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 @email@example.com. 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?
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.
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%.
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.