How much is left in the bulls’ gas tank?

Posted by Cam Hui -

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.

 

 

Too far, too fast?

Has the bull run gotten ahead of itself? The S&P 500 was up 14.5% for the first half. In addition, Ryan Detrick observed that the Zweig Breadth Thrust signal of early November showed very strong returns. It was a buy signal I also highlighted (see Zweig Breadth Thrust: From caution to YOLO). The S&P 500 was up 19.0% in the six months since the buy signal, and the market was up 3.5% since then. Combined, investors would be up nearly 22.5% since the buy signal, which is just under the 12-month average and median return.
 

 

In light of these strong returns, how much gas is left in the bulls’ gas tank? Is this the case of the market going up too much, too fast?
 

 

Warning signs

A number of warning signs are appearing. An enormous divergence has appeared as consumer survey expectations of business sentiment is weak, but stock market return expectations are strong.
 

 

As well, household stock allocations have reached an all-time high, which is contrarian bearish.
 

 

From a valuation perspective, the equity risk premium is low, indicating that investors should expect subpar long-term returns.
 

 

Tactically, the most concerning development has been the violations of both absolute and relative rising trend lines by semiconductor stocks, which were the market leaders.
 

 

 

Wait for the trend break

Another warning sign is the suppression of market volatility, as measured by the low value of the VIX Index. While some may see this as an accident waiting to happen, there is no obvious trigger.
Instead, I interpret the warnings as a market in need of a breather. The S&P 500 remains in a well-defined uptrend. While it would not be unexpected to see stock prices correct, I see no signs of any trend break that signals a major bearish episode.

 

 

I also pointed out last week that the usually reliable S&P 500 Intermediate Term Breadth Momentum Oscillator (ITBM) flashed a buy signal when its 14-day RSI recycled from oversold to neutral. The market has been bifurcated between the narrow leadership AI-related plays and the rest of the market. I interpret the ITBM buy signal as the rest of the market is showing signs of positive price momentum after becoming oversold, which is a constructive sign.
 

 

In conclusion, the stock market advance in 2024 has been impressive, but prices can continue to rise. Market internals have become frothy and overbought in the AI-related leadership, but the rest of the market is showing signs of recovery that’s indicative of a leadership rotation. My base-case scenario calls for some near-term choppiness, followed by further gains into year-end.

 

While some of the technical warnings may be disturbing, they are not signs of an immediate major market top. Analysis from SentimenTrader put this into some context, the accompanying chart shows the spread between the percentage of S&P 500 stocks above their 200 dma and percentage of NASDAQ above their 200 dma (bottom panel). High spreads of 30% or more have signaled broad market tops in the past, but the tops can take some time to develop. Keep an eye on this development, but there is no immediate need to panic.
 

 

Debate Postscript: I am not fond of political bias in my investment analysis, but the consensus is that Biden performed very badly in the presidential debate last week and the odds of a Trump win have spiked in the betting markets. I reiterate my analysis from last week:

I project that a Biden win would be bearish for bond prices and mildly bullish for stock prices. A Trump win would be bond and USD bearish and gold bullish. The path of equity prices under a Trump Administration is too difficult to forecast as it depends on too many variables.