The market’s dance of thrusts and dips

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 23-May-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.

A failed breadth thrust?

Is the Triple 70 breadth thrust that triggered on May 6 in trouble? As a reminder, a Triple 70 breadth thrust occurs when the percentage of NYSE advances exceed 70% for three consecutive days, which is a bullish momentum signal. If history is any guide, Rob Hanna’s study of such events has seen strong bullish momentum follow through.

On the other hand, the short-term warning signs have been appearing everywhere. Even as the S&P 500 advanced to new all-time highs, the 5-week RSI flashed a negative divergence, and so did the VVIX/VIX ratio.

Is this evidence of a failed breadth thrust? How should investors react to the simultaneous appearance of bullish price momentum signals like a breadth thrust and the risk of dips from negative technical divergences?

Warning signals

The warning signs were plain to see. I highlighted the excessive bullishness of the put/call ratio last week.

Moreover, the daily S&P 500 chart was flashing warning signs. It’s not unusual for the index to consolidate sideways for a few days after reaching its upper Bollinger Band before making the next directional move. The latest move was foreshadowed by a bearish recycle of the stochastic from overbought to neutral. However, the market did show a constructive reversal candle on Friday, which needs to be confirmed by bullish follow through next week.

Limited downside risk

In light of the short-term warning signs, how far can the market pull back?
The bulls can be consoled by the fact that the market is already showing near oversold readings, indicating a relatively shallow pullback. Of the five components of my Bottom Spotting Model, one, the NYSE McClellan Oscillator (NYMO), flashed a buy signal when it reached an oversold condition last week. A number of other indicators are close to buy signals. The VIX Index is nearing the top of its Bollinger Band, and the intermediate-term overbought/oversold indicator is also near an oversold condition. Historically, the market is close to a bottom when two or more components of the Bottom Spotting Model trigger buy signals.

The Zweig Breadth Thrust Indicator, which is reported with a delay, came within a hair of an oversold condition last week, and its real-time estimate did become oversold, though that does not count as an “official” oversold reading. In the past, the market has bottomed soon after similar episodes.

As well, one of the important indicators of equity risk appetite, which was bearish last week, is turning up. The relative performance of equal-weighted consumer discretionary may be bottoming, which is a constructive sign.

While these are not definitive market bottom signals, I interpret these as half-hearted buy signals that indicate low downside risk.

Key risk

Even though I believe any pullback should be shallow, the key risk to my bullish outlook is the reaction of the bond market. Last week’s blizzard of Treasury supply was not well received and caused some indigestion among buyers.

Notwithstanding the softer-than-expected core PCE report that depressed bond yields, auction supply is expected to rise and peak in June. This will put additional pressure on yields in the new month and present a key test for risk appetite. {Corrected chart below)

In conclusion, I believe the bullish implication of Triple 70 Breadth Thrust triggered on May 6 is still alive. The U.S. equity market has just hit a temporary air pocket and should experience a shallow pullback. The key risk is how the bond market reacts to a continuing flood of issuance in June, which could put upward pressure on yields and downward pressure on risk appetite.

2 thoughts on “The market’s dance of thrusts and dips

  1. More anecdotes for average Joes. Memorial Day weekend movie box office 2024 is the slowest in 30 years, without factoring in inflation. Cruises are starting to offer discounts, as opposed to rosy reports in the media. So consumers are getting more discretionary and selective. I run my own search engines trying to detect the mood of average serfs in America and plot the time series. What I found is that more and more ordinary Americans are fed up and ready to give up. Let’s see what Q2 GDP looks like in a few months. Obviously the way America is being run is not sustainable, based on observations. And the distrust of US gov data is steadily rising. There is a big gap between how average people face/experience and what gov data depict. On the other end of the spectrum people are happy with their financial situation and optimistic about the future. But they are getting cautious. Walmart management has mentioned this point in their latest earnings report.

    Things can obviously improve. Let’s continue to observe. But the reality is that the problem is becoming structural. It is getting more and more difficult to solve without some sort of pain and expectation adjustment.

  2. Since I am a short term momentum trader I place a great emphasis on technical analysis and indicators. However, I am cognizant of the fact that it is not the be all and end all. Case in point what we are presently seeing is both parties not make any attempt to address the fiscal deficit.
    In fact, it is just the opposite. We will see taxes reduced if Trump gets elected and Biden will continue to spend money on unwinnable wars. If this scenario holds we are going to continue to see a back up in yields with a slowing economy. The Fed cannot do much on the long end of the yield curve. High interest rates and a likely recession – not a pretty picture.

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