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: Neutral
- Trading model: Bearish
Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.
Subscribers can access the latest signal in real-time here.
The market ended the week at the top of a tight range between 3000 and 3240. For the bulls, they can point to:
- The market shrugging off bad news about the rising US infection rate and death rate.
- Hopeful news on vaccine development, despite some of my doubts (see A Covid recovery?).
- Constructive signs from breadth indicators and cyclical stocks.
The bears can point to:
- Nagging cautionary flags from inter-market, or cross-asset, analysis, such as the persistent downward pressure shown by the 10-year Treasury yield, which continues to test the 0.60% support level even as stocks test upside resistance.
- Faltering momentum from Chinese stocks (see Double bubble, double trouble?).
- Elevated bullishness on sentiment models, which is contrarian bearish.
There is no point in wringing my hands about the range-bound market. The market will gives us some clue on direction once it stages a breakout, either on the upside or downside. Instead, I outline some of the pockets of opportunity, and other corners of the market to avoid.
The bull case
Let’s briefly summarize the bull case. You can tell a lot about a market by the way it responds to news. The market seems to be ignoring the bad news about the deteriorating COVID-19 in the US. (Caution: The figures may be understated because of the new HHS guidelines for data.)
Market leadership rotated from the high flying technology names to cyclical stocks. Virtually all of the cyclical industries except for leisure and entertainment caught bids. Semiconductor stocks remain in a well-defined relative uptrend.
The S&P 500 Advance-Decline Line made a fresh all-time high.
The bear case
On the other hand, inter-market, or cross-asset, analysis is raising some doubts about the bull run. The Japanese Yen, which is a classic risk appetite indicator, is not buying the equity advance. In addition, the 10-year Treasury yield keeps trying to test support even as the stock market tests resistance. A significant downside breach of the 0.60% level would be a risk-off signal. Which is right, the stock market, or the currency and bond markets?
The Advance-Decline Line is also flashing a negative divergence. The strength of the NYSE A-D Line is offset by the weakness in A-D Volume. Even as stocks advanced broadly, there was more selling volume than buying volume. This is a sign of distribution that should be watched.
Lastly, bullish sentiment appears to be elevated. The II sentiment bull-bear spread has normalized to 40%, which is the roughly the level when the market peaked this year and in 2019. However, the spread was higher in early 2018 when it rose about the 50% mark.
Energy: The contrarian play
In the short run, it is difficult to know where the market will go. However, there are pockets of opportunity for superior performance for long-only accounts. Bear in mind that these are investment themes, not trading themes. There are no immediate triggers that cry out for an immediate commitment to any of these ideas.
A washed-out and unloved sector to consider is energy. The BoA Global Fund Manager Survey shows that positioning in this sector is sufficiently underweight and for a long enough duration to warrant a tactical contrarian bullish position.
From a technical perspective, the relative performance of US and European energy stocks have tracked each other. These stocks are exhibiting a constructive higher low after an initial panic low in March. There is little to choose between the different industry groups within the sector, though oil services may appear slightly better technically.
For investors who believe the energy sector may represent a value trap, they may consider ESG clean energy as the momentum play. One word of warning, though. Most of the clean energy ETFs hold a large weighting in Tesla (TSLA), which has been on a tear. However, the Cleantech ETF (PZD), which has no TSLA, managed to stage an upside relative breakout without help from Elon Musk.
Is WFH theme peaking?
The second investment theme that I would highlight is the “work from home” (WFH) theme, which may be nearing a peak. A recent WSJ interview with staffing company Adecco’s CEO Alain Dehaze raised some doubt as to how far companies can take the WFH trend.
“Remote work is unfortunately creating a social distance that we should not have,” said Mr. Dehaze, though he sees no return to workplace normalcy until a vaccine is widely available.
There are very positive aspects regarding remote work. You don’t have to commute, so you save time and money. For some, it is very convenient to work from home. But for many others, it’s a nightmare. There is the question of the quality of broadband infrastructure, computer screens and separation between private life and work.
Then there is the question, Who will pay for all the digital infrastructure work needed? Who will take the benefit of time and money saved not commuting—the employee or employer? And there is the third part, which, for me, is very important: What about the culture—the social proximity—you have in a company?
Much depends on the model of work. Are employees considered to be individual widgets, interchangeable, and expected to perform limited tasks? In cases like a call center, a WFH model is very viable given the state of current technology. But if employees are expected to be creative and collaborate, then corporate culture matters.
The question is physical distance versus social proximity. By being with colleagues, you align, you share a lot of things. You cultivate your values, you cultivate your purpose. If you are permanently alone, I don’t know how you can cultivate this.
It’s like friendship and love. You cannot cultivate friendship and love only from souvenirs, from memory. You need presence, you need to nurture. And with culture, it’s also about nurturing through experience. This social proximity will remain important.
I agree. One of the questions that I used to ask when interviewing with a company as a way of understanding the corporate culture was, “Do you socialize together after work?” Without the personal relationships, it’s far more difficult to collaborate, be creative, and add value.
This brings into question the longevity of the WFH investment theme, and the bearishness towards REITs, and office REITs in particular. From a fundamental perspective, REITs are starting to look cheap again.
From a technical perspective, the relative performance of REITs appear to be attempting a double bottom.
Gold: Too far, too fast
Lastly, gold prices have been on a tear as they staged a convincing upside breakout through the $1800 level. However, both the gold price and the inflation expectations ETF (RINF) are testing key resistance zones, and some breathers are probably in order.
Mark Hulbert pointed out that his Hulbert Gold Newsletter Sentiment Index is at an off-the-charts bullish reading, which is contrarian bearish. If history is any guide, gold prices and gold stocks are due for a correction and pullback.
While I am long-term bullish on gold. The Fed is embarking on a program of financial repression, which will depress real rates and should bullish for bullion (see Can a bull market begin without the banks?). BoA pointed out that global government bond yields are nearing Japanese yields, and the process of Japanese style financial repression is upon us.
However, gold prices have risen too far too fast. This is not the time to be all-in bullish on the metal.
The week ahead
From a tactical perspective, the market begins the week overbought, with short-term breadth indicators rolling over.
As well, the S&P 500 exhibited two spinning top candlesticks while testing resistance, which are signals of indecision. These are signals that the near-term outlook is down, but the bears have not been able to make much of such opportunities in recent weeks.
Traders also need to be aware that Q2 earnings season is in full swing. Important large cap companies are reporting, and it could mean volatility in the market.
My inner trader remains short, but only during daytime hours (see My inner trader returns to the drawing board).
Disclosure: Long SPXU