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 19-Dec-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.
If Santa should fail to call…
The Santa Claus rally window is the last four days of the year and the first two days of the new year, and it’s one of the seasonally bullish periods of the year. History shows that a failed Santa rally often leads to subpar returns for the remainder of the year. The first day of the window was December 24. So far, the market has performed well this year.
There is an adage among traders: “If Santa should fail to call, the bears may come to Broad and Wall”. If the advance continues, the risk of a major bear market in 2025 is diminished though.
So far, the question of whether Santa Claus will appear this year is a toss-up. It is constructive that Friday’s S&P 500 decline bounced off the 50 dma. While the S&P 500 closed marginally below the December 23 close, which is the Santa Claus rally starting level, both the Dow and Russell 2000 closed above their respective Santa rally levels.
Narrow leadership
Nevertheless, the rebound should continue as the advance began from deeply oversold conditions. In the past, such rallies didn’t stall until most of the overbought/oversold indicators reached overbought levels.
What’s unusual about the initial rebound is the narrow leadership. Market breadth isn’t broadening out during the relief rally.
The animal spirits don’t seem to be participating. The performance of IPO stocks, which is an indicator of speculative activity, is lagging the market.
Contrarian opportunities for the bulls
These conditions set up two possible outcomes. Either the rally fails and the market corrects in January or leadership rotates to the lagging groups of the market. With that in mind, here are some selected contrarian opportunities for bulls or investors who want some equity exposure. These highlighted opportunities trade at single-digit forward P/E ratios, which is rare in an environment when the S&P 500 trades at a forward P/E of 22. As well, each of these stocks exhibited weakness in December, which may be attributable to year-end tax loss selling and sets up the potential for a January rebound.
I produce a monthly LBO screen of non-financial stocks within the S&P 1500. For a full description of my methodology, please see my original publication,
How To Buy A Company If You Have No Money. As a reminder, I calculate a LBO price target range based on two techniques to estimate cash flows: based on normalized EBITDA margins as applied to current sales and EBITDA based on consensus forward 12-month EPS.
I found 35 stocks that qualify under my LBO criteria of 30% down which is an increase from 29 last month. Funding costs have been steady. The increase can be attributed to the combination of the underperformance of small-cap stocks, which have lagged large caps even within the technology sector, and the underperformance of energy stocks, which are appearing on my LBO screen in increasing numbers.
I highlight three selected opportunities among the possible LBO candidates, with the caveat that a deep value screen like the LBO should be used by investors to identify stocks for further detailed fundamental analysis as there is a heightened risk of value traps in many of the names. This is not a quantitative factor that can be blindly bought because of the high degree of stock-specific risk which will be difficult to diversify away.
Centene hit a 52-week low in December and passed my LBO screen on the basis of low volatility of its margins, which allow for higher debt levels, single-digit forward P/E and sizeable cash position.
Lear Corp. could be attractive for contrarian value investors. It appears on my LBO screen based on its strong cash position and steady margins. In addition, its single-digit forward P/E ratio adds to its value as a potential bargain.
Another recurring theme that I found among the LBO stocks is energy. Consider Peabody Energy. This coal stock shows a relatively large cash position and strong cash flow. Peabody Energy is a deep value recovery candidate that’s trading near the top of its LBO range.
The relative attractiveness of the energy sector is underlined by the continued accumulation of Occidental Petroleum by Warren Buffett’s Berkshire Hathaway. Occidental’s stock price is now at or below Buffett’s original purchase levels.
Are you prepared to be contrarian?
In conclusion, the stock market is likely to advance during the Santa Claus rally window, which began on December 24 and ends January 3. But the rally is attributed to an oversold bounce and marked by narrow leadership. Either the rebound fizzles in January or broadens into lagging issues. I identified selected contrarian value opportunities for bulls among Santa’s discards for potential outperformance into January and beyond.
As a reminder, a deep value screen like the LBO should be used by investors to identify stocks for further detailed fundamental analysis as there is a heightened risk of value traps in many of the names. This is not a quantitative factor that can be blindly bought because of the high degree of stock-specific risk which will be difficult to diversify away.
My inner trader continues to hold a long position in the S&P 500. 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
