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 resilient market
The US stock market has been surprisingly resilient in the face of bad news. The pattern has been the same on Wednesday and Thursday. Futures opened the day deeply negative, first on a hot CPI print Wednesday and a hot PPI print and earnings disappointment Thursday, but rallied over the day to erase most, if not all of the previous losses. The banks, which kicked off Q2 earnings season, have mostly been disappointing, but it only took one positive surprise to spark Friday’s relief rally.
A market that does not react to bad news is a sign of bearish exhaustion. Here are some other catalysts that could spark an unexpected “rip your face off” rally and change the narrative from bearish to bullish.
Here are some supportive factors that won’t be the cause of rallies, but could put a floor on stock prices.
Gary N. Smith, who is the Fletcher Jones Professor of Economics at Pomona College, wrote in Marketwatch
that the stock market enjoys strong valuation support. Using a dividend discount model to value the market, he concluded that there is a 4% chance investors will be overpaying with the S&P 500 at 3902.62.
SentimenTrader has been pounding the table for several weeks about strong insider buying of technology stocks. The 20 dma of insider buying of the NASDAQ 100 is at the highest level since 2011, indicating a bullish risk/reward setup.
reported that sentiment is becoming increasingly bearish, which is contrarian bullish.
Asset managers and hedge funds recently stepped up bearish bets against U.S. stocks to the highest level since 2016, when fears about a global slowdown were on the rise. That is according to a JPMorgan Chase & Co. analysis of futures tracking major stock indexes.
The average active investor has steadily pared her stock exposure this year and dropped equity allocations to one of the lowest levels since the start of the pandemic, according to a survey by the National Association of Active Investment Managers, which primarily polled registered investment advisers…
Estimates from Deutsche Bank show that investors have steadily decreased their exposure to stocks to some of the lowest levels of the past 12 years. That includes slashed positioning among systematic funds that make buying and selling decisions based on levels of volatility in the markets and other metrics. Meanwhile, bullish bets in the options market among traders big and small recently fell to the lowest level since April 2020.
A cyclical surprise?
While the factors outlined so far will not spark rallies by themselves, here are some catalysts that might.
Earnings season is upon us. Forward 12-month EPS estimates are flattening out as recession fears have grown. The coming weeks will be an acid test for both bulls and bears.
Despite the gloomy outlook, an important cyclically sensitive non-US bellwether reported earnings last week that may be a cause for bullish celebration. TSMC raised its sales outlook while warning that it will delay some capital spending. Positive guidance from a growth cyclical semiconductor company like TSMC is welcome relief amidst all of the macro gloom about a global recession. Semiconductor stocks are trying to turn up in relative strength, which could be a signal for a better cyclical outlook (bottom panel).
Jefferies recently highlighted a historical pattern that semiconductor stocks led the interest cycle by about six months. If these stocks are indeed starting to turn, the rate inflection point should soon follow. Keep an eye on the earnings reports of semiconductors in the coming weeks. A pattern of strong guidance could change the narrative and spark a strong market rally.
Mary Daly, President of the San Francisco Fed
, pointed out that this is a very fast tightening cycle. If the semiconductor equity cycle has indeed turned, it’s possible that the lead times will be more compressed than historical experience for that reason.
Falling energy prices?
One macro overhang for the growth outlook is the supply-demand imbalance in a number of key energy and food commodities owing to the Russia-Ukraine war. It is well known that some countries like China and India have been buying Russian energy products, but it is less known that Russian oil has been leaking into the Middle East. As an example, Saudi Arabia has been importing cheap Russian fuel oil to feed power stations and free up the kingdom’s own crude for export. While such developments do little to help Ukraine, it does keep the energy market well supplied and serves to alleviate some of the inflationary pressures that concern global central bankers. As inflation decelerates, central bankers could pivot to a less hawkish monetary policy, which would be bullish for risky assets.
While Europe’s energy shortage is gas and not oil, the latest cover of the Economist may serve as a useful contrarian magazine cover indicator.
As a reminder, this is what happened the last time the magazine published cover indicating panic over energy prices.
Falling food prices?
Finally, the most important possible surprise could come from the grains market. The FT
reported that Ukraine, Russia, Turkey, and the UN are negotiating and the parties have made “very substantial progress” on a plan to avert a global food crisis by securing the safe passage of millions of tonnes of grain through the Black Sea. António Guterres, UN Secretary-General, expressed hopes that a final deal could be reached as soon as next week.
This development could be hyper-bullish for two reasons. Food and energy have been pressuring inflation upwards, and a Black Sea deal which allows the safe passage of Russian and Ukrainian grain has the potential to spark strong disinflationary pressures that change the entire inflation expectations narrative. As well, it would alleviate the political pressures on many emerging markets and developed economies and reduce the geopolitical risk premium of risky assets.
Jerome Powell made it clear at the last post-FOMC press conference that the Fed is shifting its focus from core inflation to headline inflation. Relief in food and energy prices will be a welcome development for not only the Fed, but also other central bankers.
Headline inflation is important for expectations. People—the public’s expectations, why would they be distinguishing between core inflation and headline inflation? Core inflation is something we think about because it is a better predictor of future inflation. But headline inflation is what people experience.
In conclusion, the stock market appears to be highly resilient in the face of bad news. A number of factors, such as valuation and insider activity, are putting a floor on stock prices. Three catalysts, such as the unexpected turnaround in the cyclically sensitive semiconductors, a better-supplied oil market, and a possible deal on Black Sea grain exports, have the potential to change the macro narrative from bearish to bullish and spark a “rip your face off” rally. While none of these factors are specifically actionable, investors should be aware of possible asymmetry of risks and behave accordingly.