Preface: Explaining our market timing models
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: Bullish (Last changed from “neutral” on 17-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.
Last week, I suggested that the current market environment “argues for a buy the dip and sell the rip posture in trading”. When the S&P 500 fell a miniscule -1.8% on an peak-to-trough intraday basis, my models were registering signs of bearish exhaustion, which was a sign to buy the dip.
How could a -1.8% intraday drawdown spark such oversold extremes? One inter-market clue came from Asia, where Chinese and Hong Kong stocks cratered on bad news out of China. The Hang Seng Index skidded -4.1% on Wednesday to a new 52-week low, and there wasn’t a single advancing issue.
Jason Goepfert of SentimenTrader found that such episodes tended to resolve bullishly. It was therefore no surprise that the Hong Kong market rebounded the next day, and so did the S&P 500.
Back in the U.S., two of the components of my bottom spotting model flashed buy signals, and a third came within a hair of one. Historically, tradable bottoms have occurred whenever two or more components registered buy signals. The bullish components are the VIX Index, which spiked about its upper Bollinger Band indicating an oversold market; the NYSE McClellan Oscillator (NYMO), which fell to oversold levels; and TRIN, which rose to 1.95 Wednesday, which was just short of the 2.0 threshold that’s indicative of price-insensitive margin clerk and risk manager induced selling.
Hopefully, you bought the dip.
Fade the rally
The S&P 500 is tracing out a strongly bullish cup and handle breakout, which is an intermediate bullish pattern, but the short-term bull case is far from clear. That’s because the index is exhibiting a severe negative divergence on its 5-week RSI as it approaches its all-time high. While this doesn’t necessarily preclude further strength, the longevity of any bull move over the next few weeks may be in doubt.
In addition to the negative RSI divergence, I am concerned about the evidence of narrowing breadth and weakening bond prices, which were correlated to stock prices for much of their recent rally.
But respect the bounce
That said, it’s too early to short the market. Bears should respect the momentum of the price bounce. The NYSE McClellan Oscillator (NYMO) recycled from an oversold condition. Past episodes have seen NYMO recover to at least neutral before the relief rally petered out. While this is only a guesstimate, a typical bounce could see the S&P 500 reach slightly above 4900 before topping out.
As well, the Fear & Greed Index is elevated but not extreme, indicating further upside potential.
I remain long-term bullish. The monthly MACD of the NYSE Composite turned positive, which is a buy signal with a strong track record.
Sources of risk
Investors face several sources of risk in the coming weeks. Fed Governor Christopher Waller virtually single-handedly pushed back against market expectations of a March rate cut. Waller made it clear that while rate cuts are coming into view, market expectations of the timing and pace of rate cuts are overdone.
Recent Fed decisions have shown themselves to follow market expectations. If policymakers disagree with the market consensus, it has shown a pattern of coordinated speeches from Fed speakers to correct the market’s views. Already, the odds of a March cut fell from over 70% to about 55% today and the consensus timing of a first cut has been delayed to May.