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 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 seeks to answer the question, “Is the trend getting better (bullish) or worse (bearish)?” 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 this 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
Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.
The (inflation) universe is unfolding
The (inflation) universe seems to be unfolding as it should. Regular readers know that I have been preparing for a resurgence in commodity prices (see The 2016 macro surprise that no one talks about, written in December 2015, RIP Correction. Reflationary resurrection next? written in March 2016 and My roadmap for 2016 and beyond, written a week ago). We finally got broad based confirmation of a recovery in commodity inflation last week.
Commodity and oil prices shrugged off the Doha non-freeze surprise and broke out to new recovery highs, which is bullish as you can tell the tone of a market by how it reacts to what should have been bad news. As the chart below shows, the cyclically sensitive industrial metals staged upside breakouts above its 200 day moving average (dma), as well as new recovery highs. The energy heavy CRB Index did break out to the upside, but it is now testing its 200 dma.
I interpret the surge in commodity prices as a sign of rising growth – and these signs are reflected in the fixed income markets as well. The crowded long position in bonds that I identified is resolving itself with a steepening yield curve (see What does the crowded long position in bonds mean for stocks?). The chart below shows that the 30 – 2 year yield curve has staged an upside breakout, though the 10 – 2 year curve has yet to break out yet.
We are also seeing inflationary expectations are also ticking up in the bond market. The 5 year X 5 year forward expected inflation rate is rising, though it remains in a downtrend. The existence of the longer term downtrend is potentially important for Fed policy, as central bankers like to see some definitive confirmation of trend reversals before acting.
Thank you, China
Much of the growth revival could be attributable to stimulus that the Chinese has implemented this year (also see More signs of unbalanced Chinese growth). Callum Thomas recently documented the shift in Chinese fiscal and monetary policy towards greater growth accommodation.
He also pointed out that there are “green shoots” of a trade revival, for both China and globally.
This chart from Citi shows that, as a consequence of the stimulus package, Chinese M1 has surged, and its effect on metal prices are evident.
Commodity markets may be in for a bullish surprise. Bloomberg reports that “the great ball of China money is moving away from bonds and stocks to commodities”. Speculators are piling into obscure commodities such as steel reinforcement bars, hot-rolled coils, cotton and polyvinyl chloride. We saw in the past how naive Chinese retail money, many of whom with barely high school educations, drove Chinese stocks to frenzied levels in the past. The same could happen again, but in the less liquid commodity market.
George Soros believes that China looks eerily like the US in 2007-08 as Beijing embarks on another round of credit fueled growth. No doubt this won`t end well, but that end won`t come immediately. He admitted that the bubble “may be able to feed itself for some time”. The Chinese are throwing a party, so enjoy it (but watch for the signs that the neighbors are calling the cops).
Broad based global rally
One of the key tools used by chartists and technical analysts is breadth confirmation. We are seeing broad based breadth participation in rising risk appetite at a global level and across different asset classes. I interpret these conditions to mean that we are still in the early stages of a market rally.
Consider, for example, the strength of US and European stocks, which are all in various stages of upside breakouts and other bullish developments.
The stock indices of the major Chinese Asian trading partners are all showing strength and above their respective 50 dma.