Tips on navigating the post-inauguration rally

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: Neutral (Last changed from “bullish” on 17-Jan-2025)

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.

Time for a pause?

January is almost over, and the S&P 500 staged an upside breakout to an all-time high last week, which Jeffrey Hirsch found is consistent with market seasonality. If the seasonal patterns found by Almanac Trader were to continue, stock prices are likely to be flat to down in February.
 

The rally left the market overbought, as measured by the NYSE McClellan Oscillator (NYMO). This is not necessarily bearish. Of the nine instances in the last three years when it reached 70 or more, stock prices retreated on three occasions and either advanced or consolidated sideways in the other six.
 

Supportive sentiment

In addition, short-term sentiment readings are not excessively bullish. The AAII weekly bull-bear spread is positive at 14, but don’t represent a crowded long. These readings leave the bulls more room to run should the backdrop prove to be favourable.
 

Bloomberg reported that positioning is light and institutions are skeptical of the rally:

A measure of aggregate positioning among rules-based and discretionary investors fell to a two-month low, according to Deutsche Bank AG’s data. And commodity trading advisors cut their long stock exposure to the level last seen in the aftermath of a market rout in August, data compiled by Goldman Sachs Group Inc.’s trading desk show.
From a contrarian perspective, such skepticism bodes well for stock-market bulls because it means more dry powder to buy equities down the road, should the biggest fears fail to materialize. While political uncertainty weighs heavily on investor sentiment, inflation has been subsiding and fourth-quarter earnings season is off to a strong start.

Barring any negative surprise, my base-case scenario calls for some near-term choppiness and, at worse, a shallow pullback to the 50 dma, which represents downside risk of only 2% on the S&P 500.
 

A case of bad breadth

While the short-term outlook for stock prices appear looks like it’s flat to up, I have some concerns about the intermediate-term trend. That’s because of the growing negative breadth divergences. Even as the S&P 500 broke out to an all-time high, none of the Advance-Decline Lines confirmed with a fresh high.
 

Breadth divergences can be measured in other ways beside the A-D Line. A rapid decline in the percentage of S&P 500 stocks above their 200 dma can be signals of a substantial decline.
 

To be sure, negative breadth divergences are warnings and not immediate sell everything signals. Negative breadth divergences can take months to resolve before the bears take control of the tape.
 

Near-term consolidation ahead

My base-case scenario calls for some near-term consolidation or shallow pullback. An analysis of the relative performance of the top five sectors by weight in the S&P 500 shows no strong co-ordinated bullish or bearish trends. As these sectors represent about 70% of index weight, the index needs broad-based participation for the S&P 500 to either rise or fall.