Preface: Explaining our market timing models
The latest signals of each model are as follows:
- Ultimate market timing model: Sell equities (Last changed from “buy” on 26-Mar-2023)
- Trend Model signal: Neutral (Last changed from “bullish” on 17-Mar-2023)
- Trading model: Neutral (Last changed from “bearish” on 15-Jun-2023)
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.
The momentum buy signal
Technical buy signals are coming out of the woodwork, supported by strong price momentum and signs of broadening market breadth.
A risk-on stampede
The signs of a risk-on stampede are forming. Credit market risk appetite indicators are confirming the advance in the S&P 500.
The folks at SentimenTrader are turning bullish. As one of many examples, Dean Christians observed that “the percentage of cyclical sub-industry groups up more than 40% from their respective 1-year lows”. This is an important signal from the markets that a cyclical recovery may have begun.
Commodity prices are also recovering, though the lack of bullish confirmation from the cyclically sensitive copper/gold and base metals/gold ratios is a little disconcerting.
A crowded long
In the short run, however, sentiment has become excessively bullish. Such crowded long conditions argue for caution.
The Bob Farrell AAII Sentiment Indicator, which is AAII bulls . (AAII bears + AAII neutral/2), is up sharply (red line in chart).
The early results from Q2 earnings season have been mildly disappointing. The EPS and sales beat rates are below historical norms and EPS estimate revisions are stalling. This is all happening against a backdrop of elevated forward P/E multiples. To be sure, only 18% of the S&P 500 have reported results. We should see greater clarity next week when about half of the weight of the S&P 500 report results.
With the relative performance of cyclical industries mostly in uptrends, recent earnings reports have seen many cyclicals exhibit pullbacks. Is this just a hiccup or something more serious?
A regime change judgment call
Where does that leave us? While the intermediate-term outlooks appears uncertain, the market looks like it’s poised for a short-term correction or consolidation.
The key question for investors is whether they should buy the anticipated dip. If this is the start of a new cyclical bull, excessively bullish sentiment doesn’t necessarily have to be contrarian bearish. There have been several instances in recent history when the S&P 500 has continued to advance while the AAII bull-bear was highly elevated, which can be characterized as “good overbought” conditions.
Similarly, an analysis of the CBOE equity-only call/put ratio (top panel) shows that bullish crossovers of the 50 and 200 dma of the ratio can signal secular bull trends. The last buy signal occurred in February 2023.
On the other hand, the macro risk is that the market is repeating the double-dip recession of 1980–1982. Just as stock prices recovered after the initial dip in 1980, the Volcker Fed squeezed the economy with painfully high interest rates. The economy suffered a second setback and didn’t recover until 1982. Under that scenario, we are roughly in Q1 or Q2 1981, which is just before the short rate peak.