likely to suffer a substantial, perhaps serious, setback" (Schade, 2004). This simple rule is still relevants. Although it tends to lead a market top, it is something that should not be disregarded.

Here are the bull and bear cases under "three steps and a stumble". In particular, the current economic cycle is elongated and shallow compared to past recoveries, and therefore it would be premature to worry about Fed actions to cool down the economy just yet.

The full post can be found at our new site here.

To BAT or not to BAT? Trump`s tax reform dilemma

As the market awaits the FOMC decision and statement this week, there are a number of other critical market moving events to watch for. The Trump White House is expected to release its "skinny budget" this week, which may contain some broad outlines of the tax reform package. In addition, Angela Merkel's White House visit Tuesday could bring important news on the trade front.

Donald Trump came into office promising a series of tax cuts and offshore cash repatriation incentives for Wall Street. But tax cuts have to be offset with either revenue increases or spending cuts. Trump adviser Gary Cohn recently stated on CNBC that the White House is aiming for to be revenue-neutral over a 10-year period. As this chart from Morgan Stanley shows, this level of fiscal stimulus is highly unusual at this point of the economic expansion.

The main strategy for paying for the many of the proposed tax cuts is the imposition of a Border Adjustment Tax (BAT), which will penalize imports while encouraging exports. The BAT proposal, however, is likely to run into a number of major objections from America's largest trading partners.

Those objections have come from Canada, which is America's biggest customer, and from Germany, the sixth largest (chart via CNN Money).

Last week, Canadian prime minister Justin Trudeau spoke at a Houston energy conference and cautioned that a BAT would be bad for all parties (via Bloomberg):

A levy on goods imported to the U.S. would damage business on both sides of the northern border and could impede the growth of energy, automobile and steel industries that benefit from bilateral cooperation, Trudeau said at a press conference in Houston.

“A border adjustment tax would be bad not just for Canada but for the United States as well,” the prime minister told reporters Friday. “No two countries in the world have the close friendship, alliance, relationship and level of economic integration that Canada and the U.S. have.”

German chancellor Merkel is expected to be far less diplomatic than Trudeau.

The full post can be found at our new site here.

A toppy market, but not THE TOP

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 the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

• Ultimate market timing model: Buy equities*
• Trend Model signal: Risk-on*
• 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 will also receive email notices of any changes in my trading portfolio.


Valuation and sentiment vs. momentum
Last week, I wrote about signs of stretched stock market valuation (see  Why I am cautious on the market). Last Wednesday, I warned about excessively bullish sentiment, which suggests that stock prices are likely to pull back (see A sentimental warning for bulls and bears).

Despite these red flags, I would caution that both valuation and sentiment models are notoriously bad at timing market tops. Expensive markets can get more expensive, and stock prices don`t necessarily go down if investors get into a crowded long. These models serve the highlight the risks to a market.

Here is another take on valuation. Taking a very long term 30-year view, Urban Carmel observed that the SPX goes up and down in fits and starts after adjusting for inflation. The key to achieving superior long-term returns is to buy when valuations are low, which is not the case today.

Michael Batnick at Irrelevant Investor showed that the Cyclically Adjusted PE ratio (CAPE) is elevated when compared to its own history.

But average CAPE has been rising over time.

If valuation doesn't work for short term market timing, what should investors do? In the intermediate term, a focus on fundamental and macro momentum in addition to factors like valuation and sentiment. Current conditions can more useful for market timing. Using this framework, it suggests that risks are rising, but there is no need to panic just yet.

The market is looking toppy, but this is not "the top".

The full post can be found at our new site here.

A sentimental warning for bulls and bears

Mid-week market update: Recently, there have been numerous data points indicating excessive bullishness from different segments of the market:

• Retail investors are all-in
• Institutional investor bullish sentiment is off the charts
• Cash is at a two-decade low in global investor portfolios
• RIA sentiment are at bullish extremes
• Hedge funds are in a crowded long in equities

These giddy sentiment readings are comforting to the bear camp (chart via Business Insider) and it will be difficult for stock prices to advance under such conditions. When everyone is bullish, who is left to buy?

However, I would warn the bears that they should not go overboard and short the market with both hands. In the past, euphoric sentiment has not a good indicator for pinpointing market tops.

The full post can be found at our new site here.

A track record update

I have had a number of subscribers ask me to extend the chart of my longer term calls, which had only gone back two years. The chart below shows the highlights of my posts back to 2013, which are intended for investors with a 6-24 month time horizon. I haven't been always right. On occasion, I was early, late, or simply mistaken.

Here is the links to the past posts shown in the above chart.

A correction, not a bear June 2013
A buy signal from the option market September 2013
Are stocks tumbling too far too fast? January 2014
Global growth scare = Trend Model downgrade July 2014
Onwards and upwards August 2014
3 reasons to get more cautious on stocks September 2014
Getting close to a bottom, but not yet October 2014
Why I am bearish (and what would change my mind) May 2015
Relax, have a glass of wine August 2015
Why this is not the start of a bear market September 2015
The reason why the bulls should be cautious about a January hangover December 2015
Buy! Blood is in the Streets January 2016
Super Tuesday special: How President Trump could spark a market blow-off March 2016
How the S+P 500 can get to 2200 and beyond June 2016


In addition, these are the buy and sell calls of the trading model, which are designed for traders with a 1-2 week time horizon. Again, I haven't been always right. The most recent failure occurred when the trading model got caught long (and wrong) in the correction in late 2015.

Judge for yourself.

Why I am cautious on the 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 the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

• Ultimate market timing model: Buy equities*
• Trend Model signal: Risk-on*
• 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 will also receive email notices of any changes in my trading portfolio.


An over-valued and frothy market
As the major market indices hit new all time highs, I have become increasingly cautious on the short-term outlook. I view the stock market through the following lenses, and all of them are showing either a neutral to bearish outlook:

• Valuation
• Interest rates outlook
• Growth
• Psychology

The one wildcard continues to be political developments from Washington. A recent AAII survey indicated that roughly 75% of respondents cited politics as affecting their investment decisions:

This week’s Sentiment Survey special question asked AAII members what factors are most influencing their six-month outlook for stocks. Nearly three-quarters of respondents (73%) cited national politics, particularly President Donald Trump’s polices and what actions Congress may take. Tax reform was mentioned by many (20% of respondents), followed by regulatory reform and uncertainty over what legislation will actually be passed. Just under 23% of all respondents listed the ongoing rally and the prevailing stock valuations, with several of these respondents expressing concerns about the level of valuations or that a drop could be forthcoming. Monetary policy was cited by 8% of all respondents, followed by corporate earnings growth (7%) and investor sentiment (7%). Some respondents listed more than one factor.

Any changes in the path of fiscal or trade policy have the potential to create further market volatility.

The full post can be found at our new site here.

A frothy, over-extended stock market

I just wanted to follow up to yesterday's post (see Don't relax yet, the week isn't over). One of the key developments that I had been watching has been the recent hawkish evolution in Fedspeak. Last night, uber-dove Lael Brainard gave an extraordinarily hawkish speech. She started with the following remarks:

The economy appears to be at a transition. We are closing in on full employment, inflation is moving gradually toward our target, foreign growth is on more solid footing, and risks to the outlook are as close to balanced as they have been in some time. Assuming continued progress, it will likely be appropriate soon to remove additional accommodation, continuing on a gradual path.

As a reminder, Brainard had been the Federal Reserve governor who, if given 10 reasons to raise rates and one reason to wait, she would focus on the single reason as a way of mitigating systemic risk. The last paragraph of her speech concluded, not so much with a discussion of whether to raise rates, but what to do with the Fed's balance sheet after the rate normalization process had begun:

To conclude, recent developments suggest that the macro economy may be at a transition. With full employment within reach, signs of progress on our inflation mandate, and a favorable shift in the balance of risks at home and abroad, it will likely be appropriate for the Committee to continue gradually removing monetary accommodation. As the federal funds rate continues to move higher toward its expected longer-run level, a transition in balance sheet policy will also be warranted. These transitions in the economy and monetary policy are positive reflections of the fact that the economy is gradually drawing closer to our policy goals. How the Committee should adjust the size and composition of the balance sheet to accomplish its goals and what level the balance sheet should be in normal times are important subjects that I look forward to discussing with my colleagues.

When a dove like Brainard sounds this hawkish, there is little doubt about whether the Fed will raise rates at its March meeting.


What about Buffett's bullish comments?
In a recent CNBC interview, legendary investor Warren Buffett stated that stocks are on the cheap side, but that assessment would change if rates were to rise:

Billionaire investor Warren Buffett told CNBC on Monday U.S. stock prices are "on the cheap side" with interest rates at current levels...

"We are not in a bubble territory" in the stock market, he said on "Squawk Box." If rates were to spike, however, then the stock market would be more expensive, he added.

It looks like the Fed is about to raise start a rate hike cycle. So what now?

The full post can be found at our new site here.

Don't relax yet, the week isn't over

Mid-week market update: Boy, was I wrong. Two weeks ago, I wrote Why the SP 500 won't get to 2400 (in this rally). Despite today's market strength, stock prices may be restrained by a case of round number-itis as the Dow crosses the 21,000 mark and the SPX tests the 2,400 level.

In addition, the market's reaction to President Trump's speech to Congress was at odds to the reaction from Street strategists. While the market went full risk-on in the wake of the Trump speech, this Bloomberg summary of strategist comments made it clear that the speech was long on themes and short on details. Perhaps stocks are rallying because Trump did not go off script and sounded statesmanlike and presidential. How long the market remains patient with his lack of the specifics on tax reform, which is Wall Street's major focus, remains an open question.

In the meantime, the SPX has broken above its trend line and appears to be staging an upside blow-off. When animal spirits start to stampede like this, you never know when the rally will end.

Does this mean it's time to jump back on the bullish bandwagon? Not so fast. The week isn't over and there are a couple of other major developments (other than the Trump speech) that warrant consideration.

The full post can be found at our new site here.

How Buffett's business empire could unravel

Josh Brown had a terrific comment about the secret of Warren Buffett's success. Buffett is unabashedly "permabullish" on America:

One of the hallmarks of Berkshire’s success has been its willingness to raise or lower its formidable cash hoard in response to the presence (or lack thereof) of viable investing opportunities. One of the other hallmarks of Buffett’s approach has been to tune out forecasts and de-emphasize the importance of them in general.

The one thing Buffett has never given up on is the idea that American productivity, innovation and economic dynamism will always lead to substantially greater prosperity in the future. And he’s been right for decades, through all sorts of setbacks, crises and challenges for the nation.

So if the choice is to be in the Buffett camp vs the David Stockman camp or the Peter Schiff camp, well, I regard that as no real choice at all.

Lastly, permabulls need not be blind to the possibility of market declines, economic catastrophes (real or imagined) and other momentary trials and tribulations. Buffett’s got these possibilities built right into his manifesto:

Charlie and I have no magic plan to add earnings except to dream big and to be prepared mentally and financially to act fast when opportunities present themselves. Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.

That formula has worked out well. Stay bullish on the belief of the dynamism of America, and buy good businesses when they become cheap. In a post-election interview with CNN, Buffett expressed confidence in the supremacy of the American businesses (click on this link if the video is unavailable).

There is much to be said about the Buffett formula. According to Credit Suisse, US real equity returns has been the highest in the world. Though the stock market has experienced serious losses, prices have always come back.

A value orientation, as proxied by a high price to book, outperforms the market. Buffett then couples the value discipline by buying companies with a moat, or a sustainable competitive advantage. The combination of buying value companies with a moat has been the secret of success.

However, we may be reaching an inflection point for Buffett`s brand of investing. In the Age of Trump, the tailwinds on Buffett`s value approach may be coming to an end.

The full post can be found at our new site here.

Brace for a volatility spike

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 the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

• Ultimate market timing model: Buy equities*
• Trend Model signal: Risk-on*
• 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 will also receive email notices of any changes in my trading portfolio.


Sell the news?
There has been much written lately about low level of stock market volatility, as measured by the VIX Index. It's interesting that these concerns have even surfaced in the latest FOMC minutes:

Financial asset prices were little changed since the December meeting. Market participants continued to report substantial uncertainty about potential changes in fiscal, regulatory, and other government policies. Nonetheless, measures of implied volatility of various asset prices remained low.

A little noticed change has occurred in the markets since mid-February. Even though stock prices were grinding upwards, VIX term structure began to steepen as 3-month VIX futures rose but 1-month VIX remained stable. As well, the bottom panel shows that SKEW, which measures the price of tail-risk protection, is rising. These readings indicate that the market is anticipating a near-term volatility event.

The most likely spark for a volatility event is Trump's address to Congress on Tuesday, when he is expected to outline his tax reform proposals. This speech has the potential to raise the "uncertainty about potential changes in fiscal, regulatory, and other government policies".

The stock market has rallied substantially in anticipation of Trump's proposal of tax cuts, tax holiday for offshore cash repatriation, and deregulation. As Trump's tax reform proposals become more clear, it is becoming evident that there are two likely outcomes. Either Wall Street will have to swallow the bitter pill of the protectionist measures of a Border Adjustment Tax (BAT), or they will get delayed and bogged down in Congress.

As the market has bought the rumor of tax cuts, it may now be time to sell the news.

The full post can be found at our new site here.

Solving the data puzzle at the center of monetary policy

There has been much hand wringing by economists over the falling labor force participation rate (LFPR). As the chart below shows, the prime age LFPR, which is not affected by the age demographic effect of retiring Baby Boomers, have not recovered to levels before the Great Recession.

The lack of recovery in LFPR has caused great consternation over at the Federal Reserve. These readings suggest that there is still considerable slack in the labor market, despite the sub 5% unemployment rate.

A number of explanations have been advanced for this phenomena, such as jobless Millennials spending all their time playing video games in their parents' basement instead of looking for a job (via Nicholas Eberstadt of the American Enterprise Institute).

Another possible explanation is the growth of disability as a shield against unemployment payments run out. As the Great Recession hit, disabled workers became discouraged and chose to rely on their disability payments instead of trying to find another job.

There may be another very simple alternative explanation for the collapse in LFPR. The answer is so simple, it's criminal that anyone missed it.

The full post can be found at our new site here.

Stay cautious, but wait for the break

Mid-week market update: Markets behave different at tops and bottoms. Bottoms are often V-shaped and reflect panic. Tops are usually slower to develop. Hence the trader's adage, "Take the stairs up, and escalator down."

I have been writing that the US equity market appears to be extended short-term and ripe for a pullback, but that was last week and about 1% lower (see Why the SP 500 won't get to 2400 (in this rally)). I stand by those remarks.

I could say that the Fear and Greed Index appears to be extended and historically stock prices have had difficulty advancing further with readings at these levels.

I could also say that Ned Davis Research Crowd Sentiment Poll is also extended. Historically, stock prices have exhibited a negative bias at these levels (via Tiho Brkan).

None of this matters much to short-term traders. That's because sentiment and overbought/oversold indicators are less useful at tops than bottoms. While it may be timely for traders to tilt to the long side when panic starts to appear, market euphoria are not good trading signals of market tops. Savvy traders know to wait for a bearish break when the market gets overbought and giddy.

I am seeing some limited signs of a bearish break, but the trading sell signal is incomplete.

The full post can be found at our new site here.

Negative real yields = Equity sell signal?

An reader asked me my opinion about this tweet by Nautilus Research. According to this study, equities have performed poorly once the inflation-adjusted 10-year Treasury yield turns negative. With real yields barely positive today, Nautilus went on to ask rhetorically if the Fed is behind the inflation fighting curve.

Since the publication of that study, The January YoY CPI came in at 2.5%, which was surprisingly high. The higher than expected inflation rate pushed the 10-year real yield into negative territory. So is this a sell signal for equities?

Well, it depends. The interpretation of investment models often depends a great deal on their inputs. In this case, the questions is how does we adjust for inflation? Do we use the headline Consumer Price Index (CPI), core CPI, which is CPI excluding volatile food and energy prices, or some other measure?

As I go on to show, how we adjust for inflation dramatically alters the investment conclusion for a variety of asset classes, like equities, gold, and the USD.

As is the case in the application any quantitative model, the devil is in the details.

The full post can be found at our new site here.

Watch what they do, not just what they say

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 the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

• Ultimate market timing model: Buy equities*
• Trend Model signal: Risk-on*
• 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 will also receive email notices of any changes in my trading portfolio.



Great expectations
Bloomberg recently highlighted the huge gap between expectations and reality. As the chart below shows, soft (expectations) data has been surging, but hard (actual) data has risen, but it has not caught up with expectations.

The markets are pricing for perfection, which sets up a situation where minor disappointments could spark a market sell-off. BCA Research found that such divergences between "soft" expectations data and "hard" economic data has seen equity corrections in the past.

This week, I examine the details of how expectations have diverged from actual data on a number of dimensions.

• Small business confidence
• Corporate confidence
• Consumer confidence
• Federal reserve expectations
• Wall Street's tax reform expectations

The full post can be found at our new site here.

Why the S&P 500 won't get to 2400 (in this rally)

Mid-week market update: As the major market averages make new all-time highs, I conducted an informal and unscientific Twitter poll. I was surprised to see how bullish respondents were.

Let's just cut to the chase - forget it. Neither the fundamental nor the technical backdrop is ready for an advance of that magnitude. Even though the earnings and sales beat rates for Q4 earnings season is roughly in line with historical averages, Factset reports that the 12-month forward EPS growth is stalling. Past episodes has seen stock price struggle to make significant advances under such conditions.

In addition, the technical condition of the market shows that it is vulnerable to a pullback.

The full post can be found at our new site here.

Cry Havoc, and slip loose the dogs of (trade) war!

The WSJ reported that the Trump administration is considering a new tactic in managing its trade relationship with China. Here is the Bloomberg recap for those without a WSJ subscription:

Under the plan, the commerce secretary would designate the practice of currency manipulation as an unfair subsidy when employed by any country, instead of singling out China, the newspaper reported. American companies could then bring anti-subsidy actions to the U.S. Commerce Department against China or other countries, it said.

The discussions are part of a strategy being pursued by the White House’s new National Trade Council to balance the goals of challenging China on certain policies while keeping broader relations on an even keel, the paper said. The Trump administration would avoid, at least for now, making claims about whether China is manipulating its currency, it said.

While such an approach may seem clever, it has the risk of sideswiping American relations with a whole host of other countries other than China. As well, the imposition of countervailing duties is subject to a challenge under WTO rules.

The full post can be found at our new site here.

Why this uncanny recession indicator may not work this time

The chart below depicts the yield curve, as measured by spread between the 10-year and 2-year Treasury yields, (blue line) and equity returns (grey line). The yield curve has been an uncanny recession forecaster. It has inverted ahead of every single recession, and ahead of major equity bear markets.

Unfortunately, this indicator may not work this time.

The full post can be found at our new site here.

A blow-off top, or a wimpy top?

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 the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

• Ultimate market timing model: Buy equities*
• Trend Model signal: Risk-on*
• 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 will also receive email notices of any changes in my trading portfolio.


So many questions, so few answers
Regular readers know that I have been calling for a cyclical market top in 2017 (see The roadmap to a 2017 market top). Outside of the risk of permanent loss from war or insurrection, severe bear markets have been mainly associated with economic recessions. My analysis has been based on the likely path of the US economy, and the timing of the next recession.

My base case, call it the "blow-off top" scenario, goes something like this:

• The economy, which is in the late stages of an expansion, starts to overheat.
• Investors and traders get enthusiastic about growth and bid stock prices up to unrealistic levels (hence the "blow-off")
• The Fed responds by raising rates to cool off the economy, but find it's behind the curve...
• Which results in a recession and bear market.

The blow-off top scenario would see the SPX reach the 2500-2600 level this year as it tops out.

I have been considering an alternative, call it the "wimpy top" scenario, where the market may have topped out already.

• The economy, which is in the late stages of an expansion, starts to overheat.
• Investors and traders get enthusiastic about the prospects for cuts cuts and deregulation under the Trump tax reform plan, which is what has happened so far.
• Tax reform gets tied up in Congress and gets delayed until 2018.
• Trump appoints hawks to the Federal Reserve board (now there are three vacancies with the resignation of Daniel Tarullo).
• The new Trump appointed Fed governors, composed of hard-money advocates, becomes more aggressive, tightens monetary policy, and pushes the economy into recession.
• An equity bear market is the result.

The wimpy top scenario is based on a double whammy of fiscal policy disappointment and a pivot to a more hawkish Fed policy. In that case, Current stock index price levels are roughly as good as they get.

The key differences between the two scenarios are the likely path of fiscal and monetary policy. Those are the big questions to which we have no answers. This week, I explain the risks and offer some suggestions of how to watch which scenario is the more likely one to unfold.

The full post can be found at our new site here.

What's wrong with the VIX?

Mid-week market update: Increasingly, I have seen cases being made for an equity market correction. This Bloomberg article, "Five charts that say not all is well in the markets" summarizes the bear case well.

• Uncertainty is at a record high: The number of news stories using the word "uncertainty" is surging.
• Wall Street vs. Washington: While the Global Economic Uncertainty Index is elevated, the VIX Index remains low by historical standards.
• The price of hedging tail-risk is rising: Even as the VIX remains low, the CBOE SKEW Index, which measures the price of hedging extreme events, is high. Which is right?

• Gold is rising: Gold is often thought of as a safe haven in times of stress and the gold price has recently been inversely correlated with equity prices.

• Watch for gold and bond yields to rising together: "Gold may prove the “tell,” according to Chris Flanagan, also at Bank of America. He advises investors to watch “for the combo of rising yields and rising gold prices to signal impending market volatility.” Three consecutive quarters of rising benchmark bond yields and gold prices preceded previous market falls including the 1973-1974 bond market crash and Black Monday in 1987, he says. The yield on the benchmark 10-year U.S. Treasury has risen to 2.44 percent from 1.77 percent since Trump’s election win. Gold has moved sideways."

Much of the anxiety can be summarized as, "What's wrong with the low level of the VIX Index? Isn't the VIX supposed to be a fear gauge?"

Why are't stock prices falling if actual fear is so high?

The full post can be found at our new site here.

Peak populism?

Technical analysts often use the magazine cover indicator as a contrarian indicator. When an idea has become so commonplace that it becomes the cover of a major magazine, the public is all-in and it's time to sell.

The Economist reported on an ad hoc study by Greg Marks and Brent Donnelly at Citigroup using covers from The Economist and did find contrarianism works, even though The Economist is not really a popular mainstream magazine:

Interestingly, their analysis finds that after 180 days only about 53.3% of Economist covers are contrarian; little better than tossing a coin. After 360 days, the signal is a lot more reliable—68.2% are contrarian. Buying the asset if the cover is very bearish results in an 18% return over the following year; shorting the asset when the cover is bullish generates a return of 7.5%.

Now consider the following Time magazine cover and accompanying story on Steve Bannon, who is said to be the man behind the Donald Trump presidential throne.

There is also this cover from The Economist within the same week.

Still not convinced? How about this cover from Der Spiegel. You don't even have to read German to understand the idea.

It isn't just me, Helene Meisler raised the same question about magazine covers, which was answered by Liz Ann Sonders at Schwab.

Here at Humble Student of the Markets, our mission to focus on investing and try to remain apolitical. Like most on Wall Street, we don't protest political developments, we trade them.

Rather than interpreting these magazine covers as just peak Trump, as he will be POTUS for the next four years, the contrarian message may be "peak populism". Nate Silver recently wrote an article called "14 versions of Trump's presidency, from #MAGA to impeachment", where he laid out a variety of scenarios of how Trump's presidency might proceed.

I would like to offer some details of how the reversal of peak populism might work. As well, there is a possible trade for contrarian investors who are willing to bet on the "peak populism" theme.

The full post can be found at our new site here.