Making sense of the Mona Lisa market

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: Neutral

Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at 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 Mona Lisa market

The Economist aptly characterized the current circumstances like the Mona Lisa:

What is the Mona Lisa doing? At first glance the subject of the world’s most famous painting seems to be smiling. Look again and her smile fades. When it next reappears, it is a different sort of smile. Leonardo da Vinci achieved this ambiguous effect with the use of sfumato, where he blurred the lines around Mona Lisa’s face. No matter how many times you look, you are unsure quite what is happening.


The post-pandemic economy is like the Mona Lisa. Each time you look, you see something different. After chaos in the banking industry, many analysts are now convinced that the world economy is heading for a “hard-landing” recession. Few seem to expect a “no-landing” scenario, in which the economy remains untroubled by rising interest rates—a fashionable opinion just weeks ago, and one which itself supplanted a common view late last year that a mild recession was certain.


Even though the stock market isn’t the economy, it’s also beset by a series of cross-currents that are difficult to interpret, much like the Mona Lisa.


Starting with earnings season, which is in full swing. It began with a series of strong reports from large banks, but one key test came last week when about 50% of regional banks, which were at the epicentre of the latest banking crisis, reported. Equity bulls breathed a sigh of relief when the KBW Regional Banking Index held technical support.




Even though the regional banks held support, the bulls face a series of obstacles to overcome, and it isn’t clear at all whether they’ll succeed.


Credit crunch ahead

The banking crisis has sparked concerns about a credit crunch as banks re-calibrate their loan books in light of the heightened stress in the financial system. Reuters reported that New York Fed President John Williams sounded a word of warning about the effects of tightening credit.


“Conditions in the banking sector have stabilized, and the banking system is sound and resilient,” Williams said. But he added the troubles will likely make credit more expensive and harder to get, which will in turn will depress growth.


“It is still too early to gauge the magnitude and duration of these effects, and I will be closely monitoring the evolution of credit conditions and their potential effects on the economy,” Williams said.


The good news is any credit crunch could do the Fed’s work in tightening monetary policy and a more accommodative interest path may be possible. In a CNN interview, Treasury Secretary and former Fed Chair Janet Yellen addressed the “tightening of lending standards in the banking system” and the tightening “could be a substitute for further pricing, further interest rate hikes that the Fed needs to make”. The credit cycle is indeed turning. The Fed’s survey of senior loan officers shows a significant tightening of lending standards since COVID Crash.


Evidence of tightening credit is confirmed by the NFIB small business survey.



Tightening credit is how recessions start.



The challenges of earning season

FactSet reported that with 16% of the S&P 500 having reported earnings results, 76% of companies have beaten EPS estimates, which is slightly below the 5-year average of 77%, and the sales beat rate is 63%, compared to the 5-year average of 69%. It’s still early in earnings season and challenges are ahead. Historically, the trajectory of ISM Manufacturing PMI has been correlated with the earnings beat rate. ISM has been tanking. Will the beat rate follow?




The debt ceiling and De-Dollarization

In addition, concerns over the resolution of the debt ceiling are rising. The price of credit default swaps has soared to levels last seen in 2011.



The debt ceiling debate has brought the deficit hawks out and raised the fears of de-dollarization, or the loss of the USD as the status of a global reserve currency. We are here to put those fears to rest.
Intertwined with de-dollarization fears are geopolitical concerns and the rise of the Chinese yuan as a reserve currency. But one key characteristic of a reserve currency is that there must be plenty of it sloshing the global financial system. In order for that to happen, the issuing country needs to run a persistent trade deficit like the U.S. Instead, China has been running trade surpluses, which creates headwinds for spreading its currency around the world.


The Swiss Franc (CHF) is a favorite of the hard money crowd, but it can’t be a viable major reserve currency. There just aren’t enough CHFs around. Gold is the same story. Consider that the U.S. is one of the largest holders of gold in its reserves. Imagine if the U.S. Treasury sold off every ounce of gold in its inventory. At the current market price of about $2,000, it would net roughly $300 billion, which doesn’t’ even cover a single year’s fiscal deficit. The aggregate market capitalization of all gold mining companies ranks somewhere between the market cap of Proctor & Gamble and ExxonMobil. In other words, gold stocks are a round error when compared to the total size of global equities.

Brad Setser has been a master in tracking balance of payment flows and he finds no evidence of de-dollarization in China’s foreign currency reserves. Remember that when a Chinese exporter sells something to a U.S. customer, it receives USD in return. The Chinese producer then has to decide what to do with those dollars, which shows up in balance of payment flows. In practice, most of it ends up invested us Treasury and Agency paper.


Setser also found that there is no evidence of de-dollarization from non-China sources.



Instead, the USD Index has repeatedly successfully tested support and held ground. A rally in the greenback could prove to be negative for stock prices as the USD and the S&P 500 have shown themselves to be inversely correlated to each other.




A liquidity retreat

Tactically, the market is likely to seem some headwinds in the week ahead. The stock market has been supported by liquidity injections as a reaction to the banking crisis. Now that the panic is over, the Fed is withdrawing liquidity from the financial system, which is likely to create headwinds for stock prices.



Another proxy for system liquidity are crypto-currency prices, which are in retreat.



In conclusion, the market is behaving like the enigmatic Mona Lisa as it is beset by a series of cross-currents that investors may not even be aware of:

  • The uncertainties stemming from Q1 earnings season.
  • The possible effects of a credit crunch on the economy and the Fed’s reaction.
  • The concerns over a potential debt ceiling impasse.
  • The de-dollarization narrative, and the effects on the USD, which has shown itself to be inversely correlated to the S&P 500.

For now, these cross-currents are serving to create volatility as neither bulls nor bears have been able to gain the upper hand. Expect a range-bound choppy market until a trend emerges.


12 thoughts on “Making sense of the Mona Lisa market

  1. Brent Johnson explains the Eurodollar. There are many times more eurodollars than dollars and all of this acts as a buffer. It is also hard to replace with something else. The assets/liabilities that comprise the eurodollar system cannot be ignored. If you make a digital token backed by a basket of commodities your basket needs to be many many trillions in size. Just take oil, 10 billion barrels is not even 1 trillion $, so how does one back a digit with a hard asset? One also has to blockchain all of this. A lot of trouble when you consider that the US $ is there and backed by the US. It’s like trying to get rid of the shadow banking system. It’s not easy. My feeling is that the de-dollarization talk is a combination of the media and it’s fear mongering and grumpiness of those who feel powerless over it.
    The debt ceiling debates have happened close to 30 times, they will raise it eventually, and it will happen again over and over.
    I wonder about the zombie companies and when those bugs hit the windshields. A strong credit crunch could trigger a pivot. But there is no doubt that all this debt and high interest rates cannot go on for long without something bad happening. Since the market looks ahead, is future bad news good news?

    1. Yodoc,

      Agreed. De-dollarization is repeatedly brought up, seems likes it’s just something to Fear for some, i.e. investors, and fantasize for others who are like you said, Grumpy and powerless. Dollar isn’t going anywhere because of the tentacles that one must have in the International systems before they can dream about upsetting the system. China is trying to create those by putting up systems in Africa and the new silk road etc. etc., however their political system makes them Not reliable. So, where do we go to have an international system that everyone can work with, and you end up with Dollar every time. Seems to me it’s the go to even when we say, “This time, it’s different.”

      1. Remember Tiananmen Square, remember covid lockdowns, and Evergreen. There is a reason why Chinese people buy real estate outside of China, they don’t trust their own government. We do the same thing but on a smaller scale. The euro-dollar market is something like 10 trillion. So what happens if you use gold instead of USD and credit gets squeezed? Somebody needs to come up with tons of gold. I don’t think that anything has the depth and liquidity of the USD, so to replace it you need something massive. There is something called Linde’s law (I think), where if something has been around for 5000 years like gold has, it will likely be still around 5000 years from now, provided of course that nobody comes up with a cheap way to get a few cubic miles of the stuff out of the ocean. The USD has been around as a major currency for 100 years, give or take…80 if you start counting at Bretton Woods, so it should be around for another 80. Of course that could change. But what of the Yuan? Nowhere near as long.
        Besides, I don’t trust dictators.

  2. What may cause the market to go up? Looking beyond the valley of trough earnings for one. But there has to be some indication that earnings are reaching that point in the next quarter or two. Disinflation that gets PCE closer to Fed’s target in the next few months. Debt ceiling resolution without substantial cuts in discretionary spending. Labor wage growth to around 3%.
    I think there are headwinds to equities upside. Why take the risk when there is an alternative?

    1. Well, have some in equities, good solid blue chip , been around a long time stocks that make money. Because if we get a melt up like David Hunter foresees, you will just watch it go up and fear to get in and watch it go higher. Good companies will survive the interest rate challenges as well as a recession, but have some cash for a bottom if we get one. There is apparently a heavy net short position on the SPX, it could get squeezed. It’s not like AMC and GME but we saw what happened

      1. Thanks! I do have equities that are of the type you described. Also, switching more to blue chip companies in health care and areas I think are in secular growth like Defence and Aerospace, cybersecurity. Even then I am reducing overall allocation and putting in treasuries(will be a source of funds down the road).
        I lean bearish currently without the risk of shorts in the portfolio.

  3. Just finished Trade wars are Class Wars by Michael Pettis and Mathew Klein. I highly recommend that everyone read it. It covers a lot of ground on this.

  4. The analysis and commentary on Credit markets is sparse in these posts inspite of it being a bigger asset class. Does anyone follow an analyst like Cam for the credit market insights?
    Northern Trust is recommending overweight position in High Yield Bonds. Head scratcher for me!

    1. I have found that margin debt is, at best, a coincidental indicator of stock prices.

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