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: 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 failed reversal
Last week, I highlighted a possible bullish reversal candlestick on the weekly chart, but warned that the reversal needs to be confirmed by the next candle. This week, the S&P 500 weakened and failed to confirm the reversal candle, though the market is still exhibiting a positive 5-week RSI divergence and it is still testing support at the 200 week moving average.
Regardless, I am seeing helpful signs of leadership rotation. During bear markets, the old market leaders fade and new leadership emerges to lead the new bull cycle. The change in leadership is a constructive market internal that is indicative of a bottoming process.
Ready to rally
Sentiment readings indicate that the market is washed out and poised to rally. The Investors Intelligence bull-bear spread had fallen to levels last seen during the GFC.
The TD-Ameritrade Investors Movement Index, which measures the positioning of that firm’s customers, fell to historically low levels, which is contrarian bullish.
The NDR Crowd Sentiment Poll has fallen to levels last seen at the 2008 low, which should put a floor on stock prices. The market just needs a catalyst to begin an advance.
A change in leadership
The US equity market has seen a definite shift in leadership. Changes in market leadership can be a sign that a bear market is turning into a fresh bull. As the old bull and old leaders falter, new blood and new leaders take up the baton. Large-cap growth FANG+ names, which had been the leaders since before the onset of the COVID pandemic, have seen their relative strength completely roll over.
A more detailed analysis of the relative performance of the three major growth sectors shows that they are all struggling.
Tactically, FANG+ prices may be experiencing headwinds because of SNB selling. Detailed disclosures of changes in the SNB balance sheet shows that most of the equity sales are concentrated in large-cap US growth stocks.
By contrast, the relative performance of cyclical value sectors are more positive.
A detailed relative performance analysis of selected cyclical industries shows:
- A relative breakout by infrastructure stocks;
- Broker-dealers have been in a relative uptrend since early July, though the group hasn’t achieved a relative breakout yet;
- Homebuilding stocks, which should be in the gutter with the tanking housing market, is in a relative uptrend;
- Retailers are forming a saucer-shaped relative bottom;
- The laggards are transportation and semiconductor stocks.
It’s possible that the market has seen the lows for the cycle. The S&P 500 is trading at a forward P/E of 15.4, but the forward P/E is about 12 on an ex-FAAMG basis, which is arguably cheap by historical standards.
An ex-FAAMG forward P/E of 12 is in the vicinity of mid- and small-cap P/E ratios.
Indeed, the small-cap Russell 2000 and S&P 600 have been strengthening against the S&P 500 since May in an uneven manner and attempting a relative breakout.
Bear market rally ahead
My base case scenario calls for a bear market rally for several reasons. The market has been extremely oversold, as measured by the NYSE McClellan Summation Index. Past readings of under -1000 have seen stock prices rally, even in the bear markets of 2002 and 2008.
However, the rotation from growth to value isn’t entirely convincing. While large-cap value has turned up against large-cap growth, mid- and small-cap value and growth aren’t confirming the rebound.
In conclusion, the stock market is poised to undergo a bear market rally. Sentiment and technical conditions continue to be supportive of a short-term bottom. Beneath the hood, the market is undergoing a change in market leadership, which can be indicative of a long-term bottom process as the old leaders falter and the new leaders take up the baton.
Disclosure: Long SPXL