Reversals everywhere

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 bsoe 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: 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 those email alerts is shown here.

Subscribers can access the latest signal in real-time here.


Fun with Japanese candlesticks

Last week’s market action in the S&P 500 was a classic lesson in the usefulness of Japanese candlesticks. I wrote last weekend that the market was oversold and due for a rebound. The S&P 500 cooperated on Monday by exhibiting a hammer candle, in which the market tanks but rallied to a level equal to or above the open. Hammer candles are indications of capitulation selling and a possible short-term bottom, but the pattern needs to be confirmed by continued strength the next day. The bottom was confirmed Tuesday when the index advanced and regained the 50 dma.


The second candlestick lesson came on Wednesday, when the S&P 500 showed a doji, when the open and closing levels are about the same. Doji candles are signs of indecision and possible reversals but must be confirmed the next day. The S&P 500 duly weakened Thursday and stabilized Friday ahead of the long weekend. All of this is occurring as the S&P 500 forms a triangle, which suggests that a big move is just around the corner.



In short, it was a master class in trading Japanese candlestick patterns. Not all candlesticks resolve in textbook manners, but they did last week.



Reasons to be bearish

Now that the bearish reversal is in place, the path of least resistance is down. The intermediate-term breadth momentum oscillator (ITBM) flashed a sell signal when its 14-day RSI recycled from overbought to neutral. In the past, these sell signals have been effective about three-quarters of the time.



My cautious outlook is supported by negative divergences in equity risk appetite indicators. In particular, speculative risk appetite for high-beta story growth stocks is tanking (bottom panel), which is bearish.



Breadth indicators are wobbly again. The NYSE Advance-Decline Line has been unable to regain its upside breakout level. Net NYSE highs-lows are negative again. The percentage of S&P 500 stocks above their 50 dma has deteriorated to the critical 50-60% zone that separates bullish and bearish trends.



Determining downside risk is always a difficult exercise. In the past, ITBM sell signals have resolved with pullbacks in the 5-10% range. In this case, a test of the 200 dma, which stands at about 4420 and represents about a 7% drawdown, is a reasonable guesstimate. However, the sell signal presented by the negative 14-month RSI divergence of the Wilshire 5000 has typically ended with corrections of up to 20%.




The earning season wildcard

A 20% pullback would involve a major bearish catalyst. A possible source of volatility is the Q4 earnings season. So far, consensus EPS estimates have been steadily rising.



With December headline CPI at 7.0% and headline PPI at 9.7%, one of the key questions for investors is whether companies can pass through increased costs. 



What about the effect of the Omicron wave? As an example, Bloomberg reported that lululemon revealed Omicron had dented its sales. Was LULU an exception or the start of a trend?


The company best known for its yoga pants said that it started the holiday season strongly. But then it suffered from several effects of omicron, including staffing shortages and reduced operating hours in certain locations. Even before the latest variant, consumer-facing companies were grappling with supply-chain snarl ups and not having enough workers. If these pressures continue, Lululemon won’t be the last to highlight the consequences. 


So far, companies with strong brands, such as Nike Inc., and with scale, such as Walmart Inc. and Target Corp., have been able to withstand the supply-chain challenges, while weaker firms have struggled to stay afloat. Last week, Bed Bath & Beyond Inc., which is in the midst of a turnaround plan, cut its sales and profit forecast.
Expectations are elevated, but companies have tended to manage expectations so they’ll surprise Street estimates. The very preliminary results are disconcerting. Four large financials reported Friday morning. JPMorgan beat on earnings and sales expecations. Blackrock beat on earnings but slightly missed on sales. Citigroup missed on both. Wells Fargo beat on both. Of the four stocks, only Wells Fargo advanced.



The geopolitical wildcard

The other major source of market risk is geopolitical instability over Ukraine. US-Russia talks on the issue broke up with the Russian side characterizing the discussions at a “dead end”. Russian troops have been massing on the Ukrainian border and the muddy season is ending soon. The window for an invasion will open as soon as the ground firms.


A discussion of whether an invasion is justified is beyond my pay grade, but Adam Tooze of Columbia University recently outlined the challenges the West faces with Russia. Simply put, economic sanctions are not a very useful levers for two reasons. First, Russia has a strong foreign exchange reserve position.

Hovering between $400 and $600 billion they are amongst the largest in the world, after those of China, Japan and Switzerland.


This is what gives Putin his freedom of strategic maneuver. Crucially, foreign exchange reserves give the regime the capacity to withstand sanctions on the rest of the economy. They can be used to slow a run on the rouble. They can also be used to offset any currency mismatch on private sector balance sheets. As large as a government’s foreign exchange reserves may be, it will be of little help if private debts are in foreign currency. Russia’s private dollar liabilities were painfully exposed in 2008 and 2014, but have since been restructured and restrained.



As well, Russia is too big to effectively sanction. More importantly, it will continue to accumulate reserves as long as oil prices stay above $44 a barrel.


Russia is a strategic petrostate in a double sense. It is too big a part of global energy markets to permit Iran-style sanctions against Russian energy sales. Russia accounts for about 40 percent of Europe’s gas imports. Comprehensive sanctions would be too destabilizing to global energy markets and that would blow back on the United States in a significant way. China could not standby and allow it to happen. Furthermore, Moscow, unlike some major oil and gas exporters, has proven capable of accumulating a substantial share of the fossil fuel proceeds…


Putin’s regime has managed this whilst operating a conservative fiscal and monetary policy. Currently, the Russian budget is set to balance at an oil price of only $44. That enables the accumulation of considerable reserves.
Even as the Ukrainian story occupies the front page, an equally important geopolitical development that is on back pages is the recent crisis in Kazakhstan. From the Kremlin’s point of view, Kazakhstan represents a vital Russian interest for a number of reasons. First, it has an enormous border with the Russian Federation. About 20% of the population are ethnic Russian and political instability will create a refugee crisis for Russia. As well, several Soviet-era space launch sites that are still being used by Russia are located in Kazakhstan and the country is a major producer of uranium.



While Kazakhstan’s independence from the Soviet Union was relatively smooth economically, it has been ranked as one of the top countries for corruption. It is, therefore, no surprise that NGOs such as George Soro’s Open Society Foundation and the US-based National Endowment for Democracy (NED) funded democracy movements in the country. However, the NED has the unfortunate history of being spun out of the CIA during the Reagan years because it was felt that the CIA should not be seen as directly supporting pro-democracy movements in other countries. In the past, the NED has supported “color revolutions” in former Soviet republics, which has cast suspicion on the organization, especially to a former KGB officer like Vladimir Putin.


The Russians recently sent about 2,000 paratroopers to stabilize the situation in Kazakhstan when mass protests erupted over fuel price increases and the troops began withdrawing last week after accomplishing their mission. Nevertheless, Putin could view the Kazakh protests as covert American intervention in a former Soviet republic that is of vital interest to Moscow, which raises the temperature of the Ukraine situation.


I don’t want to over emphasize Russia’s role in the world. Russian GDP is roughly the same size as Italy’s. However, geopolitical tail-risk is probably higher than the market is discounting and an invasion could spark a major risk-off episode in the markets.


In conclusion, the tone of the market is turning bearish. Technical internals are deteriorating and my base case scenario calls for a 5-10% pullback in the coming weeks. A downdraft of 20% represents an outlier case but would need a major bearish catalyst such as severe earnings disappointments or the emergence of geopolitical risk.



Disclosure: Long SPXU


30 thoughts on “Reversals everywhere

  1. This chart of several key sectors YTD (Value, Growth, Low Vol, S&P 500, LT Bond, BlackRock) blows my mind;

    The swings between sectors in two weeks are epic while the S&P 500 is tame. First lesson from this is the Fed liquidity is still pouring into financial markets (until March), floating assets in general up while investors shift their favorites.

    A few observations;
    Value is outperforming Growth by 12% in two weeks! That is just Value’s Energy up huge and Banks up a lot. Your average money manager (especially those with an ESG mandate) or investors in general are not long much Energy if at all. So they as a group are hurting.

    Low Vol (and Defensives) was outperforming until yearend and now not. Real Estate, Healthcare and Utilities are failing. Big Surprise. Investors are seeing expected safe havens failing. Even bonds are not providing promised countercyclicality.

    BlackRock is something I track as a great bull/bear market indicator. All money managers make more money if stocks go up because that propels their assets higher and confident investors pour in more money. Margins widen and money manager stocks like BlackRock outperform the S&P 500. They just celebrated becoming a $10 Trillion AUM manager. That leveraged dynamic works in reverse when stocks fall and people pull money out. Here is a chart of BlackRock BLK. Looks very sick.

    Since the December 20 intermediate market low, BLK is down 5% when the market is still up about 2%. This is the first bull market rally in which BLK has not led, let alone failed. Very ominous. Their Growth oriented ETFs would have been most popular and they are getting killed.

    We are entering investment ‘Winter’ season with the severe cold weather later after March when Fed liquidity is pulled. But maybe knowing this, stock investors will discount it and the markets feel the chill sooner.

    1. over the past few yrs BLK tended to lead the broad indices. very ominous indeed…. especially now BLK just fell below its 200dma

  2. My other post is very negative about the shorter term outlook. Let me offer some Big Picture positives.

    First on interest rates. When we look at charts up close, we see rates projected to go up from zero to possibly 1% by year end and another half percent the next year to total 1.5%. That looks like a mountain but when you look at a ten year chart of Fed Funds, it’s a molehill. Rates in 2018 were 3%. With inflation running 3% more or less in those next years and much more this year, we have huge negative interest rates that will keep punishing bond savers and pushing them into stocks.

    The Omicron might be a silver lining for the global economy and stocks. We may look back at the tsunami of Omicron mild infections almost as a global vaccination plan that will give us close to herd immunity against the nastier varieties of Corona-19. We could then be see occasional, regional seasonal outbreaks on the endemic variety with life returning to normal. In fact, that positive longer-term outlook could be growing over the next couple of months and spurring stocks higher.

    Lastly, if Omicron fizzles out quickly and the economy and especially schools reopen, the November election results could swing back towards the Democrats. This helps stocks since government spending will be higher with House majorities. A GOP majority, now expected, would lock down spending as they did under Obama to set the stage of a poor economy for the 2024 Presidential election. Dems are always better for stocks.

    Lastly, the Fed in future years might let inflation run hot by being continually behind the curve. This is because higher interest rates needed to effectively control inflation, might be disastrous for the economy since their zero rate policy has led to massive increases in total, societal debt. As long as they are behind the curve, stocks in general, especially inflation-loving companies, will go up. Cash will be trash and bonds big losers.

  3. We are having a consolidation…well sideways price action, and after congestion there is a breakout, only up or down?
    I think a contrarian position is to look at what is not ESG, simply because ESG is political and politics never made money or real goods. The ESG movement has gone on long enough to have an effect. After the next big correction or bear, go long on energy, and by the same token maybe ESG will highlight the top.
    Four year chart of the SPY is definitely scary. Let’s humor the fibonacci Elliott wave guys. in 2018 from bottom to Oct high about 8 months….multiply by 1.6 is about 13 months which from the low at the beginning of 2019 puts us close to the 2020 pre covid top. Take 13 months multiply by 1.6 gives us 21 months which is pretty close to where we are now from the march 2020 low…scary huh? Especially when you see that each low is lower.

  4. A couple of points;
    1) When using triangles don’t you need to see which way it breaks before you know how the triangle is resolved ? i.e. the triangle is only a “set-up”.
    2) I find it useful to also look at the S&P500 equal weighted SPEW-X and the NYSE composite to get a larger view of the markets. In my opinion these don’t look as bad as the S&P500. That’s not to say that we still won’t get a “downdraft” though.

    1. I think that triangles are found after the fact….like there is uncertainty in the market, different patterns can show, but eventually one pattern manifests. According to Elliott waves a triangle is the 2nd last wave of a larger wave, so wave 4 of an impulse or wave B of a correction, but they just label a triangle like pattern at a top or bottom differently. So yes, I think that what matters is how it breaks. If you look at the 4 year SPY chart, there is a huge expanding triangle, with wave E being the march 2020 low, the “thrust” out of it surely has been impressive, but then we must be near the end and if true, since a triangle in this case would be wave 4, then a major down is coming…..if this happens, they will point out the triangle and say “see!”….but if we don’t get a collapse, then the labels (wave counts) will be different.
      There is a big uncertainty about what central banks will do….is this talk about tightening and rates genuine? I know they are saying it, but when the markets are crashing and we get a recession looming, and interest costs of government debt get super high, will they allow a full fledged depression? I don’t think so. The cause of a lot of this is government spending, which requires more debt….so, will our elected officials sacrifice their careers for the greater long term good? I really doubt that. So government deficits will continue, which means more money printing. That does not mean that the market can’t tank, it can and probably will, but as far as real interest rates go….I don’t see how they can become positive unless we get some serious deflation…yeah, not likely good deflation but the nasty kind.
      One thing about triangles, there is no real limit to how far things can go on the thrust, just the expected minimum. I still think the chart is ugly and worrisome…then again if one considers how valuations are at record highs, are you surprised?


    I had a statistics class at Michigan with Professor Allen Spivey in the Eighties – one of the best. The use of PCs and Excel were still in their infancy at the time – with which he had each student build forecasting models from scratch. The thing I remember most clearly is the emphasis on extrapolating the most recent data.

  6. Dear Cam, I saw you e-mail alert on Twitter but I received no e-mail. In addition to that I do thing that the US markets are closed today. Please let us know what happened.

  7. High growth tech/software stocks (ARKK types) have lost the most since peaking in 1H 2021. Many of them are down 60% – 80%. Does anyone have any opinion on them?

    1. if you chart ARKK:SPY and look at a 3 year daily moving average, this has crashed below the 3 year ema…not good in my opinion.
      covid new cases seem to be on a downward path…this will have to get some attention if it persists…but we are back in a weekend.
      yesterday less than 300k, a week ago was 850k, South Africa and UK also going down…one can always hope it is almost over

        1. Well, if you look at long term charts of a stock vs spy and use a 3 year ema, what I have found is that there can be long stretches of over or under performance. So if ARKK:SPY goes below the 3 year ema it may stay there for a long time. Not 100 % of course, but it is very common. If the market tanks, ARKK may do worse.
          the ratio was much lower than now, so if the ratio drops by 50% and the SPY drops 50%, then ARKK will be down 75% from now. Remember that ARKK was sub 20 in 2016 and many of the companies have Hugh price to sales ratios which is a downside risk. You know the famous quote about Sun Microsystems.

  8. Energy seems to be breaking out. Maybe fears of war with Russia? I noticed XLE just now recovered from its drop in 2020.

    Still holding my longs on SP500, XLE and XOM from last year with hedges on SP500.

  9. Cam’s excellent analysis, all the commentary above and otherwise points to a negative outlook for the market ranging from a Winter freeze to a correction. No one in my knowledge is positive. It seems too one sided. Is it possible that there is a sideways consolidation in a wide range similar to RUT for next several months?
    Asking for a friend to help with this question.

    1. Anything can happen, we are overdue for a bear market. All the liquidity and money injected may take time to subside. I am watching for good covid news, and I expect this news to be frontrun so we could easily get a pop in the near term. I agree that this is not euphoria, but euphoria could show up if covid finally seems done.
      Not helping much am I?

      1. Thanks for answering the call. I realize that no one really knows but we still want to prognosticate. And how do you get any degree of confidence? I trimmed a lot when Cam initially suggested it. In cash more than in recent months. I feel we are in the middle of a correction. Using options to hedge some more downside risk. Time will tell.

    1. Normally the contrarian take would be a green close. What’s the likelihood the market breaks to the downside instead to SPX 4500?

      1. I’m seeing a lot of panic and hopelessness with the people I interact with – over the last few days.

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