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: Buy equities
- Trend Model signal: Bullish
- Trading model: Neutral
Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at @humblestudent@toot.community. 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.
The market gods smile on the bulls
Last week was a very data-heavy week, filled with macro events and earnings reports from several megacap growth stocks. I was expecting volatility as anything could have happened. Instead, the market gods smiled on the bulls as most of the events resolved in bullish fashions. Inflation (Employment Cost Index) was tame. Employment (JOLTS, ADP, and NFP) were either weak or exhibited weak internals. The Fed raised rates by an expected quarter-point. Powell tried, but failed to put on a hawkish face. The positive market reaction to META overwhelmed to negative reactions to AAPL, AMZN, and GOOGL earnings results.
As a consequence, all of the market averages staged convincing upside breakouts through resistance.
Is this a sign of a market liftoff that signals a new bull?
Bullish signals
The latest rally was accompanied by strong breadth, as measured by new highs-lows on the NYSE and NASDAQ. Past bear market rallies saw advances stall whenever net new highs turned positive. Not this time.
Rob Anderson of Ned Davis Research defined breadth as the number of sectors trading above their 200 dma. Past instances of strong advances have been good buying opportunities.
The Economist recently published a magazine cover questioning the viability of the Goldman Sachs business model. If history is any guide, these covers have been terrific contrarian signals. I interpret this as a bullish signal not only for GS, but the entire high-beta broker-dealer industry.
Estimating upside potential
I can anticipate the next question: How far can stock prices rise?
The S&P 500 is trading at a forward P/E of 18.4, which is just below its 5-year average of 18.5 and above its 10-year average of 17.2. A market driven by speculative fever could see the forward P/E spike to 21-22, which represents an upside potential of 15% to 20%.
Key risks
Needless to say, valuation risks are growing. Q4 earnings season results have been subpar and the E in the forward P/E is falling.
In addition, the rally in US markets may be a counter-trend relative performance rally. US equities had been lagging for several months. A relative rebound was to be expected but its sustainability is an open question.
The performance of risk assets like equities has been inversely correlated to the USD. The USD Index weakened to test a key support level. While the greenback weakened after the FOMC decision and press conference, it strengthened against the EUR and GBP in the wake of the ECB and BoE rate decisions on Thursday. Equity bulls are hoping that the USD can break support, which is another open question.
The NYSE Summation Index (NYSI) has spike to above 1000, which is an overbought condition. Historically, oversold conditions of under -1000 (pink lines) have been strong indicators of tradable bottoms, but overbought conditions (grey lines) be resolved in different ways. They can either signal short-term tops or pauses, or the start of a major bull. Of the 17 instances in the last 20 years, 10 have either ended in pullbacks and consolidations, and 7 in continued advance. Is this a plain vanille overbought condition, or a “good overbought” reading that signals a sustained bull?
In conclusion, the S&P 500 advance appears extended and it can pull back at any time. While the intermediate-term trend looks bullish, don’t be surprised to see a period of pullback and consolidation before stock prices can rise in a sustainable manner.
I can’t get past all the reasons that the market should go down.
Looking at ADLines, they are down but recovering.
Looking at 2 year yields, they are still strong while in 2000 and 2008 and 2020 they crashed down and only bottomed after the $SPX, so if this holds true, we haven’t crashed yet, or we won’t at least for the next few months. In this setting, if we have already done the lows then we could have a lot of upside.
Maybe this time is different, because we never had helicopter money stimuli, along with a pandemic and a global fiat financial system that is loaded with debt. Still, my head is stuck at the “something’s going to break” narrative. Maybe we should get buttons with Murphy’s law on it and send them to the Fed.
If you can’t figure it out, stay out….mostly in cash, but I will wait and see if there are more signs that we are heading up.
On Friday the US monthly jobs number was an incredibly and surprisingly high number. Gold and silver bullion crashed and the dollar surged. Fed funds futures shot up. Junk bond spreads narrowed sharply. This announcement set many things in motion.
Does this mark a turning point in the dollar? Before this strong number, it looked like the US was heading for a sure recession lagging Europe and China that had a betteroutlook. This might mean a near term pull back in commodities and Value versus Growth. The global market ex-US has been so strong until very recently. Much of that was dollar weakness. This could change.
“It’s our job to restore price stability and achieve 2% inflation. Market participants have a very different job… It’s a great job. In fact, I did that job for years, in one form or another. But we have to deliver.”
The above statement by Powell, implies, at least to me that the Fed will do whatever is needed to bring inflation down to 2%. The path is disinflationary but until they see definite signs of achieving 2%, they will not cut rates.
The idea of valuations getting to 21-22 times forward earnings seems far fetched.
There is more pain ahead, imo. Ultimate market timing model turning bullish is not consistent with the fundamentals.
But that is one of the values of these postings. Just because we can’t wrap our heads around something doesn’t mean it won’t happen. The problem of course is that moves can be dramatic.
There are well thought out posts that may turn out wrong but we should still pay attention to them. Having doubts is a good thing in my opinion . ES mini is down for now.
I agree. I read each post twice as well as the thoughtful comments. I read other opinions and form my own. I am the investment manager for our family’s portfolio along with an outside advisor. I don’t need to hit for the fences but not bury my head in the sand either. My goals and perspectives are my own!
I am seeing things differently than Cam is.
You’re stressing me out just thinking of the responsibility! Things come down to balance don’t they. Swinging for the fences has it’s appeal, and we all see examples like AAPL or TSLA etc and dream of 100 baggers but just like in baseball, a lot of singles usually wins the games.
Historically price leads fundamentals about 9 months at the peaking, and about 6 months from the bottoming. All indicators are falling into place one by one. Don’t be surprised by a strong year. US is still the place to be.
Carmel’s pivots chart suggests pullback to the range of 3870 to 4020, a 7% max drop. Seems like a small price to pay tbh…
Another view today: Goldman Sachs’s Kostin thinks the Year will end around 4000. Valuations are in 84th percentile given the interest rate environment. In a recession, it could be 3200.
Risks are asymmetrical!