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 15-Nov-2024)
- Trading model: Bullish (Last changed from “neutral” on 15-Oct-2024)
Update schedule: I generally update model readings on my site on weekends. I am also on X/Twitter at @humblestudent and on BlueSky at @humblestudent.bsky.social. 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 bulls seize control
The S&P 500 printed a bullish reversal last week. It began with a decline that was halted at the 20 dma and that’s just above a large price gap, followed by an outside reversal day when it exhibited a bullish engulfing pattern. The bullish reversal was confirmed when the index rose and filled a price gap that was acting as resistance.
The market action was a test for both bulls and bears. Gap fills, and how quickly they are filled, are a sign of the strength of the underlying trend. The filled upper gap is a signal that the bulls are seizing control of the tape once again.
Magnificent Seven leadership
Even as the S&P 500 struggled to fill the upside gap, the Magnificent Seven ETF (MAGS) signaled its leadership quality by filling the gap before the index. Moreover, MAGS has been in a relative uptrend since mid-October.
For traders, the market highlight of the week was the NVIDIA earnings report, which came in Wednesday after the bell. The stock has been in a well-defined uptrend that began in August and it’s now testing overhead resistance. The price reaction to the earning report turned out to be a non-event. Most notably, the stock has been roughly flat against the Magnificent Seven since early October, indicating that Magnificent Seven leadership is not just NVIDIA (bottom panel).
No breadth divergences
Under normal circumstances, Magnificent Seven leadership would be a sign of narrowing breadth, which would be a negative divergence and a warning of an unsustainable advance. Those concerns are alleviated by the sideways relative return pattern of the equal-weighted against the cap-weighted S&P 500 (middle panel) and the minor relative uptrend exhibited by the Russell 2000 in the past month (bottom panel).
An analysis of different Advance-Decline Lines shows that breadth is relatively healthy. Only the S&P 500 A-D Line has made an all-time high. The accompanying chart shows that breadth appears weaker as market cap decreases, as evidenced by the weaker performance of mid- and small-cap A-D Lines.
Another bullish data point can be found in the behaviour of risk appetite indicators. Both the relative performance of junk bonds (green line) and the relative performance of consumer discretionary to consumer staples (red line) is confirming the S&P 500 advance.
A possible sentiment warning
However, one key risk that appeared is a warning of excessively bullish sentiment from the option market, which is contrarian bearish. The 10 dma of the CBOE put/call ratio fell below its 1-standard deviation Bollinger Band, which has been a signal of a short-term top in the past.
However, other sentiment indicators, such as the AAII Bull-Bear spread, show a reading of 19.4, which is considered to be neutral and not wildly bullish.
Similarly, the NAAIM Index, which measures the sentiment of RIAs who manage individual investor funds, is elevated but well off the highs set in the last two years.
In conclusion, the S&P 500 arrested its decline at its 20 dma and exhibited a bullish reversal and this reversal was confirmed by bullish internals. My base case calls for a rally into year-end. The coming week is the start of the seasonally bullish period to year-end. One key risk is option sentiment is showing signs of froth, though other sentiment indicators remain in neutral territory.
My inner trader is staying bullish. 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 SPXL
1. Argentina debt was upgraded very recently which is a major first step toward better economy. Expect its equity market to perform very well in the future. This is just getting started. Currently Argentina market is beating SPX by a big margin.
2. For whatever it’s worth many traders are watching IWM:SPY ratio of 0.41 to decide whether to pour more money into IWM. This ratio is the number reached at Aug top when market had a big and swift correction. Small caps have underformed for so many years vs large caps. Rising over 0.41 and staying above would signal the reversal from the relative bottom at July is complete. If past playbook is still valid we will be looking at many years of small caps outerperformance. Watch how Trump policies affect small caps.