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.
Do you believe in breadth thrusts?
Technical analysts recently became very excited when price momentum signals began to flash buy signals. Walter Deemer highlighted a simultaneous case of breakaway momentum
and Whaley breadth thrust
. Ryan Detrick
analyzed the 10-day NYSE advance-to-decline ratio and found strong historical results.
Should you trust the historical evidence of breadth thrusts? Opinions are varied.
Buy the dip?
The market entered last week in an overbought condition but pulled back. It’s not unusual to see stock prices pause after a breadth thrust buy signal. Does this present an opportunity to buy the dip?
A study of strong overbought conditions, as measured by the NYSE McClellan Oscillator (NYMO), doesn’t tell us much. There were six instances in the last 20 years when NYMO reached an overbought reading of 100 or more. The market continued to rise in three and declined in three. The results amounted to a coin toss.
prefers the Reagan adage of “trust but verify”. He prefers to see clusters of breadth thrusts, which was not in evidence in the current instance.
One way of verifying a price momentum signal is to monitor if the price momentum factor is working at the individual stock level. While market-level price momentum (breadth thrusts) can be impressive, the market needs positive follow-through, led at the stock level. Stocks that have been going up need to continue to rise. At the last two major bottoms in late 2018 and in 2020, different versions of the price momentum factor exhibited positive returns. So far, the price momentum factor hasn’t shown much of anything, but arguably it’s still early.
On the other hand, the relative performance of defensive sectors lagged in the recent market rally, which is supportive of the bull case.
An ironic technical outcome of the looming debt ceiling impasse could be short-term equity bullish, notwithstanding the negative effects on market psychology. That’s because the US Treasury is expected to draw down the Treasury General Account (TGA) at the Fed to cope with the debt ceiling breach. A falling TGA injects liquidity into the banking system, which could be supportive of higher stock prices.
Fed liquidity, which is the combination of the effects of Quantitative Tightening, changes in the TGA account, and Reverse Purchase Agreements (blue line), have been correlated to the levels of the S&P 500 (red line).
A short-term sell signal
Last week, I highlighted a tactical sell signal when the correlation between the S&P 500 and VVIX, which is the volatility of the VIX Index, spiked. This is usually an indication that the option market does not believe the short-term advance in stock prices, especially if the market is overbought. The overbought condition is beginning to reverse itself but readings aren’t neutral yet, which could foreshadow some more short-term downside potential, but it tells us little about the intermediate-term trend.
In the short run, a near-term bottom is probably not in sight just yet. The term structure of the VIX is still upward-sloping and there are few signs of fear.
Crucial tests ahead
The next few weeks will represent crucial tests for global risk appetite. The S&P 500 stalled at trend line resistance and support can be found at about 3850, while resistance is at about the current level of 3975. A breakout in either direction could be a useful directional signal for traders. From a fundamental perspective, a substantial number of S&P 500 stocks will report earnings in the next 2-3 weeks and set the tone for equity risk appetite.
As well, the FOMC meeting on February 1 could be a source of volatility. The long Treasury bond ETF (TLT) tested a key resistance level but retreated to 10 dma support. The international sovereign bond ETF (IGOV) staged an upside breakout but pulled back to the breakout turned support level.
Stay tuned. My inner trader is still tactically short the S&P 500. The usual caveats apply to my trading positions.
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