4 reasons why you should be tactically bullish

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: Neutral (Last changed from “bullish” on 26-Jul-2024)
  • Trading model: Bullish (Last changed from “neutral” on 25-Jul-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 “good overbought” advance?

The rebound off the August 5 panic bottom has shown an astounding level of price momentum. The S&P 500 printed a William O’Neil Follow Through Day, which is an indication of strong positive price momentum with a 1.7% advance on higher volume than the previous day. It went on to break out through its 50 dma and a falling trend line by gapping up through those levels. The next test to exceed the bearish engulfing pattern on August 1.

The market appears to be on its way to start a “good overbought” advance. Here are some other reasons why this rally could continue.

Strong momentum

The stock market is exhibiting evidence of strong price momentum. The market came within a hair of a buy signal. As a reminder, the ZBT buy signal flashes a buy signal when it recycles from oversold to overbought within 10 trading days.
The Zweig Breadth Thrust Indicator plunged to a near oversold condition on the day of the August panic. Last Friday was day 9 of the almost breadth thrust window, and the indicator is near overbought.
Call it an almost, or incomplete, breadth thrust.

A sentiment reset

Investor sentiment has reset in the wake of the market panic. Analysis by Deutsche Bank shows investors’ aggregate allocation to stocks is now in the 31st percentile and underweight, compared to the 97th percentile of the historical range three short weeks ago.

Similarly, the NAAIM Exposure Index, which measures the sentiment of RIAs who manage individual client funds, has fallen below its 26-week Bollinger Band. This has been a virtually foolproof tactical buy signal.

The 10 dma of the CBOE put/call ratio spike above its 1 standard deviation Bollinger Band, which indicates fear and a contrarian buy signal.

VIX spikes are bullish

There have been numerous studies showing that VIX spikes are contrarian bullish. The VIX Index touched 65 on the day of the market panic on August 5 and fell below 20 soon afterward. A study of VIX action that fall from above 40 to below 20 shows strong positive returns, though one-year returns were below average.

Positive internals

Technical internals are flashing bullish signals. The equal-weighted relative performance of the consumer discretionary stocks and global consumer discretionary to global consumer staples are turning up, which are indications of positive risk appetite and cyclical buy signals.

Breadth indicators are confirming the market advance. Both the S&P 500 and NYSE Advance-Decline Lines have made fresh all-time highs.

What about leadership?

I continue to favour a tilt away from Magnificent Seven leadership for this next bull phase. Magnificent Seven has led profit growth for several quarters, but the other 493 stocks in the S&P 500 are projected to deliver their first profit growth since Q4 2022.

In addition, small-cap indices are breaking out of their trading range, which is a constructive sign that they are out of the penalty box and poised for further gains.

In conclusion, the stock market is poised for continued strength. I can think of at least four reasons to be tactically bullish on stocks: price momentum; a sentiment reset from bullish to caution, which is contrarian bullish; the historical bullish record of VIX spikes; and positive and supportive internals. I continue to favour non-Magnificent Seven leadership for the next bull phase.

In normal circumstances, my inner trader would have exited his long positions by now as technical conditions have normalized from an oversold extreme to neutral. However, the strength of price momentum has convinced him to hold on until readings become overbought. The usual disclaimers apply to my trading positions.

I would like to add a note about the disclosure of my trading account after discussions with some readers. I disclose the direction of my trading exposure to indicate any potential conflicts. I use leveraged ETFs because the account is a tax-deferred account that does not allow margin trading and my degree of exposure is a relatively small percentage of the account. It emphatically does not represent an endorsement that you should follow my use of these products to trade their own account. Leverage ETFs have a known decay problem that don’t make the suitable for anything other than short-term trading. You have to determine and be responsible for your own risk tolerance and pain thresholds. Your own mileage will and should vary.

Disclaimer: Long TNA

6 thoughts on “4 reasons why you should be tactically bullish”

  1. On the monthly chart which is not complete of course, we have a hammer, maybe a hanging man. In august 2007 and October 2014 there were also monthly hammers which rallied after but soon enough after there were significant declines. There were RSI divergences at the time. I know that divergences happen and the market can keep rising, but 2 or 3 months from now puts us at around election time, and all the fear that elected representatives *must feel* will fade post election. Something to keep an eye on, but for now, nobody wants to rock the boat. One thing that both sides want is to be reelected.

    1. Election year seasonality tends to see stock market weakness in October, followed by post-election gains.

      1. A few weeks ago, you wrote an article/assessment that we are in mid-cycle in the stock market. I’m curious to find out if we have reached a late cycle yet or at least, enter into late cycle.

  2. This American environment is certainly seeing the same setup as past intermediate legs higher.

    But there is possibly something nasty brewing offshore with the American dollar extremely weak, gold breaking out strongly and iron ore prices plunging along with other base metals also weak.

    This makes me very cautious.

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