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: Bearish
Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at @firstname.lastname@example.org. 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 rejection and a breakout from resistance
Last week, I highlighted the key technical tests that the S&P 500 was about to undergo as it breached its 200 dma and it was nearing a falling trend line. Ultimately, the stock market failed at resistance and pulled back to a key support level. Long Treasury prices, which had been highly correlated with stock prices in 2023, underwent a similar technical test but staged an upside breakout.
The stock/bond ratio is now weakening. Anyone who expected Mr. Bond to die in the face of hawkish Fed policy must be disappointed.
A change in tone
The change in tone in the Treasury market can be attributed to several factors. One is growing evidence in the jobs market. Initial jobless claims are rising, albeit slowing, from their April trough.
Unit labor costs, which were reported last week, decelerated and came in softer than expected. It was a welcome antidote to the upside surprise exhibited by average hourly earnings in the November Non-Farm Payroll report.
Before you get overly excited, the Atlanta Fed’s wage growth tracker showed that wage growth for job switchers rose from 7.6% in October to 8.1% in November while the overall wage growth rate stayed constant at 6.4%, indicating continued tightness in the labor market.
Oil prices broke a key technical support level, which was a surprise in light of the expected strength in demand from the China reopening narrative.
As well, used car prices continue to weaken, which is positive for disinflation.
Moreover, the Bank of Canada’s dovish rate hike raised hopes of a possible pause in the global rate hike cycle. The BoC increased rates by 50 basis points, but signaled a possible pause in its statement: “Looking ahead, Governing Council will be considering whether the policy interest rate needs to rise further to bring supply and demand back into balance”.
Asset market implications
The divergence between Treasury and equity prices has bearish implications for risk assets. Much of the recent market relationships can’t be relied on anymore.
As an example, the relative performance of large-cap growth stocks has been inversely correlated to Treasury yields because of the long-duration characteristic of growth stocks. As the bond market begins to discount a growth slowdown and probable recession, don’t expect growth to outperform under these circumstances.
Indeed, both the absolute and relative performance of technology stocks are struggling, and relative breadth indicators (bottom two panels) are also lagging behind the S&P 500.
Despite the Treasury market rally, investors should be cautious about high-yield credits. While the relative performance of junk bonds is tracking the performance of the S&P 500, leveraged loans (red dotted line) are flashing warning signs of rising credit risk.
The week ahead
Looking to the week ahead, investors will be watching the November CPI report on Tuesday and the FOMC decision Wednesday. The Cleveland Fed’s inflation nowcast of 0.47% and 0.51% for headline and core CPI respectively are ahead of consensus expectations of 0.3% and 0.4%. The risk of a hot negative surprise is elevated and the market reaction to the PPI print on Friday was a potential preview of the market reaction.
The market is discounting a 50 basis point hike in December, a terminal rate that’s just over 5%, and rate cuts in mid 2023. Keep an eye on expected inflation, and the unemployment rate that will be published in the December Summary of Economic Projections after the FOMC meeting. While the inflation rate will determine the pace of rate hikes, the Fed’s perception of the labor market will determine the timing of rate cuts.
I have argued the lack of recovery in the labor force participation rate by older workers translates into a higher natural unemployment rate, which will keep the job market tight. Market expectations of rate cuts in mid 2023 would be unrealistic under such a scenario. The prospect of a prolonged tight Fed as the labor market stays tight would be bullish for bonds but bearish for stocks.
In conclusion, the Treasury bond market is turning up while the stock market is turning down, which is a condition that hasn’t been seen for much of this year. I believe that this market action is the market’s signal of weaker economic growth, which should be bond bullish and equity bearish. However, much of the short-term outlook will depend on next week’s CPI report and FOMC meeting.
As a reminder, I reiterate my discussion of my trading position exposures from last week:
I would like to add a note about the disclosure of my trading account after discussions with some readers. I disclose the direction of my trading exposure to indicate any potential conflicts. I use leveraged ETFs because the account is a tax-deferred account that does not allow margin trading and my degree of exposure is a relatively small percentage of the account. It emphatically does not represent an endorsement that you should follow my use of these products to trade their own account. Leverage ETFs have a known decay problem that don’t make the suitable for anything other than short-term trading. You have to determine and be responsible for your own risk tolerance and pain thresholds. Your own mileage will and should vary.
Disclosure: Long SPXU