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: Neutral
- 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.
Why is the stock market holding up so well? What happened to all the warnings from the Fed? One speaker after another warned that the Fed is nowhere near a dovish pivot. CNN
reported that former New York Fed President Bill Dudley issued a similar warning that rising stock prices translate into even more rate hikes:
Dudley added that another rate hike of three-quarters of a percentage point is still “potentially in play,” depending on how the economy evolves. He expects the Fed will need to raise interest rates to 4% or higher — up from 2.5% today…
Dudley warned that the uptick in the stock market may be counterproductive because it translates to easier financial conditions. And that’s exactly the opposite of what the Fed wants as it tries to tame inflation.
“Ironically,” Dudley said, “the big rally in financial markets increases pressure on the Fed to do more.”
Wall Street shrugged off the Fed’s warnings and Friday’s hot jobs report. The S&P 500 is testing a key resistance level, and the NASDAQ 100 blew past resistance and it is now approaching a key falling trend line.
Why is the market defying gravity?
The bear case
The bear case is easy to make. I have already outlined the warnings from Fed officials. Despite the strong rally off the June bottom, net NYSE and NASDAQ new highs have not turned convincingly positive.
NASDAQ 100 stocks have been the leaders in the latest advance, but on balance volume, which measures net accumulation and distribution, is exhibiting a negative divergence.
John Authers at Bloomberg reported that Jason Goepfert of SentimenTrader is warning his Dumb Money Indicator is flashing a sell signal.
This threshold generally serves as a good delineator between healthy and unhealthy markets. During persistent bull markets, the model consistently levitates above 60%. When it stays below 60% consistently, sentiment is poor and periods of recovery tend to bring in sellers.”
The chart above shows that Dumb Money Confidence loosely tracks the S&P 500. When the market is going well, the dumb money gets more bullish and vice versa. The last couple of times it significantly rose, it quickly peaked and equities turned as well. That implies that the next down leg is imminent. So far this year, as the chart below shows, Dumb Money Confidence has continued to tend to chase the S&P, and the 60% barrier has twice acted as a point at which the market turns down (bringing traders’ confidence with it):
Earnings estimates are falling
In addition, forward 12-month EPS are falling and the forward P/E valuation is no longer compelling. Q2 earnings season is subpar as measured by EPS beats but slightly above average on sales beats. Perhaps one reason why the market has acted well is forward guidance is better than average.
Nevertheless, it’s disconcerting to see negative EPS revisions across all time horizons.
The bull case
Here is the bull case. Hedge funds are still pressing their short bets in S&P 500 futures and positioning rivals the COVID Crash bottom levels of 2020. The crowded short reading should act to put a floor on prices should the market weaken.
Price momentum (bottom panel) is very strong. Past episodes of strong momentum in the last 20 years have resolved bullishly. The only exception was last March (pink vertical line) when the 5-week RSI failed to reach an overbought condition. Keep an eye on this indicator, if RSI were to become overbought a new bull is confirmed.
All the talk of sentiment and momentum aside, the overlooked reason for price strength is the market may be sniffing out disinflation. The S&P 500 has been inversely correlated with oil prices, and WTI fell below $90 last week, which is a level not seen since the Russia-Ukraine war began.
Tactically, the S&P 500 is following the FOMC pattern of 2022, when the market rallied in the wake of an FOMC meeting. In the past, the peak has occurred 1-2 weeks after the meeting. If history is any guide, that should put the timing of the peak about now.
My base case scenario continues to call for a re-test of the June lows, but I allow that there is about a one-third chance the market is undergoing a V-shaped bottom. The coming days should bring more clarity from the market.