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: Bullish
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.
Breaks at key support
A week ago, I wrote that I was bullish on the equity outlook, but the S&P 500 appeared to be extended short-term and the Powell testimony and Jobs Report could be sources of volatility (see China: Global bullish catalyst?). I was right on the volatility as Powell sounded a hawkish tone and the SVB crisis didn’t help matters. The S&P 500 violated its key support levels at the 50 dma and 200 dma. In addition, the equal-weighted S&P 500, the mid-cap S&P 400, and the small-cap Russell 2000 all blew through the bottom of descending channels.
Is this the End? Here are the bull and bear cases.
In response to Powell’s remarks, Fed Funds futures is now discounting a 50 basis point move at the March 20 FOMC meeting and a terminal rate of 550-575 basis points. The 2-year Treasury yield spike above 5%, which is a high for this cycle before pulling back. These conditions should be very challenging for stock prices, but the S&P 500 only fell -3.1% from Friday to Thursday, which is the day before the Jobs Report. Is that all the Fed can do to dent the stock market?
Meanwhile equity risk appetite indicators are exhibiting positive divergences.
From a long-term perspective, the analysis of the 50 and 200 dma of the equity call/put ratio shows that sentiment is recovering from an excessively condition. The crossover of the 50 and 200 dma is a constructive sign that signals the start of a new bull leg in stocks.
The bear case
Here is the bear case. The Fed’s hawkish tone put a bid under the USD, which has been inversely correlated to equity prices. The USD Index has been range bound but it may be about to stage a major technical breakout, which would be negative for risk appetite.
Stock prices may also be facing headwinds from liquidity conditions. Fed liquidity is showing a negative correlation to the S&P 500. The lack of liquidity is a potential a headwind for the bulls, though the sudden banking crisis could compel the Fed to inject funds into the banking system.
From a technical perspective, the NYSE McClellan Summation Index (NYSI) is recycling from an overbought condition, but the stochastic hasn’t reached an oversold reading yet, which suggests further downside potential in the next few weeks.
As well, different versions of the Advance-Decline Line are breaking below support, which is an ominous near-term development. Market breadth has sustained considerable technical damage. Unless stock prices can immediately reverse those losses, they may need a period of basing before they can rally higher.
What’s the verdict? The S&P 500 has been consolidating sideways since it staged an upside breakout through a falling trend line in January. The upside breakout was constructive for stock prices, but until the consolidation period resolves itself either to the upside or the downside, it’s difficult to be definitive about direction. While I am constructive on stock prices, some caution needs to be warranted here.
Tactically, the market is poised for a relief rally. Three of the four components of my Bottom Spotting Model have flashed buy signals. The VIX Index has spiked above its upper Bollinger Band, which is an oversold market reading, the NYSE McClellan Oscillator is oversold, and TRIN spiked above 2 on Thursday, indicating price-insensitive selling, which is a characteristic of a margin clerk driven liquidation. Only the term structure of the VIX Index hasn’t inverted on a closing basis, though it did invert several times during the day on Friday.
Subscribers received an alert Friday that my inner trader had initiated a long position in the S&P 500 and he had bought into the panic. The usual disclaimers 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.
The headline volatility event next week will be the CPI report. The FOMC meeting will be in the following week on March 20. Brace for further choppiness.
Disclosure: Long SPXL