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 prices. 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: Sell equities
- Trend Model signal: Bearish
- 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.
A disorderly unwind
Just when you thought it was safe to go back into the water after an FOMC meeting that turned out to be more dovish than expectations, the Swiss National Bank unexpectedly raise rates by a half-point after holding it at -0.75% for almost a decade and sent global asset prices reeling.
Here’s why the SNB’s actions mattered. The rate hike was a reversal of a long-held policy of the SNB, which had been trying to hold the CHFEUR exchange rate down in order to bolster Swiss competitiveness. CHFEUR spiked nearly 2% on the news. The daily move far exceeded anything in its seven years of Swiss interest rate stability.
The outsized move in the CHFEUR exchange rate made Value-at-Risk (VAR) models go haywire. For readers unfamiliar with these models, they estimate risk based on the past history of volatility. When actual volatility spiked, risk managers tapped traders on the shoulders and told them to reduce the size of their books. Almost instantly, global markets sold off in a price insensitive liquidation stampede.
It was a textbook example of non-linear dynamics. A metaphorical butterfly flapped its wings in Zurich and the global financial markets shuddered.
Price insensitive selling is a classic sign of capitulation. Here are some other ways of watching for an oversold extreme and washout.
The ratio of the percentage of S&P 500 above their dma to the percentage of S&P 500 above their 150 dma reached 20%. These are market crash levels last seen in 2002, 2008, 2011, and 2020. All saw short-term snapback rallies. Moreover, NYSE 52-week lows haven’t spike to these levels other than the 2008 crash in the last 20 years.
The AAII weekly bull-bear spread deteriorated to another crowded short extreme reading again. Other than a recent episode, bearish sentiment hasn’t been this high since 2011.
Other signs of washout and capitulation on Thursday include:
- Reports of the second biggest sell program in a year and the fourth biggest of all time.
- Reports of no-bid markets in high yield bonds.
- A 93% downside volume day on the NYSE.
- The S&P 500 saw over 90% of its issues decline on Thursday and that was the fifth episode in seven days. This has never happened in the history of the index since 1928, according to SentimenTrader.
- A panicky Drudge Report headline on Thursday as a contrarian sentiment indicator.
For investors who are willing to be patient, the rewards can be high. Mark Hulbert
found that if you bought the S&P 500 after it first fell -20%, which occurred last Monday, the average one-year gain since World War II was 22.7%.
A more detailed analysis by Jonathan Harrier
identified 11 similar events since 1950. While returns were strong, investors also endured significant drawdown risk.
For the last word, I leave you with Stan Druckenmiller, who recently spoke at the Sohn Conference:
This is my 45th consecutive year as a Chief Investment Officer. In 45 years I’ve never seen a constellation where there’s no historical analogue. I probably have more humility in terms of my views going forward than I’ve ever had.
In conclusion, this volatility too, shall pass. Hopefully, the markets can return to a more normal state next week.