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 (Last changed from “sell” on 28-Jul-2023)
- Trend Model signal: Bullish (Last changed from “neutral” on 28-Jul-2023)
- Trading model: Neutral (Last changed from “bullish” on 02-Jan-2024)
Update schedule: I generally update model readings on my site on weekends. I am also on X/Twitter at @humblestudent. 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.
As good as it gets?
As the S&P 500 tests overhead resistance at its all-time high after staging a cup and handle upside breakout, it’s experiencing negative 5-week RSI divergences that have the fingerprints of a near-term top. Is this as good as it gets, at least for now?
Numerous short-term technical warnings are appearing. Market breadth, which started broadening out in November, began to roll over into narrow leadership starting in mid-December.
Megacap NASDAQ leadership has recovered and it has especially been in evident in 2024. Viewed in isolation, narrow leadership isn’t a concern. But relative breadth indicators (bottom two panels) are in decline, which is a bearish warning.
Here is the good news and bad news on breadth. The good news is net new highs are still positive, which is a constructive sign. The bad news is the market has been deprived of positive price momentum, as evidenced by negative RSI divergences. Under such circumstances, the consolidation and corrective period is unlikely to end until net new highs turn negative.
Sources of volatility
Here is what the market is worried about for the remainder of January. The first and most immediate source of volatility is the results of the Taiwan election. Lai Ching-te, whose Democratic Progressive Party (DPP) is known to favour Taiwanese independence, has won the Presidency. However, the win wasn’t a resounding one, as the DPP has lost its majority in the legislature and any major initiatives may be challenging for the new President. Nevertheless, his win is certain to force China to react in some forceful way. While the odds of an immediate invasion is low, a show of force similar to the one in reaction to the visit by then House Speaker Nancy Pelosi could rattle markets.
Bloomberg Economics estimated that a China invasion of Taiwan would cost the world economy $10 trillion, which is about 10% of global GDP and far greater than the blow of the Ukraine war, COVID Crash and the GFC.
As well, the stock market is entering Q4 earnings season. Forward 12-month EPS estimates are rising going into earnings season and it’s best to keep an eye on how this evolves. The S&P 500 is trading at a forward P/E of 19.5, which is above its 5-year average of 18.9 and 10-year average of 17.6. Any negative surprises at elevated valuation levels could mean a disorderly shock to stock prices.
As well, the Quarterly Refunding Announcement (QRA) at the end of January could be a source of volatility. The last QRA sparked a global bond market rally when the U.S. Treasury announced that it was conducting most of its borrowings in short-dated paper, which alleviated the supply pressure on coupon-bearing bonds. What will Treasury do this time?
A pause in an uptrend
In conclusion, I reiterate my view that the stock market is undergoing a temporary pause in an uptrend. In the past, exhibitions of strong price momentum as measured by the percentage of S&P 500 above their 50 dma rising from below 20% to 90% have been long-term bullish. However, such episodes have also resolved in short-term consolidations or corrections.
The short-term outlook can be characterized as a riptide market. Everything looks good, but risks are lurking beneath the surface, namely negative technical warnings and several sources of volatility. Expect the rest of January to be choppy to down, which argues for a buy the dip and sell the rip posture in trading.
I don’t expect any corrective action to be too deep. Sentiment readings from the option market are cautious. In particular, the equity-only put/call ratio is approaching levels consistent with trading bottoms.