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: Neutral
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.
Where’s the rally?
For several weeks, I have been saying that a bear market rally could happen at any time, but the market keeps weakening. One of the challenges for the bulls is to put together two positive days, which they have failed to do. Another is to stage an upside breakout through the declining trend line.
The market closed Friday in the red. One constructive sign that can be found in the above hourly chart is the index closed while testing a support level. Should it stage an upside rally from here, the logical first resistance level is the first Fibonacci retracement at about 2700, with additional resistance at the 50% retracement objective of about 2840.
This is insane! Where’s the bear market rally?
The bad news
Let’s start with the bad news. There have been reports trickling out from the state level of a tsunami of unemployment claims due to the loss of service jobs from social distancing edicts. Consequently, the Street is now bracing for a moonshot-like surge of initial jobless claims next Thursday.
The reverse side of the unemployment coin is new hires. The Upjohn Institute reported that February new hires hit a brick wall:
Employers cut back even sooner than we thought: New hires fell over 200,000 in February, and that’s a 12-month moving average. In the raw numbers, we went from 5.59 million in February 2019 to 3.85 million in February 2020.
FactSet reported that the market is trading at a forward P/E of 13.9. which is below its 5-year average of 16.7, and 10-year average of 15.0. That sounds cheap, right? But there’s a catch.
The E in the forward P/E ratio is only beginning to fall.
FactSet reported that companies are only just beginning to quantify the effects of COVID-19. Only 213 of 479 S&P 500 companies cited “coronavirus” or “COVID-19” in their quarterly earnings calls.
While many of these 213 companies discussed the current negative impact or the potential future negative impact of the coronavirus on their businesses, 76 companies (36%) stated during their quarterly earnings call that it was too early (or difficult) to quantify the financial impact or were not including any impact from the coronavirus in their guidance for the current quarter or current year. On the other hand, 58 companies (27%) included some impact from the coronavirus in their guidance or modified guidance in some capacity due to the virus.
In other words, only 58 companies in the index were able to give any guidance on the negative effects of the pandemic during their earnings calls. To be sure, some of these earnings calls occurred in January and February, before the full effects of the pandemic reached American shores. Have they given any additional guidance since then? The answer is not really.
Of the combined 134 companies that either stated it was too early to quantify an impact from coronavirus (76) or did include an impact from coronavirus in their guidance (58) during their quarterly earnings calls, only 13 companies have issued quarterly or annual guidance since their call with a revised impact from the virus. On the other hand, 11 companies have withdrawn, suspended, or not confirmed previous quarterly or annual guidance since their quarterly earnings call.
In other words, expect further wholesale earnings downgrades in the near future.
That’s the bad news.
Here is the good news. The technical internals of the market are improving. As an example, the relative strength of the high beta factor compared to the low volatility factor is bottoming and turning up, indicating improving equity risk appetite.
Other market internals are also improving The Advance-Decline Line is starting to bottom out and it is exhibiting a positive divergence. NYSE new lows are contracting, % bullish is improving, and 14-day RSI is showing a positive divergence. All of these signs point to bearish exhaustion.
The NASDAQ 100 chart tells a similar story. While the NASDAQ A-D Line is not exhibiting a positive divergence, the other three indicators are showing bullish divergences.
Deutsche Bank’s analysis of hedge fund equity positioning reveals an extreme crowded short position, which is consistent with our thesis of bearish exhaustion. Should any bullish catalyst appear to spark a rally, expect a short covering stampede to rapidly rocket stock prices upward.
Short run breadth is currently oversold, and the market is ripe for a rally on Monday. Even if the market does rise, let’s just see if the bulls can muster market strength for more than one day.
My inner investor is positioned for maximum defensiveness. My inner trader is on the sidelines. He is waiting for signs of a relief rally before jumping in on the long side.