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 24-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.
Divergences everywhere
From a technical perspective, divergences may not matter in the short term, but long-term divergences are particularly worrisome.
The accompanying chart shows a series of long-term divergences that are concerning. Even as the S&P 500 rallied to all-time highs, the NYSE Advance-Decline Line did not confirm the fresh high. The relative performance of high beta to low volatility stocks, which is an indicator of equity risk appetite, is barely testing its overhead resistance. In the meantime, the 10-year Treasury yield (inverted scale) has been climbing and higher yields offer an increasingly more attractive alternative for investors. And the USD, which is historically inversely correlated to the S&P 500, has been rallying and creating headwinds for stock prices.
How concerned should investors be about these divergences?
Long-term bullish, but…
Notwithstanding the problems of the divergences, there are good reasons to be long-term bullish on stocks. The monthly MACD of the NYSE Composite has turned positive, which historically has signaled a multi-month bull run.
As well, the percentage of S&P 500 stocks above their 50 dma (bottom panel) surged from under 20% to 90% in a breadth thrust. Such instances have always resolved in higher prices 12 months later. However, it’s not unusual for the market to consolidate and pullback, marked by percentage above 50 dma to retreat to at least 50%.
The previous chart is a weekly chart and doesn’t show daily readings. A more detailed analysis of this indicator shows that it fell below 55% last week, which is close to the 50% threshold.
However, investors should be cautioned by this historical study by Nautilus Research which shows that a series of bearish outcomes after similar events.
Rolling correction or Volmageddon?
I offer two possible scenarios as to how these divergences will play out. The more benign one is a rolling correction which manifests itself as a sideways consolidation. Breadth started to broaden out last week. As growth stocks faltered, value stocks took the baton and advanced.
The rolling correction hypothesis is based on weakness in Magnificent Seven growth stocks while value stocks exhibit strength. While such a rotation is evidence in large caps, it is less prominent across the other market cap bands and in international stocks. Investors need to monitor for more definitive signs that value is gaining the upper hand before concluding that a rolling rotation is underway.
This leaves investors with a minor mystery. Banking system liquidity (blue line) has largely been moving sideways but the S&P 500 (red line) has been steadily climbing. Where is the money coming from to push up stock prices?
One guess is from the option market and the leverage that options can provide. This brings us to the less benign scenario of an increase in volatility, which is inversely correlated with stock prices. Cem Karsan of Kai Volatility has argued that the new preferred practice of selling naked put positions to enhance income has created option positioning that put a floor on stock prices in the short term. The expiry of VIX options on February 14 reset much of dealer positioning and opens the door to greater price swings. Historically, the period from mid-February to late April has seen volatility spike.
In conclusion, I am long-term bullish on equities, but the stock market may be vulnerable to a setback in the short run as negative divergences are appearing everywhere. These divergences could resolve in a sideways consolidation and rolling correction, or a sudden downdraft marked by a spike in price volatility. The NVIDIA earnings report in the coming week could be pivotal to the near-term market outlook.
Option skew, as measured by the market value of call options compared to equivalent put options, are extremely high for NVIDIA and other semiconductor stocks. The last two times this happened ahead of NVIDIA’s earnings report was in October 2021 and June 2023. The stock rose strongly and both it and the S&P 500 consolidated sideways after the earnings reports. Will the same pattern repeat itself next week? What if NVIDIA misses expectations?
My inner investors remains bullishly positioned. My inner trader recognizes that there are downside risks to stock prices but momentum has been strong. He is not so foolish as to short the market in front of a momentum train. He would rather wait for a downside break first to re-evaluate the technical picture before taking action.
Some interesting observations to keep an eye on. After the CPI report there was a very sharp downturn in prices. Subsequent to that the QQQs rallied but MSFT, APPL, GOOG and AMZN did not close the downside gap they had made on the plunge. Now on a weekly basis some of them have made an outside down week. Also, NVDA on a weekly basis has made a doji. Both these combined give a bearish tilt to the QQQs.
NVDA earnings and the mishap that could possibly happen is widely advertised. It is possible that investors/traders might sell the stock down prior to the release of earnings.
I have seen mentioning of using option collar being floated in quite a few places. So I expect a limited range reaction to NVDA earnings report so as to render these option pairs worthless. But this is immediately after the report. And after that we don’t know. Judging by money flow there has been substantial outflow from AAPL. Most of them into NVDA. This is not limited to fast money hedgies. A lot of big time investors are into it. The game is getting bigger.
Yes there is a trial balloon released in the headlines. Basically it says that Mag7 needs to take a break and let others run. Two big value sectors, Industrial and Financial, are into high momentum. The new highs are very broad. But as Cam mentioned here, it is in the large cap area. Nevertheless certain areas of small and mid caps are going strong. All we need is a USD and rates decline. Then these two areas will have their turns. In fact IWM and MDY are now right there to burst up.
Very interesting development from OpenAI with the release of Sora. Each iteration of software offering is getting more amazing. In these days of major tech breakthrough we have despots like Putin, Xi, Kim, and ayatollahs on this planet and we have religious zealots living with 7th century thinking. Very bizarre!