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: 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 those email alerts is shown here.
Subscribers can access the latest signal in real-time here.
As the S&P 500 advanced to fresh highs despite widespread evidence of negative RSI and breadth divergences, the market faces a number of unanswered questions that may be indicative of possible impending leadership rotation.
How the market resolves those questions will be clues to the next major leg for stock prices.
In addition to the negative breadth divergences, here are other bearish omens for the stock market. One component of my risk appetite model is persistently flashing a warning. While the equal-weighted consumer discretionary to staple ratio has confirmed the market’s highs, the ratio of high beta to low volatility stocks is exhibiting a series of lower lows and lower highs.
Credit risk appetite is also not behaving well. The relative performance of junk bond prices to their duration-equivalent Treasuries is also displaying a negative divergence.
Another possible black swan is appearing from overseas. Chinese and Hong Kong equity markets recovered Thursday after regulators convened an emergency video conference to reassure banking executives that crackdowns on the education sector were localized. The measures are not part of a series of broad-based initiatives to hurt companies in other industries. The relief rally didn’t hold as the market sold off Friday.
More ominously, the shares of mega cap property developer China Evergrande continued to weaken.
UBS pointed out that 77% of Evergrande’s liabilities are due in the next 12 months. This puts pressure on the company to cut sale prices on its product and depress real estate prices.
Other property developers also weakened and broke major multi-year support in sympathy. As real estate represent a major asset of Chinese households’ savings, skidding property developer shares could be the start of a Chinese Lehman Crisis.
Reflationary green shoots
On the other hand, the cyclically sensitive copper/gold and base metals/gold ratios are strengthening. The 10-year Treasury yield normally tracks these ratios closely, but it remains depressed. Are these reflationary green shoots that investors should take notice of? What does this mean for the 10-year Treasury yield?
The rise in the copper/gold and base metals/gold ratios is surprising as it is occurring in the face of a rally in gold prices. The market interpreted the FOMC statement and Powell’s press conference comments as dovish. Real yields fell (and TIPs prices rose); the USD Index fell (bottom panel, inverted scale); and gold prices surged to test its 200 dma. This sort of market action is constructive in light of Mark Hulbert
‘s read of gold timer sentiment data, which is in the bottom 13-percentile and contrarian bullish.
A contrarian analysis of market-timer sentiment reaches a similar conclusion about the near-term outlook for both gold and stocks. The average recommended gold exposure level among short-term gold timers my firm monitors is currently lower than 87% of all daily readings since 2000. This indicates a considerable level of bearish sentiment on gold, which is bullish from a contrarian perspective.
Gold’s ability to regain the 200 dma would be a positive sign. If it holds the breakout in the coming days, it would be bullish for the yellow metal and a signal of the reflationary trade has regained the upper hand.
The Simone Biles job market?
Finally, keep an eye on the July Employment Report due out on Friday. Barron’s highlighted the problem of labor market shortages in this week’s issue, which is giving employees greater bargaining power.
The story isn’t just higher wages, but better working conditions. The employment situation is becoming a Simone Biles job market. For the uninitiated, Simone Biles is the most decorated gymnast in American history with a record haul of Olympic and World Championship medals to her name. She quit at the Tokyo Olympics just before a competition, citing mental health issues. A minor political controversy has erupted about her decision. When viewed through a labor market prism, the fundamental question becomes a worklife balance issue and how much mental health hardship individuals should endure for the sake of their employer.
Friday’s release of the Employment Cost Index came in below expectations, which has dovish implications for Fed policy.
Keep an eye on prime-age EPOP and LFPR, wages, and other signs of tight labor markets in the July Jobs Report. This will affect the market’s view of the inflation outlook (see How to engineer inflation
) and be a driver of monetary policy.