Sunday, October 22, 2017

Beware the expiry of the 19th Party Congress Put option

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: 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 will also receive email notices of any changes in my trading portfolio.


A China-led reflationary recovery?
Copper and industrial metal prices have been on a tear lately. Prices bottomed out in early 2016, and the latest rally has seen a recovery to levels last seen in 2014.



China is a major driver of commodity demand, and her economic growth has been surging recently. It is therefore no surprise that copper and industrial metal prices have been soaring.


The latest upside surprise in Chinese PPI prompted David Ingles at Bloomberg to ask if China is leading a bout of global reflation.



Callum Thomas at Topdown Charts also observed that China is at the epicenter of the global reflation theme.


The developed markets are also experiencing a synchronized upswing.



On the other hand, China is currently holding its 19th Party Congress. It doesn't take a genius to understand that any bureaucrat who creates conditions that causes either a growth slowdown or financial instability during this critical period will have made his own life very difficult. In effect, Beijing has given a 19th Party Congress put option to the market, where nothing bad would be permitted to happen to the economy ahead of the meeting.



Skeptics could therefore ask if the current growth revival is real, or window dressing ahead of the Party Congress. What happens after the expiry of the 19th Party Congress Put as the meeting winds up next week?

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

Wednesday, October 18, 2017

A continued grind upwards

Mid-week market update: I wrote last weekend that there was a possibility that the stock market may undergo a melt-up, followed by a crash (see Market melt-up and crash?). That scenario may well be occurring, and I sent out an email to subscribers on Monday stating that my trading account had moved from all-cash to being long stocks.

There are a number of reasons for my tactical position. First, I had set a line in the sand on the weekend. The SPX was overbought, as evidenced by the combination of a weekly close above the upper Bollinger Band, and RSI-14 above 70. In the past, a mean reversion of RSI-14 below 70 was a signal for a correction of 2-5%. That sell signal has not occurred yet.



In fact, RSI-14 has not even mean reverted below 70 on the daily SPX chart.



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

Tuesday, October 17, 2017

What would a Taylor Fed look like?

Bloomberg reported that Donald Trump interviewed John Taylor for the position of Fed chair and "Trump gushed about Taylor after his interview", as "Kevin Warsh has...seen his star fade within the White House". The current list of leading candidates under consider are said to be Jerome Powell, John Taylor, Kevin Warsh, and Janet Yellen. Taylor's rise in the candidate stakes is a bit of a surprise, as he had been regarded as a dark horse.

The question for investors is, "What would a Taylor Fed look like?"

Taylor is famous for the "Taylor Rule", which is a rules-based method of determining the Fed Funds rate. The rules-based approach is a favorite of the Republican audit-the-Fed crowd, and therefore Taylor will have substantial support should he get nominated. The standard application of the Taylor Rule would see the Fed Funds target substantially higher than it is today.


Despite these dire projections, Matthew Boesler at Bloomberg argued that a Taylor led Fed would not be substantially different from a Yellen Fed, because Taylor would have difficulty bringing the members of the FOMC to such a hawkish tilt to monetary policy:
Resistance from the other participants on the rate-setting Federal Open Market Committee, which currently numbers 16 participants, is why investors need not worry too much about Chairman Taylor leading the Fed onto a much faster rate-hike path than the three rate increases next year penciled in by officials in quarterly forecasts updated in September.

“Taylor would have a very hard time persuading the rest of the FOMC to abide by the prescriptions of his original rule,” said Roberto Perli, a partner at Cornerstone Macro LLC in Washington. “In fact, he won’t be able to persuade hardly anyone -- there isn’t much sympathy in the FOMC for a policy that blindly follows rules.”
On the other hand, uber-dove Neel Kashkari of the Minneapolis Fed argued that the application of a Taylor rule would have kept millions out of work:
In December, I wrote an op-ed in the Wall Street Journal explaining that forcing the Federal Open Market Committee (FOMC) to mechanically follow a rule, such as the Taylor rule, to set interest rates can cause tremendous harm to the economy and the American people. My staff at the Minneapolis Fed estimates that if the FOMC had followed the Taylor rule over the past five years, 2.5 million more Americans would be out of work today. That’s enough to fill the seats at all 31 NFL stadiums simultaneously, almost 6,000 more people out of work in every congressional district.
Who is right? How should we assess John Taylor as a potential Fed chair?

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

Sunday, October 15, 2017

Market melt-up and crash?

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: 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 will also receive email notices of any changes in my trading portfolio.


The challenges of a late cycle bull
I have been making the point that the American economy is in the late stages of an expansion. This presents some investment challenges as an inflection point may be near. As the chart below shows, while every equity downdraft has not signaled a recession, every recession has seen an equity bear.


The question is, "How far away are we from a recession?" I try to answer that question this week by focusing on three components of the economy using the leading indicators in my Recession Watch Monitor:
  • The household sector;
  • The corporate sector; and
  • Monetary conditions.
Further, I analyze the nowcast of the economy and the market outlook from both macro and technical viewpoints. The market may be setting for a scenario where stock prices melt-up, followed by a market crash of unknown magnitude.

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

Wednesday, October 11, 2017

Peak small cap tax cut euphoria?

Mid-week market update: The intermediate term technical trend remains bullish, it`s hard to argue with the strong momentum that the market has displayed. Ari Wald recently pointed out that the market is experiencing a "good overbought" condition (my words, not his) that has the potential to carry the market much higher.


However, the current market environment may be setting up for a short correction. The SPX is trading above its upper weekly Bollinger Band (BB). Past episodes, when viewed in isolation, have been relative benign. The market has either continued grind upwards, or move sideways. That said, I am monitoring the weekly RSI-14 indicator when the market is above its upper BB. Past breaks below the 70 after an overbought reading have seen the market pull back. (Note that the weekly RSI reading remains above 70, and therefore no sell signal has been generated.)



I am watching the evolution in small cap leadership, which may be in the process of breaking down. Such a development could be a signal of near term market weakness.



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

Monday, October 9, 2017

The VIX also rises

Deep in the recesses of my memory from my youth, I recall reading an Ernest Hemingway quote that went something like this:
How did you go bankrupt?
Two ways. Gradually, then suddenly.

From The VIX Also Rises
The VIX closed at an all-time low last week. Anyone who bought volatility in the last couple of years would have suffered the same fate outlined in the Hemingway novel.



To be sure, there are good reasons for the VIX decline. One reason is the drop in pair-wise correlation between stocks. When this happens, the diversification effect of owning different stocks rises, which depresses index volatility relative to individual stock volatility.



It isn't just the VIX, but the volatility of other asset classes have also fallen. The MOVE Index, which measures interest rate volatility, is also at depressed levels.


Charlie Bilello recently asked if shorting volatility is a free lunch. The answer is an emphatic "no", because traders who take on that trade have to live with the possibility of 90%+ drawdowns. Bilello went on to state that drawdowns from a short VIX position "is not a question of if but when", though he was silent on the timing, or the trigger for such an event.


With overall realized volatility at historically low levels across all asset classes, the trigger for a VIX spike might come from a non-equity asset class.

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

Sunday, October 8, 2017

Is 3% for 6 months enough to take equity risk?

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: 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 will also receive email notices of any changes in my trading portfolio.


A lukewarm buy signal
Mark Hulbert recently updated the market forecast of former Value Line research director Sam Eisenstadt. Eisenstadt has had a remarkable record of forecasting equity returns, according to Hulbert.
The reason to take this projection seriously is Eisenstadt’s track record. Consider a statistic known as the r-squared, which measures the degree to which one data series predicts or explains another. If the first series perfectly predicted the second, the r-squared would be 1.0; if the first series had absolutely no predictive ability the r-squared would be zero.

For the data plotted in the chart below, the r-squared is 0.31, which is significant at the 95% confidence level that statisticians often use when determining if a pattern is genuine. Though you might be disappointed that this r-squared isn’t higher, you should know that most of the models that get attention on Wall Street and in the financial press have r-squareds that are far lower—if they’re not actually zero.

Eisenstadt`s latest six month SPX forecast is 2620 to 2640, which represents a gain of about 3%. The chart shows Eisenstadt`s forecasts, as documented by Hulbert, since 2013. The forecast levels are shown in blue, with the actual below (black if the market beat his target, red if it missed).


Hulbert wrote that Eisenstadt has two critical inputs to his forecast, both of which are mildly bullish:
Eisenstadt constructs his model to include all factors he has found to have an ability to project the stock market’s subsequent six-month return. Though his model is proprietary, Eisenstadt has told me that two of the more important inputs are low interest-rates and market momentum. Both factors are mildly positive right now.
No forecast is complete without some understanding of the risks to the forecast. When I peek under the hood of the Eisenstadt's model, interest rates and momentum represent sources of both risk and opportunity to the market. Investors will have to judge for themselves whether a potential 6-month gain of 3% is worth the risk.

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

Thursday, October 5, 2017

Be careful what you wish for: Catalonia independence edition

The situation in Catalonia is a mess. Catalan frustrations are understandable. The region is the most prosperous of all in Spain, and shares similar characteristics as norther Italy to the rest of Italy, or North Rhine-Westphia and Bavaria to Germany.


Here at Humble Student of the Markets, we try not to take political positions, but we stand in principle against the suppression of democracy. However, the independence referendum was ruled to be unconstitutional, but the heavy-handed reaction of the Rajoy government did not help matters.

Where do we stand now?

King Filipe IV has condemned the vote, as he has taken the position that it is unconstitutional. Catalan President Carles Puigdemont is offering mediated talks, but threatened to declare independence perhaps as soon as this weekend.

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

Wednesday, October 4, 2017

Nearing upside target, what now?

Mid-week market update: Back on July 19, 2017, I wrote about using point and figure charting as a way of projecting an upside SPX target when the index stood at 2473 (see What's the upside target in this rally?). Using different sets of inputs that represent different time horizons and risk tolerances, I arrived at a target range, and a median upside target of 2561. The final targets were roughly the same whether outliers (highlighted in red) were removed or not.


Now that the index is within about 1% shy of the median target, what now?

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

Monday, October 2, 2017

How American policy could tank China

As China approaches its 19th Party Congress, there has been no shortage of analysis about what to watch for. Here are a couple of examples worth reading:
  • The meeting that could seal Xi's grip on China (Bloomberg)
  • Beijing's Game of Thrones: Signaling loyalty before the Party Congress (China Focus)
Of particular importance is the Reuters report that the Party plans to amend its constitution at the Party Congress as a sign that Xi Jinping is tightening his iron grip:
China’s ruling Communist Party is expected to amend its constitution at a key party congress next month, state media said on Monday, in a sign that President Xi Jinping aims to enshrine his guiding ideological doctrine in the charter.

Since assuming office almost five years ago, Xi has rapidly consolidated power, with moves such as heading a group leading economic reform and appointing himself military commander-in-chief, although as head of the Central Military Commission he already controls the armed forces.

The Politburo, one of the party’s elite ruling bodies, deliberated a draft amendment to the constitution to be discussed at the congress that would include “major theoretical viewpoints and major strategic thought”, the official Xinhua news agency said.
For investors, the main focus is how China plans to continue its objective of rebalancing growth from the old credit driven infrastructure building model to an economy based on household consumption. As the IMF recently noted, some progress has been made, but the transition has been slow.


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

Sunday, October 1, 2017

Buy the breakout?

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: 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 will also receive email notices of any changes in my trading portfolio.


A typical late cycle advance
In a recent post (see Equity lessons from the bond market), I urged equity investors to monitor the signals from the bond market as they contained important and often overlooked information about the future direction of stock prices. In particular, the yield curve was an important indicator, as past instances of an inverted yield curve, where short rates trade above long rates, was an uncanny signal of recession, and equity bear markets.

While the shape of the yield curve is an important indicator, I may have discovered an indicator that leads the yield curve signal. As the chart below shows, the copper/CRB ratio has risen strongly ahead of yield curve inversions in the last two cycles. The copper/CRB ratio is valuable because copper is a cyclically sensitive commodity, and the ratio filters out the noise from changes in overall commodity prices.



This ratio has worked well in both disinflationary and inflationary eras. The top in the late 1990's was a disinflationary period characterized by falling commodity prices (see bottom panel). But the copper/CRB ratio rallied out of a relative downtrend (green line, middle panel) just before the yield curve inverted (top panel). During the inflationary era that ended in 2007-08, the copper/CRB ratio flashed a parabolic climb ahead of the last yield curve inversion.

Fast forward to 2017. The copper/CRB ratio has staged a relative breakout in late 2016 and early 2017 and roared ahead, which is an indication of a late cycle blow-off. The yield curve has not inverted yet, and it may not necessarily invert this cycle because of the Fed's extraordinary measures of the past few years. By the Fed's own estimates, its QE program has depressed the term premium on the 10-year Treasury note by 100 basis points. Unwinding QE will put upward pressure on long dated yields, which has the effect of delaying an inversion signal - until it's too late.

The analysis of sector and industry rotation confirms the thesis of a late cycle rotation. The Relative Rotation Graph (RRG) is a way of depicting the changes in leadership in different groups, such as sectors, countries or regions, or market factors. The charts are organized into four quadrants. The typical group rotation pattern occurs in a clockwise fashion. Leading groups (top right) deteriorate to weakening groups (bottom right), which then rotates to lagging groups (bottom left), which changes to improving groups (top left), and finally completes the cycle by improving to leading groups (top right) again. The latest RRG chart of the US market shows leadership by late cycle inflation hedge groups such as energy, mining, and gold stocks.


The same pattern of inflation hedge leadership can also be found in Europe. While US technology has revived and revised into the top right leadership quadrant, European technology stocks have weakened, which makes the tech rally suspect.



In short, the current market action has the feel of a bull market blow-off top. For investors and traders, the question is whether they should jump on the rally, with an emphasis on inflation hedge groups. This week, I examine the bull and bear cases, first for the equity market, then address the question of sector exposure.

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

Thursday, September 28, 2017

Things you don't see at market bottoms, CFD leverage edition

It is said that while bottoms are events, but tops are processes. Translated, markets bottom out when panic sets in, and therefore they can be more easily identifiable. By contrast, market tops form when a series of conditions come together, but not necessarily all at the same time.

I have stated that while I don't believe that the stock market has made its final cyclical top, we are in the late stages of a bull market (see Risks are rising, but THE TOP is still ahead and Nearing the terminal phase of this equity bull). Nevertheless, psychology is getting a little frothy, which represent the pre-condition for a major top. This is just another post in a series of "things you don't see at market bottoms". Past editions of this series include:
As a result, I am publishing another edition of "things you don't see at market bottoms".

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

Wednesday, September 27, 2017

Equity lessons from the bond market

Political operative and former Clinton advisor James Carville once quipped that he wanted to be reincarnated as the bond market so that he could intimidate everybody. Equity investors and traders are well advised to remember that comment, as there is much to be learned from a cross-asset, or inter-market, viewpoint from bond market action.

For example, the relative performance of junk bonds is a terrific indicator of overall risk appetite.



The relative performance of financial stocks is also related to the yield curve, with the caveat that any analysis using a single variable can lead to erroneous conclusions as there may be other factors at play.



The shape of the yield curve is also correlated with the relative performance of value and growth stocks. That relationship makes sense, as a flattening yield curve (falling green line) is the bond market's signal of slowing growth expectations. In an environment where growth is scarce, growth stocks should outperform, and vice versa.



So what is the bond market telling us now?

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

Sunday, September 24, 2017

The Fed has spoken (and what that means)

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: 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 will also receive email notices of any changes in my trading portfolio.


The risks to the bond market
The Fed has spoken. Janet Yellen made it clear that the Fed is ready to normalize monetary policy, come hell or high water. This tone to US monetary policy begs the question of how much interest rates can rise.

The Citigroup Economic Surprise Index (ESI), which measures whether high frequency economic releases are beating or missing expectations, has been on a tear for the last few months. In the past, rising ESI values have put upward pressure on bond yields (blue line). How far can they go up this time, and what kind of effects will they have on stock prices?



Moreover, there are a number of indications that the Fed will become increasingly hawkish, and the trajectory of interest rate increases discounted by the market are well below actual Fed actions.

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

Thursday, September 21, 2017

NAAIM buy signal update

I had highlighted an unusual contrarian buy signal in my last post (see Round number-itis at 2500). NAAIM sentiment, which is reported weekly, turned anomalously bearish last week and fell below its lower Bollinger Band. Past episodes of such occurrences have turned out to be very good contrarian buy signals.


The reading last week was anomalous because every other sentiment indicator had become more bullish, while NAAIM RIAs got more bearish. This week, NAAIM managers turned more bullish, while the AAII survey became more cautious.


Was last week's contrarian buy signal for real, or a data blip?

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

Tuesday, September 19, 2017

Round number-itis at 2500

Mid-week market update: I normally write my mid-week market update on Wednesday, but the market action on FOMC decision days tend to be wildcards and not necessarily indicative of future market direction, therefore I am writing my commentary a day early.

I agree with Jonathan Krinsky of MKM Partners when he wrote that the stock market is likely to encounter some resistance at SPX 2500, but the intermediate term remains bullish.


There are a number of strong negative seasonal factors at work, as well as some short-term overbought indicators that point to either a period of consolidation or shallow pullback. That said, I discovered a little noticed but unusual sentiment buy signal that has historically resolved itself bullishly in the past.

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

Sunday, September 17, 2017

A secular bottom for inflation?

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: 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 will also receive email notices of any changes in my trading portfolio.


Rising inflation = Secular commodity bull
This chart has been floating around since July and was featured in a Marketwatch article. While it is interesting from the viewpoint of a chartist, the stretched relationship between stocks and commodities is difficult to reconcile when seen through macro and fundamental lenses. Rising commodity prices require a sustained recovery in inflation, or a collapse in the value of financial assets. How is that possible in this era of inflation undershoot and pedal-to-the-metal central bank QE?


I think I found the answer, and it may be a signal of an inflection point in inflation, interest rates, and asset return patterns.

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

Thursday, September 14, 2017

Things you don't see at market bottoms, Paris Hilton edition

It is said that while bottoms are events, but tops are processes. Translated, markets bottom out when panic sets in, and therefore they can be more easily identifiable. By contrast, market tops form when a series of conditions come together, but not necessarily all at the same time.

I have stated that while I don't believe that the stock market has made its final cyclical top, we are in the late stages of a bull market (see Risks are rising, but THE TOP is still ahead and Nearing the terminal phase of this equity bull). Nevertheless, psychology is getting a little frothy, which represent the pre-condition for a major top. This is just another post in a series of "things you don't see at market bottoms". Past editions of this series include:
As a result, I am publishing another edition of "things you don't see at market bottoms".

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

Wednesday, September 13, 2017

A "good overbought" advance, or an imminent pullback?

Mid-week market update: A number of major averages hit fresh all-time highs this week. For traders and investors, the question is whether the market is likely to continue to grind upwards while flashing a series of "good overbought" signals, or will it pull back?



Here are the bull and bear cases.

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

Tuesday, September 12, 2017

The Fed's perfect storm of 2018

I see that the world is catching up to me. The resignation of Federal Reserve vice chairman Stanley Fischer has sharpened the focus of analysts on the future composition of the Fed Board in determining the direction of monetary policy. This is a topic that I have been writing about since June (see A Fed preview: What happens in 2018?).

As well, in light of leaks indicating that Gary Cohn is no longer the front runner to be the next Fed chair, there has been widespread speculation as to the identity of the next Fed chair in determining interest rate policy. A number of commentators, such as Pedro da Costa, have speculated that Trump's demand for personal loyalty is likely to usher in an era of a highly politicized Federal Reserve and destabilize the Fed's credibility. This factor is particularly acute as there will be four vacant seats on the Fed's Board of Governors after Fischer's departure - and that does not include the possible replacement for Janet Yellen.

In other words, we have potential chaos at the Fed in 2018.

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

Sunday, September 10, 2017

Correction is over, wait for the blow-off 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: 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 will also receive email notices of any changes in my trading portfolio.


The bull and bear cases
In my last post (see A step-wise market advance), I indicated that some of the concerns that overhang the stock market have been alleviated. Falling risk levels should act to put a floor on stock prices. Does that mean that stock prices are ready to rocket to new highs?

This week, I analyze both the near-term bull and bear cases for stocks. The bull case is based mainly on broad based fundamental momentum, such as continued improvements in ISM.


The bear case, on the other hand, is based on a case of bad breadth.


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

Wednesday, September 6, 2017

A step-wise market advance

Mid-week market update: In my post written last Sunday (see September uncertainties), I outlined three disparate sources of uncertainty that faced investors in September.
  • Legislative uncertainty over the debt ceiling and tax reform;
  • Geopolitical uncertainty over North Korea; and
  • Uncertainty over Fed action.
While some of those problems have been temporarily resolved, developments since the weekend have raised further questions about others. This suggests that the market will follow the recent pattern of a stepwise advance, but remain range-bound pattern until many of these uncertainties are resolved.



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

Monday, September 4, 2017

The bullish implications of the North Korean Bomb

In the wake of the news of the latest North Korean news, Donald Trump responded with his usual tweetstorm.


The markets have learned that Trump doesn't necessarily follow up presidential tweets with action. Official statements, on the other hand, are another matter. In the aftermath of the North Korean missile test which overflew Japan, the statement that "all options are on the table" was far more serious and chilling.

After the North Korean H-bomb test, Trump met with his senior advisors and Secretary of Defense released the following statement to the press:
Good afternoon, ladies and gentlemen. We had a small group, a national security meeting today with the president and the vice president, about the latest provocation on the Korean Peninsula. We have many military options. The president wanted to be briefed on each one of them.

We made clear that we have the ability to defend ourselves and our allies, South Korea and Japan, from any attack. And our commitments among the allies are ironclad: Any threat to the United States or its territories, including Guam, or our allies, will be met with a massive military response. A response both effective and overwhelming.

Kim Jong-Un should take heed of the United Nations Security Council's unified voice. All members unanimously agreed on the threat North Korea poses, and they remain unanimous in their commitment to the denuclearization of the Korean Peninsula. Because we are not looking to the total annihilation of a country, namely North Korea. But as I said, we have many options to do so. Thank you very much, ladies and gentlemen.
It was a measured response that made the following points:
  • The United States is not looking to preemptively annihilate North Korea, but
  • Any threat to the US or its allies will be met with "a massive military response".
How should investors react in the face of escalating tensions? Is the world on the brink of nuclear war, or another Korean war?

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

Sunday, September 3, 2017

September uncertainties

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: 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 will also receive email notices of any changes in my trading portfolio.


September headwinds and tailwinds
Welcome to September. Looking forward, this month is known to be seasonally bearish. Jeff Hirsch of Trader`s Almanac found that September was the worst month of the year, based on seasonal factors.


Ryan Detrick of LPL Financial Research further dissected past September seasonality. While while returns have been negative, he found a silver lining. When the SPX is trading above its 200 dma, which it is today, the market has seen positive average returns, though the percentage positive is still below 50% at 47.9%.


That said, investors face a sea of uncertainty as we head into September. I have never known the market to perform well under conditions of high uncertainty, but consider the hurdles ahead:
  • Legislative uncertainty over the debt ceiling and tax reform
  • Geopolitical uncertainty over North Korea
  • Uncertainty over Fed actions
Can stock prices climb the proverbial wall of worry in September, or will it retreat and test its correction lows seen in August?

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

Tuesday, August 29, 2017

The surprising conclusion from top-down vs. bottom-up EPS analysis

Mid-week market updateBusiness Insider recently highlighted an earnings warning from Strategas Research Partners about possible earnings disappointment for the remainder of 2017 and early 2018. Expect a deceleration in EPS growth because of base effects:
A big part of Strategas' argument stems from the fact that the period against which current earnings are compared — the first half of 2016 — was notably weak. And that, in turn, pushed year-over-year growth to unsustainable levels.

As the chart below shows, Wall Street is not bracing for the decline. Its estimates are represented by the blue columns, which show continued profit expansion over the next two quarters. Strategas has other ideas. Adjusting for historical factors, the firm sees earnings growth declining over the period before being cut almost in half by the first quarter of 2018, as indicated by the red columns.

In addition, Strategas believes that sales growth appears "toppy".


On the other hand, Ed Yardeni has the completely opposite bullish view:
(1) S+P 500 forward revenues per share, which tends to be a weekly coincident indicator of actual earnings, continued its linear ascent into record-high territory through the week of August 10.

(2) S+P 500 forward operating earnings per share, which works well as a 52-week leading indicator of four-quarter-trailing operating earnings, has gone vertical since March 2016. It works great during economic expansions, but terribly during recessions. If there is no recession in sight, then the prediction of this indicator is that four-quarter-trailing earnings per share is heading from $126 currently (through Q2) to $140 over the next four quarters.
Yardeni's believes that there is little risk to stock prices, as long as forward 12-month EPS and revenues are rising.


What`s going on? How do investors reconcile the two contradictory conclusions of analysis of the same data set?

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