I’ll never complain about a lack of panic again

Posted by Cam Hui -

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: Neutral
  • 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 reversal bottom

Last week, I lamented that the stock market appeared to be fearful, but not panicked. Be careful what you wish for, you might just get it.

 

On Wednesday, the S&P 500 violated a key neckline support level of an apparent head and shoulder pattern. On Thursday, the Russian Army crossed into Ukrainian territory and conducted what Putin called a “special military operation”. Global markets adopted a risk-off tone and S&P 500 futures were down -2.5% overnight. The index opened deeply in the red but recovered strongly on the day on high volume to form a classic reversal bottom.

 

 

If war is what it took, I’ll never ask the market gods for panic again.

 

 

Supportive internals

Market internals are supportive of a bullish reversal. Even though the large-cap S&P 500 briefly violated support, the mid-cap S&P 400 and small-cap S&P 600 both held support, which is a constructive development.

 

 

On an intra-day basis, three of the four components of my Bottom Spotting Model had flashed buy signals, only to see one of the models reverse itself as the VIX Index closed below its upper Bollinger Band.

 

 

 

Supportive sentiment

Even before the shooting began, sentiment models were supportive of a short-term bottom. The AAII bull-bear spread had fallen to -30, which is consistent with signs of panic bottoms.

 

 

II sentiment tells a similar contrarian bullish story. The bull-bear spread had fallen to just above zero and bearish sentiment had spiked to levels that were indicative of panic.

 

 

As well, Macro Charts pointed out that the traded value of put options had spiked and the traded value of call options had plunged.

 

 

 

Selected industries of interest

Here are some indutries to consider in the current heightened geopolitical risk environment.

 

Ukraine is the breadbasket of Europe and the war is likely to curtail production. Instead of buying an agricultural products ETF, I prefer to focus on companies that support the agricultural industry (MOO). The ETF is holding above absolute support and recently staged an upside breakout through relative resistance.

 

 

Another obvious industry is that benefits in the current environment is aerospace and defense, which broke up through a relative downtrend and exhibiting positive relative strength.

 

 

Finally, cyber security stocks represent a group that has been overlooked in the current environment but they are starting to catch a bid. They violated an important relative support level but recently recovered above relative support turned resistance. This is an industry that could show significant potential for outperformance.

 

 

In conclusion, a short-term bottom is probably in, but it’s difficult to predict short-term market fluctuations in the current circumstances. The situation on the ground in Ukraine is highly fluid and a jittery market is highly sensitive to headline risk. 

 

Investors could focus on agriculture (MOO), aerospace and defense (ITA), and cyber security (HACK) for outperformance opportunities in the current elevated geopolitical risk environment.

 

 

Disclosure: Long TQQQ

 

46 thoughts on “I’ll never complain about a lack of panic again”

  1. What follows here could be the investment idea of the century or “WTF was Ken thinking???”

    I use momentum to confirm a new narrative or not. I keep informed on reasons sectors of the investment world might do better or worse. Then if the sector makes a significant shift in momentum, I can calculate if I should buy in or avoid.

    There is a possible new narrative on Gold Bullion going up and the U.S. dollar falling that could see a huge shift. I’m not predicting it but just saying if it is happening, I will go with it even if it seems too extreme (i.e. bullion $3,000 plus plus plus).

    Here is the new narrative;
    The U.S. dollar is the fiat global reserve currency. That is a privilege with amazing power and responsibility. It allows them to run huge current account deficits forever and have countries leave their surplus dollars in the U.S. where they are then used it to buy Treasuries.

    Governments both US and European are messing with the critical SWIFT system. If the U.S. dollar is the blood, the SWIFT system is the blood vessels. Until this week only us Fed-phoebes knew about SWIFT. Now high school students are holding up signs demanded Russia be kicked out of SWIFT.

    The only time SWIFT was pulled on a country was when Trump opted out of the Iran nuclear deal and started heavy sanctions. The Europeans hated dropping the deal but could do nothing when Trump threatened any sanction breaking country with being kicked out of SWIFT. The Europeans meekly got into line. But they suddenly learned the value of SWIFT.

    The Europeans were reluctant to invoke SWIFT against Russian banks because they know how nasty it is and the possible negative international financial effects in the future. But suddenly mobs were demanding SWIFT action (pardon the pun).

    Not only SWIFT but key global government central banks are seizing Russian government and oligarch overseas deposits in the hundreds of billions. Note that the U.S. seized Afgan and Iranian government deposits in the past. They were small and seemingly unique but Russia is a whale.

    Look at this from China’s standpoint. They see themselves on the outs politically with Cold War II happening. On some future pretext, will the U.S. seize their trillions on deposit or kick them out of SWIFT causing an instant depression in China? I expect those deposits will mysteriously go away. Other buyers will need to be found which could mean higher interest rates.

    When Trump used the SWIFT threat against the Europeans during their objections to dropping of the Iran deal, there was a movement afoot to find an alternative to the SWIFT system controlled by the U.S. That quieted down. I expect we will hear of much new things in this area or maybe it will happen silently in the background.

    All this to say, the fiat U.S. dollar privilege as the reserve currency may be coming to an end. We could see a surprisingly weak U.S. dollar.

    This all could lead to any number of new narratives. One is commodities in general and gold in particular could go up amazingly and consistently. Inflation within the U.S. could be a much bigger problem. A weak currency leads to inflation pressures. Interest rates could go up more than expected. Inflation might become a continuing problem.

    These are all possible new narratives I will be watching if those effected ETF sectors start moving to reflect any of these new dynamics. Maybe nothing will happen and a lack of momentum will have me not committing to these ideas. That is the beauty of momentum-style investing. Follow the money. Don’t predict, just understand why.

    One thing is for sure, expect China and other Central Banks to hold much fewer U.S. dollars on deposit at the Fed. That means new buyers must be found or rates have to be much higher to attract new money. Higher rates mean we are galloping towards a recession faster.

    1. China and Russia together make up 17-18T in GDP which roughly equals that of combined Europe with US and Japan at combined 27 T. So, even if there are two payment systems (China already has one), where would the flow be and who would you trust to hold your reserves? Countries run by two dictators? I don’t think so. Dollar is more of a safe haven, IMO.
      But there is something to the narrative.
      Russia is an emerging economy but gets more attention due to energy, nukes, and Putin.

  2. Ken,
    one question, Doesn’t weaker $$ translate to higher returns for Mega and Large caps which are global? I understand the concern about $ no longer being a Reserve currency, but this has been said before about $ losing it’s Reserve status for the last 50 yrs. If the world is going to be split between Russia/China and U.S. + West, who do we trust more in such a case, certainly not Russia and China, right? Just spit balling as a counter to your post

    1. Lower dollar does help international earnings but punishes domestic. So relatively better to hold them. Problem is we will be in a bad global stock market very likely.

  3. I wonder what ESG will have to say about this. Apparently some pretty big demonstrations against Russia. Russia cannot successfully occupy Ukraine long term unless the Ukrainians wish them to. I think many people are willing to endure higher prices if Russian oil and gas stays in Russia, and I would not want to be in the business of importing Russian goods at this time.
    There was a nice store in Montreal called House of Iran where I sometimes bought caviar. It went out of business soon after the Iranian revolution. My take on this is that Putin misjudged the global outrage that would happen perhaps someone will give him coffee laced with Polonium …karma is a bitch….

  4. Hi Ken in my blog yesterday I said gold was in an uptrend. Trends have a life of their own. For example when oil was trading negative last year nobody imagined it could go to $100. We live in strange and difficult times. We now need to imagine anything that is impossible is possible.

    1. TSLA at – 100?
      What can be manipulated, can be manipulated more than we think possible.
      But unless there is a liability attached things don’t go negative…with oil it was a storage issue so the liability was “here is your oil, go put it somewhere”, with rates in Europe being negative this is central banks, lack of large enough safe mattresses and also with bonds when rates go more and more negative the price of the bonds go up…the real damage will be when rates stop being as negative and then the price goes down along with a still low or negative rate.
      Unless there is a change in liabilities, share holders cannot be subject to more than a 100% loss on the shares, so if anyone wants to pay me 100$ for every share of TSLA they give me (tax free of course), I’ll take them.
      I bought some puts on UVXY on Thursday, and UVXY went from around 22 to 16.37, the puts went down in price, which is truly interesting….some things can be manipulated. My thinking on this is that maybe short selling of UVXY created a market for selling out of the money puts as a way of picking up spare change because the only risk of writing a put if you are short is limiting your gain on the short, just like selling covered calls. So I am really curious about what will happen this week because UVXY has this horrible decay and should the rally continue UVXY should keep dropping. But I remember what happened in 2020 with option spreads on the SPY…I vividly remember how even well into the money spreads at expiration were not even close to what they should have been. I’m not talking last day but at market close where an in the money spread of say 240/235 which should have been 5 was more like 3….nothing like having a nice put spread, watch it zoom into the money, way into the money and get nothing, because not only is the spread not responding, but to get out of the spread you have to deal with the bid ask spread on each arm….you can lose money being right.
      Moral of the story , if you expect a freewill in the SPY (or anything else) don’t do a spread, just get a vanilla put.

      1. Volatility is the biggest factor in options pricing. As Market rallied, volatility drops and option prices drop. As it gets closer to expiration, extrinsic value plummets. OTM options bought when volatility is high are a difficult proposition. Options hedges work better if initiated when volatility is low (lower).

        1. Yes and when the market rallied volatility dropped, and UVXY fell about 30% in 2 days, which on the UVXY basis is volatility. So if you bought some SPY calls Thursday, and the SPY jumped by 30%, which would mean going from 410 to 530 which would require the SPX to be around 5400 by Friday close, would you really expect your SPY calls to have decreased in price? Exp march 18th, so not long life, but enough that the loss of premium due to time decay is not overwhelming.. In any case, if you bought a SPY call for the SPY at 400, and on Friday it closed at 437 you would expect them to be worth about 37 bucks on Friday at close. This is not what happened in 2020

          1. Just to avoid confusion, march 18 is when my UVXY puts expire. What I am talking about is SPY puts that I traded in early March 2020, that I bought that were near the money as a spread and even though the market was in freefall, the spread did not widen, even after expiration, market closure. If you were to look at say puts with an expiration of feb 25 on the SPY with strikes of say 445 and 440, at the close on the 25th, the spread should be very close to 5 $, because the 440 would be about 2.25 and the 445s about 7.25. This was not the case in Mar 2020, not even close. Normally there is arbitrage which tightens the bid /ask, so at 3:59 pm on Friday those 440 puts would have a bid ask something like 2.15 bid 2.25 ask, something like that, not say 1.85 bid , 2.45 ask….I am telling this experience, because it is tempting to do a spread to reduce cost and figure you can collect the spread value if things end up in the money…this did not happen in Mar 2020, so if you expect a freefall, don’t do a spread, just buy a put, not a put spread, and if the market falls, volatility will go up, your put should go up in price regardless of whether it was way out of the money or in the money, but you might be disappointed with a spread that you are unable to cash out at a profit. Of course if you buy a spread with little life, and out of the money so that you pay say 5 cents and the SPY drops enough that it is in the money, the spread will be more than 5 cents so you should make money but you will be disappointed because the bid/ask on each arm will be wide, and the prices will not reflect the strikes.
            I am amazed at how long they have kept GME up, and trading such volumes, unless I missed something and GME is a must own stock. I don’t know how they do it, but they do.

  6. yodoc2003,
    If both legs are in the money at expiration, you would get full value of the spread through exercise and assignment. I prefer SPX options sometimes because they settle into cash regardless. But they are roughly 10 times 1 spy spread. 1 SPX spread ~ 10 SPY spreads.
    What happened in March 2020 was absolutely crazy.

    1. exactly, and that’s my point….so if another major air pocket happens, people don’t get sucked in. If UVXY keeps dropping at some points my puts will gain value so long as the premium due to time does not evaporate faster which is related to how much life is left

  8. Looks like Putin won’t cover his short position until SPX 4020 which is where the weekly gap up occured on 4/2/21. Weekly gaps on the SPX don’t happen too often, but when they do, eventually they get back filled. The pandemic of 2020 backfilled a weekly gap that took 3 years, back to 2/10/17 and magically the market started to rise a week after the back fill on 3/20/20.

    Are we sure Putin doesn’t have a CTA? Let me go check out his 1997 Ph.D. dissertation on commodity and the Russian economy.

  9. Reopening in the premarket session many of the the same trading positions closed on Friday, albeit sized down by half.

  10. Interesting chart pattern.
    If you draw a line on an ES mini chart across the tops starting Feb 9, we broke this resist line on Friday, with the plunge in the ES mini overnight that line acted as support. Good sign for the bulls.
    But charts are just that, and trends last until they don’t.

  11. Curious! How can Putin get out of this morass with his power intact? He has been very popular in Russia but his credibility will dive if this invasion does not succeed. Anyways, the dive in Ruble and other sanctions are bound to make the lives of Russians even more difficult. Russia will likely remain isolated for months or longer or until he is no longer the head of the state.

    Does that mean he will go to any extent to defend his power?

    1. Are we able to realistically gauge Putin’s popularity? I don’t think so. Autocrats tend to be unpopular to begin with, and I would be highly skeptical of approval ratings.

    2. Two sources… I have a few Russian friends who really admire him. They think he is the strongest leader on the world stage today.

      I think it was either Economist or FT that referenced a poll that they consider to be quite reliable.

  13. The problem of course is that these patterns do not always work. But a failed breakout, or breakdown of a head and shoulder pattern can signal a really strong move the other way. Elliott wave patterns work in hindsight, just like a trend that lasts 10 years works in hindsight. For example the market has been in a bull market since 2009. I don’t buy 2020 as a bear, any more than 1987, but in 2012 we could not say it would keep going up, but now we can draw a channel that shows an intact channel, except for a brief break in 2020…what happened after? a moonshot is what happened. Back to Elliott waves, when you get a correction, it can be an expanded flat, which means 1 wave down, 1 wave up which goes higher than the prior high,(this makes the head) then a wave down which is often sharp and goes lower than the first down wave, this makes the false break of the head and shoulders. The final shoulder is made by the subways of that last down wave. So then later you look and see this flat, but it was a correction and the market rips out of the consolidation…in retrospect. So if the market goes on to new highs in the next few months we might see that pattern, if the market does not then they will see a different one.
    In 2019 I was was looking for an expanding triangle, I had drawn lines etc, we got the final wave in 2020 but I was too paralyzed, it was like the world was ending.
    So what can give the market rocket fuel? Covid ending, Russia getting stuck in a war it will lose eventually, Fed being more dovish on account of the war.
    So a possible Elliott wave pattern is that 2020 was a wave 4, then we started a huge wave 5 whose first wave topped sept 2 , 2020. Then wave 2 down. Wave 3 topped nov 5 2021, then we got an expanded flat..3 waves down to dec3, then 3 waves up to year end/early January, then 5 waves down to feb 23….the C wave of a flat is 5 waves not 3 and is usually nasty, just like a 3rd wave is usually the strongest. So wave 4 ended most likely feb23, and wave 4 usually goes to or beyond the subwave 4 of the preceding wave 3, so October 4 2021.
    Beautiful if it works, who knows? But if so we should start wave 5 which would exceed the old high unless they call it a truncation lol…but to say wave 4 is done, we need to get past 4600, and even then we could still get a truncation and then comes the BIG bear.
    This is just possibilities, will we see it? I don’t know. It is a bit like seeing shapes in clouds, you see what looks like a horse but did you know that shape would form an hour before? No
    There is a beauty in technical analysis, but really only after the fact, we could also be in wave 1 of the big bear, but the credit markets are too calm which is why I think it ain’t done yet.
    Look at a chart of SPY for 2007 to 2009 and you see 5 waves down with the 3rd wave being the worst of them, and it ended lower than the low of 2002…so for the SPY the Dotcom bust was wave A, the rise to Oct 2007 was B and then wave C the GFC, where we thought the financial system was going to implode…so we see this after the fact.
    So where does this fit with forecasts? Well if we are doing wave 5 most likely we get a new high, but then the bear will take us to levels possibly even lower than 2009, over the course of years and possibly roller coaster up and down or like 1929 or nasdaq 2000…fall off a cliff, big dead cat bounce then horrible ride to the bottom. This is what I expect is more likely because 1929 and nasdaq 2000 both went parabolic, just like we are experiencing. No idea when this happens, but in 2000 the credit markets were stressed from 1998, worse after LTCM, so there were warnings, but the nasdaq went parabolic.
    Maybe the credit markets are messed because of the Fed so we don’t get a warning this time, but they acted up in June 2007, and oct 2018 and only after 2020 did they get lower in 2021 than the lows of 2018. This would suggest we are not at the end yet, but if the market makes a new high and credit markets are getting stressed, get nervous, get some good gains off the table that you put aside for when the S&P refits the 600s.
    Sounds crazy, but 1929 the dow lost 90% and the nasdaq in 2000 lost 83%.
    Can’t sleep Ukraine….may freedom live in Ukraine

    1. looking at the last few days 4100 has to hold, and if we break 4600 we should be good. If we are in a flat with the futures doing A during the night Sunday, then B today and are starting C, expect a nasty move down to 4200 or so but not sub 4100. If it breaks 4100, it’s not a flat wave 2. But usually C is sharper than A, which is not possible because A happened basically at the open on Sunday, so more like 4300 range, but we will only know after the fact.

  14. Dmitry Medvedev tweeted this about an hour ago:

    Today, some French minister has said that they declared an economic war on Russia. Watch your tongue, gentlemen! And don’t forget that in human history, economic wars quite often turned into real ones.

    I think the picture is getting clearer about where we are headed and why the Ukraine war is just the first act.

    1. It’s my sense that today’s selloff lacks the downside momentum of last week’s selloff(s).

    2. I hope the NATO and the US/Europeans are thinking of giving a way out to Putin. Admitting Ukraine into the EU now is a declaration of war against Russia.

      Else, here begins the WWIII. There won’t be WWIV.

      1. That is difficult, because Putin has demands. And those demands include NATO going back to 1997. He will try to force us into accepting those demands, that is his way out. But if we accept you can imagine what is going to happen in Riga and Tallinn.

      2. There is more or less open economic war now between Russia and the EU, it has not fully escalated yet, but we should expect Putin to show the strength of his hand before he even considers negotiating in earnest.

      3. I think Putin didn’t want Ukraine to join NATO. That was an explicit demand. Asking post-1997 NATO countries to join the Russian Federation is an impossible ask. I don’t think he was looking for that.

        1. I’m sorry but I do not agree, Ukraine joining NATO was not a realistic option. Weapons yes, but not NATO. The negotations before the war failed because Putin made exactly those demands. Most thought it was just a negotiation tactic and here we are.

  18. Continued back-and-forth action almost every other day – which may be a plus as it tends to negate the need for retests if/when the indexes finally make a sustained run to the upside.

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