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 that 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. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here
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 email alerts is 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: Buy equities
- Trend Model signal: Bullish
- Trading model: Bullish
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 those email alerts is shown here.
Subscribers can access the latest signal in real-time here.
A slow-motion pullback
I have been writing about the possibility of a blow-off top ever since the S&P 500 rose above its rising trend line (see A blow-off top ahead?
). In the past, blow-off top episodes were characterized by a spike upwards in one week, followed by a precipitous drop the next week.
This time, the S&P 500 experienced a slow-motion pullback as it visited the site of the 50 dma during two consecutive weeks.
Is the pullback over?
The bull case
Here is the bull case. The S&P 500 ticked off all of my bottoming model criteria, except for a lack of fear as measured by the term structure of the VIX. Is that enough for a bottom?
The NASDAQ 100, which was one of the worst-hit parts of the market, exhibited a positive RSI divergence. It has since rebounded and trying to regain its 50 dma. As well, the high-octane ARK Innovation ETF bounced off a relative support level against the S&P 500 and it recovering.
The small-cap Russell 2000 has been mired in a trading range, but its relative performance against the S&P 500 bounced off a 50% retracement level. I interpret that as a constructive sign for this high-beta portion of the market.
The market is also on a NAAIM buy signal. The NAAIM Exposure Index measures the opinions of RIAs who manage individual clients’ portfolios. In the past, a decline of this index below its 26-week Bollinger Band has been a reliable buy signal that indicates low downside risk.
From a fundamental perspective, earnings estimates have been surging as an indication of fundamental momentum. Everything else being equal, rising estimates translates to lower forward P/E ratios and more attractive valuations.
The bear case
On the other hand, the bears also have a case for unfinished business to the downside. Despite the stock market rally, the relative performance of most defensive sectors remain above their relative support levels. This is an indication that the bears haven’t lost control of the tape.
pointed out that the market is overdue for a pullback and fear spike. The Fear & Greed Index hasn’t fallen below 20 since the March 2020 low, which is an unusual condition.
As well, J.C. Parets recently contrasted the somber tone of the New Yorker cover from March 2020 at the time of the market bottom, to the optimistic tone of the latest cover. If the first cover represented a contrarian buy signal, does this mean the May 24, 2021 cover is a contrarian sell signal?
What’s the verdict, bull or bear? Jurrien Timmer at Fidelity has compared the trajectory of the stock market recovery to the market surge in the wake of the 2009 bottom. If the market were to follow the same path, the S&P 500 is due for a 16% correction.
Bear in mind, however, that history doesn’t repeat itself. It just rhymes. There is no doubt that the market is due for a pause, but the inconclusive nature of the bull and bear debate leads me to believe that investors are due for a period of choppiness in the coming weeks and possibly months.
My base case scenario calls for a range-bound market. Tactically, the market was oversold and it was due for a relief rally. I am open to the possibility that the market could test the old highs and make marginal new highs. I would monitor these bullish tripwires as signals that the bulls have regained control of the tape:
- A wholesale violation of relative support by the defensive sectors of the market.
- The VIX Index decisively falls through its 20 dma, which would be a signal of bullish momentum.
On the other hand, if the VIX maintains support at its 20 dma, expect a sideways choppy market and a possible retest of the S&P 500 50 dma.
Disclosure: Long SPXL