Trading the seasonal weakness

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: Bearish (Last changed from “neutral” on 06-Sep-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.

The stock market is suffering the “bad news is bad news” jitters, and there has been plenty of bad news. Let’s start with the release of the Fed’s August Beige Book, which is filled with downbeat commentary: “Economic activity grew slightly in three Districts, while the number of Districts that reported flat or declining activity rose from five in the prior period to nine in the current period.”

The jobs outlook sounded weak: “Employers were more selective with their hires and less likely to expand their workforces, citing concerns about demand and an uncertain economic outlook. Accordingly, candidates faced increasing difficulties and longer times to secure a job. As competition for workers has eased and staff turnover has fallen, firms felt less pressure to increase wages and salaries.”

Compare that with the Beige Book from July 2008, which was already seven months into a recession: “from July 2008: “Most Districts reported labor markets as unchanged or slightly weaker compared with the last survey period, and that wage pressures were generally modest. Demand for labor remained high for skilled workers in most industries, while several Districts reported widespread weakness in the financial services, auto, and construction industries.”
 

 

The August Payroll Report came in at 142,000, which is less than 164,000. July was revised down from 114,000 to 89,000 and June was revised down from 179,000 to 118,000. The unemployment rate fell from 4.3% to 4.2%. Leading indicators of employment, such as temporary jobs and the quits/layoffs rate from JOLTS, were falling. New Deal democrat, who monitors a series of coincident, short-leading, and long-leading economic indicators, call this jobs report the first indication of a hard landing.

These figures will set the narrative for the upcoming rate cutting cycle, though the figures are probably not enough to warrant a half-point cut at the September FOMC decision. The market is discounting a quarter-point cut at the September meeting, but two half-point cuts at the November and December meetings, which is a pace seldom seen outside of recessions.
 

 

Add to that the ominous negative divergence between stock prices and banking system liquidity.
 

Even though market participants pivoted to risk-off, sentiment is nowhere near panic levels. Stock prices are facing further downside risk.
 

 

To top it all off, the usually reliable S&P 500 Intermediate-Term Breadth Momentum Oscillator (ITBM) flashed a sell signal when its 14-day RSI recycled from overbought to neutral.
 

 

 

Constructive signs

Before investors become overly bearish, bad news may be nearing a nadir. The U.S. Economic Surprise Index appears to be bottoming, indicating that the flood of disappointing economic news may have peaked.
 

 

Despite the hard landing jitters, bottom-up forward 12-month EPS estimates are rising, indicating strong fundamental momentum.
 

 

Even as the S&P 500 violated its 50 dma, breadth indicators are holding up well. While readings have declined, they haven’t entirely cratered.
 

 

I interpret these conditions as a plain vanilla market correction rather than the start of a full-fledged bear market.
 

 

Bottom spotting

If seasonal tendencies are anything to go by, stock prices will continue to weaken until late October. Here is what I am watching for as signs that the market is bottoming.

Watch for the 5-week RSI to reach an oversold condition, which would be the sign of a washed out market. The S&P 500 should hold at or above its 40 wma at about 5200.
 

 

Another sign of an oversold extreme is an oversold reading in the Zweig Breadth Thrust Indicator. While this usually doesn’t resolve in a ZBT buy signal, which requires the ZBT Indicator to surge from oversold to overbought in 10 trading days, oversold conditions have resolved in short-term bounces at the very least.
 

 

Another “can’t fail” sign of a tactical bottom can be seen whenever the NAAIM Exposure Index, which measures the sentiment of RIAs who manage individual client funds, falls below the bottom of its 26-week Bollinger Band.
 

In conclusion, the stock market is due for a period of sloppiness and corrective action in the next two months. However, macro and technical indicators do not point to a major market top. I have outlined a number of bullish tripwires for traders to take advantage of a pending sale on stock prices and buy the dip.

Subscribers received an email alert on Friday that my inner trader had initiated a short position in the S&P 500. The market fell far faster than I expected and it would be not be surprising to see a bounce next week to either sell into or add to my shorts. 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.

Disclosure: Long SPXU