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.
The market’s conclave
The recently released film entitled “Conclave” tells the story of how Vatican cardinals sought to elect a new pope after the death of the old one. The film is focused on the conclave, or the meeting of cardinals, as they are locked up in the Vatican and the political maneuvers of the different factions in electing their candidate. The situation is fluid and emerging leadership is highly uncertain.
That’s where the stock market is today. The large-cap growth old leadership is faltering, and different candidates are vying for the top spot. I use RRG charts to tell the story.
Relative Rotation Graphs, or RRG charts, are a way of depicting the changes in leadership in different groups, such as sectors, countries or regions, or market factors. The charts are organized into four quadrants. The typical group rotation pattern occurs in a clockwise fashion. Leading groups (top right) deteriorate to weakening groups (bottom right), which then rotates to lagging groups (bottom left), which changes to improving groups (top left), and finally completes the cycle by improving to leading groups (top right) again.
An analysis of RRG rotation shows that growth sectors, technology, communication services and consumer discretionary, which is dominated by Magnificent Seven giants Amazon and Tesla, are weakening. While technology and communication services remain in the top right leading quadrant, they are likely to fall into the bottom right weakening quadrant in the near future if they follow the normal clockwise rotation pattern.
The contenders for the new leadership are value stocks, consisting of financials, industrials, energy and materials, and defensive stocks, consisting of healthcare, consumer staples, utilities and real estate. A growth to value rotation would mean a bullish and benign internal rotation for stock prices, while the emergence of defensive sectors as market leaders is a signal of a market pullback.
In the meantime, the market is waiting for the white smoke from the market’s conclave that signals which faction won in the end.
A sector leadership review
I review the relative returns of the different sectors for some clues.
A review of the relative performance of the growth sectors shows that only communication services has shown consistent positive relative strength. The relative performance of the other two sectors can only be best described as choppy.
The NASDAQ 100, which is a proxy for growth stocks, is also exhibiting some worrisome market internals. Even as the NASDAQ 100 broke out to all-time highs, the relative returns of the Magnificent Seven (bottom panel, red line) has falter0ed. This is another sign of weakening large-cap growth leadership.
The relative performance of the cyclically sensitive value sectors does not inspire high confidence in their leadership qualities. Financial stocks have seen a bid, but that’s probably attributable to the anticipation of further deregulation which benefits banking profitability. The relative returns of the other value sectors are choppy, though material stocks may be trying to form a relative bottom.
The relative performance of defensive sectors are all showing signs of bottoming patterns, but they have not exhibited definitive signs of leadership qualities that indicate the bears have taken control of the tape.
Liquidity headwinds
What could tip the market into a pullback instead of a rolling correction? One headwind that it faces is diminishing banking system liquidity.
Stock prices have been correlated with liquidity, but liquidity has been going sideways for several months while the S&P 500 has advanced.
Bitcoin has been regarded as a real-time proxy for liquidity, which has shown a strong correlation with the S&P 500. Bitcoin has begun to diverge negatively against the stock market in the past few weeks.
The previous chart was based on weekly prices, here is a daily price close-up, which shows that Bitcoin has been flat to down while the S&P 500 staged a marginal breakout to all-time highs. In addition, MarketWatch reported that the on-chain demand for Bitcoin has been weak: “Bitcoin’s apparent demand — or the difference between the amount of bitcoin mined and the inactive supply for over a year — fell from a high of 279,000 in December to around 62,500 as of Wednesday [February 19th}.” Downward pressure on Bitcoin prices has the potential to translate into weakness in the S&P 500.
Watch the Yen
Another tail-risk to consider is the potential of a repeat of the yen carry trade unwind, which sparked a sudden risk-off episode last August. Yields on JGBs have recently surged as the Bank of Japan’s monetary policy has turned more hawkish, which puts upward pressure on the yen. Further yen strength that moves the USDJPY rate decisively below the 150 level could spark another risk-off episode.
Japan’s January core CPI came in ahead of expectations, and along with continual strength in the Economic Surprise Index has the potential to put upward pressure on Japanese rates and the yen exchange rate.
The week ahead
Where does that leave us? The S&P 500 staged marginal upside breakouts to a marginal all-time high last week, led by the NASDAQ 100. Both indices weakened below support-turned-resistance and tested their respective 50 dma. The equal-weighed S&P 500 never staged an upside breakout, and the mid-cap S&P 400 and small-cap Russell 2000 are languishing below their 50 dma.
From a technical perspective Further S&P 500 weakness could target the price gap that begins just below 5900. Keep in mind, however, the S&P 500 closed Friday at roughly the level seen on Trump’s Inauguration Day. It remains to be seen whether the Trump Put would activate should stock prices weaken further.
Major sources of volatility in the coming week will be the NVIDIA earnings report and a decision on the delayed 25% tariffs on Canada and Mexico should be forthcoming. Mr. Market seems to be shrugging off the tariff threat by focusing on Trump’s pro-growth policies and believe that tariffs are only a bluff. This is not the kind of environment to be taking on more risk.
In conclusion, a sector rotation analysis reveals a market lacking in leadership, divided between a scenario of a rolling rotation from growth to value or a corrective pullback. My base case calls for a minor correction. The market faces several cross-asset headwinds from weakening banking system liquidity, a threat of a replay of the Yen carry trade unwind and renewed threats to growth from a trade war.
Momentum had an epic crash last week. High Momentum in almost all subindexes including the DJ Market Neutral dropped much more than Low Volatility in the same ones. Does this mean large investors became momentum players and their market stance has changed? Very possible and negative for previous winners.
Big bad news was Steve Cohen, best hedge fund investor, very negative on US market. He talked about “austerity” being negative for the economy at a big investment conference. Others have been thinking lower deficits are good for lower interest rates and hence good for markets. Most investors have never seen government austerity. It is bad for the economy and can lead to surprising bad outcomes.
Kevin Bassett is looking to reduce the deficit to 3% from 6%. Seem nice but watch out. Richard Koo writes about how Japan several times tried to lower their big deficits and every time the deficit went UP and not down as taxes fell and cost of social services went up. Big unexpected surprise.
Plus, their stock market fell into bear markets.
That video of Musk on stage last week with his chain saw celebrating slashing government spending might look very bad when looking back in future.
Federal deficits mean private credits which is where the money is spent that supports the economy/market. Cut deficits and less money goes to the aggregate “us”.
I mean if you fire 500, 000 federal workers, what do they live on after unemployment or disability or retire voluntarily? It may cost less to pay social security than a full time job, but those people spend less. More people looking for jobs may reduce wage inflation, but they spend less and very few ex gov’t workers will successfully create their own enterprises.
“It’s the *hubris* stupid” to paraphrase. The hubris of the elites to think they are smarter and can do what other nations and empires have tried and failed over the millennia.
Human nature is what is at the root of corruption, abuse, whatever. I anticipate some nasty market reaction, and then we get a “put” of some kind. The only question is if the put will lead to new highs with accompanying euphoria or a shoulder on the way down.
VIX is up a bit, $$HYIOAS not much I trust bond spreads more than what people say.
Remember, they misdirect. Look at 1998 what happened and what followed.
Last correction is stair down and elevator up. Let’s see if market behaves similarly this time and deviates from the historical norm again.
Market participants have gone more short term, with Fri and Mon down days more often and the other three days more positive. This is due to Trump’s EOs and other accivities, very intensive in nature. People don’t want surprises and hence less commitment. From another perspective Trump’s pace cannot sustain indefinitely (I could be wrong) so this shall pass.
Potential catalyst NVDA report next week. Several suppliers have hinted the bulk of GB200 72/36NVL adoption has shifted to H2 this year, as opposed to H1. It may or may not cause NVDA share to lose considerable altitude. Other B configs are selling very well and may not cause rev miss by much. If you see a big share price drop, go for the opportunities.
Yeah, no clear direction but the unfavorable Feb 2nd half seasonality is still in play. And then there is this short-term strong on-going long/short rotation between US nad Chinese large cap techs.