4 reasons to be cautious about the ZBT buy signal

Posted by Cam Hui -
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: Bearish (Last changed from “neutral” on 11-Apr-2025)
  • Trading model: Neutral (Last changed from “bullish” on 14-Apr-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.

 

 

A ZBT Buy Signal

I have recently seen a number of buy signals triggered with strong historical long-term returns. The latest is the Zweig Breadth Thrust. The technique was first detailed in Marty Zweig’s book, Winning on Wall Street, first published in 1986. It’s a rare signal that was triggered only eight times since the book’s publication.

 

The signal required the market to exhibit strong price momentum. The Zweig Breadth Thrust Indicator needed to recover from an oversold to overbought condition within 10 trading days. The signal has had a 100% positivity rate on a 6- and 12-month horizon. The market fizzled over short-term horizons on three instances when the Fed was raising rates, which is not the backdrop today. That said, Tom McClellan published a study of ZBT signals going back to the 1920s and found that the results ended to be hit-and-miss.

 

 

The ZBT buy signal triggered late last week. Notwithstanding the stellar historical record of this indicator, I am struggling with the long-term equity bull case and I have four reasons to be cautious.
 

 

High Volatility = Bear Market

The market is exhibiting a series of high-volatility events that have the fingerprints of a bear market.
 

 

The S&P 500 achieved the fourth-highest realized volatility in the last 75 years. Whether the price volatility is to the upside or downside, such conditions are not signals of a healthy bull.
 

 

Even though the VIX Index has fallen below 30, which is a sign of normalization, the term structure of the VIX is still inverted, which indicates elevated levels of market anxiety.
 

 

 

High Uncertainty

Arguably, the ZBT buy signal could be a sign of an all-clear. Market conditions and psychology have deteriorated so much that they have nowhere to go but up. But I struggle with that thesis as uncertainty remains extremely elevated and I see few signs of relief for macro and fundamental conditions on the horizon.

 

Intermediate market bottoms occur when the conditions that sparked the fear are relieved, such as Mario Draghi’s “whatever it takes moment” to save the euro, but I struggle to see how the market resolves the uncertainty arising from Trump’s tariffs and efforts to dismantle Pax Americana, or the security and financial umbrella that underpins global world order since the end of World War II. To be sure, relief rallies can occur as trade discussions progress, but the expectation of 90 trade deals in 90 days is highly unrealistic.

 

The latest Fed Beige Book contained 80 references to the word “uncertainty”. Not only is the figure an all-time high, the scale had to be doubled from the previous print of 45 in March. As a reminder, uncertainty in the business environment retards capital spending and hiring plans, which leads to slower growth.

 

The Financial Times reported that companies mentioned “tariffs” on over 90% of S&P 500 earnings calls so far this earnings season. The term “recession” was mentioned on 44% of calls, compared with less than 3% on those covering Q4 2024.
 

 

As a reminder, uncertainty in the business environment retards capital spending and hiring plans, which leads to slower growth.
 

In the meantime, earnings estimates are weakening as Q1 earnings season progresses. Amidst all of the uncertainty, some companies have responded by withdrawing guidance. These figures are troubling inasmuch as forward P/E valuations are elevated.
 

 

In the past, market crises such as the 1987 stock market crash, LTCM blowup, GFC and COVID Crash were met with a fiscal or monetary response, or both. This time, the crisis was inflicted by policy and the prospect of the deployment a fiscal or monetary safety net is slim.

 

Instead, the U.S. federal government is setting up a pro-cyclical response by weakening the social safety net ahead of a probable growth scare and possible recession. Former Fed economist Claudia Sahm highlighted a passage from the Kansas City Fed from the Beige Book:

Funding cuts from the USDA were highlighted as particularly impactful regarding services for seniors. Specifically, one pantry reported cutting back the amount of food they can give from three to five days of shelf stable food to two days of food every 30 days due to funding cuts. Pantries also expressed heightened funding uncertainty across government, corporations, and individuals and uncertainty about food price pressures.

In the end, stock prices depend on the earnings outlook and its P/E multiple. The best-case scenario I can envisage is a rollback of tariffs to a uniform rate of 5% to 10% above levels before “Liberation Day”. Supply chain disruptions and elevated tariffs causes a growth slowdown, but no recession. The Fed response by cutting rates in Q3 or Q4. Congress passes a package tax and spending cuts that’s at best fiscally neutral. S&P 500 forward earnings stay relatively stable, but the forward P/E compresses from 19.8 today to about 16 because of uncertainty, which translates to a downside potential of -15% to -20%.

 

 

Hard and Soft Data Convergence

Investors have been puzzled recently by the divergence in the weakness of the soft sentiment data and the resilience of the hard activity data. The divergence can be partly explained by the anticipation of weakness, or at least uncertainty, that’s reflected in the survey data, and front-running tariff spending that pulls purchases ahead from future months in the hard activity data.
 

 

The soft and hard data is about to converge. Molson Hart explained in a recent Twitter/X post of how supply chain bottlenecks are about to appear:

Around April 10th China to USA trade shut down. It takes ~30 days for containers to go from China to LA. 45 to Houston by sea, 45 to Chicago by train. 55 to New York by sea. That means that there are no economic effects of what was done on April 10th until about May 10th.

 

Around that time (it’s already started to happen) trucking work is going to dry up. Warehouses will start doing layoffs because no labor is needed to unload containers and some products will be out of stock, reducing the need for shipping labor.

 

All this will start in the Los Angeles area. After about 2 weeks, it’ll start hitting Chicago and Houston. Already, shipping volumes from China to the U.S. are collapsing. The wheels are already set into motion.

 

The public will start to see COVID-style supply shortages in the May–June time frame all over the U.S.

 

 

None of these problems can be magically wiped away by the promise of trade negotiations, which China has denied are under way, or even a trade deal, which will take months to negotiate.
 

It’s therefore no surprise that my Trump factors are all rising, indicating high risk levels. The trade war factor has been in a steady uptrend. Inflation expectations have staged an upside breakout but pulled back below to test the breakout level. The relative performance of foreign sovereign bonds to 7–10-year Treasuries have also broken out, indicating a loss of confidence in the USD and Treasuries as safe-haven assets.
 

 

 

Sell in May?

Here’s another historical study to consider. Wayne Whaley observed that a negative stock market performance in April, which currently stands at -1.5%, tends to resolve in subpar returns for the rest of the year.
 

 

This leads to the conditional study of “sell in May” conducted by Callum Thomas of Topdown Charts. He found that while the adage “sell in May and go away” had limited utility, it’s far more useful during bear markets.
 

 

What about the bullish implications of the Zweig Breadth Thrust? I attribute the buying stampede to a short-covering and beta-chasing rally by hedge funds, which were stopped out of their equity positions in the recent risk-off episode as they normalized their positions.

 

By contrast, positioning surveys of retail investors show that they have been buying the dip, which is contrary to the conclusion of opinion surveys like AAII, which shows extreme levels of bearishness. Capitulation bottoms don’t look like this.
 

 

There is also more negative news from a fund flows and positioning perspective. Harvard and Yale universities have announced that they are liquidating portions of their private equity portfolios in order to fund their operations. The forced sale of illiquid assets will undoubtedly depress private equity valuations and possibly put downward pressure on public equity markets. The most likely effect would be seen in small-cap stocks, which have already been lagging the S&P 500 since late 2024.
 

 

In conclusion, last week’s Zweig Breadth Thrust buy signal gave investors reasons to be bullish on stocks, but I beg to differ. Uncertainty remains high and I struggle to outline a clear intermediate-term bull case for stocks. Moreover, hard activity-based data is poised to converge toward the soft weak survey-based data in the coming weeks, which has not been fully discounted by the market. This is a bear market and investors should adopt a position of maximum caution.

 

8 thoughts on “4 reasons to be cautious about the ZBT buy signal”

  1. Well they say sentiment is bearish, and this supports that statement.
    It’s certainly not a time to go short though with this signal. Maybe trim back on longs . But a signal is a signal.
    There was a lot of volatility around the Dotcom bubble, with LTCM going bust. Lots of head scratching at unicorns with not much more than a name.
    Markets can stay irrational longer than one can stay solvent.
    So much can happen with policy changes.
    We may get a stampede, but in which direction?
    Perhaps this happens before blowoff tops, which are truly rare events.

  2. The 12 ma of the monthly pc ratio is still going down, of course it could change and the month is not over.
    The monthly $$HYIOAS has a really long upper wick, month not over ofc, but usually this gives a few months of lower readings. We have to see if it bounces say off the 12 ma before heading up, or even gets to the 12 ma.
    In June of 2007 it shot up, and yet the high in the markets was in October. So it’s a. cause for concern but by may 1 we see what that upper wick looks like.
    What will Trump say between now and next week?

  3. Draw a line from the Dec 21 top to the Dec 24 top of the SPX. If we get a blowoff that breaks thru that, when it goes back under , it’s over. Time for spxu or spy puts
    If we get a waterfall crash, it doesn’t happen.

  4. Maybe it is different this time. I am trying not to be political but there are few economists and business people who think the “reciprocal tariff” scheme is a rational idea. And what business in its right mind will commit billions of dollars and years into the future when the goal post changes week after week? The decisions that are being made are whimsical and irrational. Adam Smith must be turning in his grave. This is not an example of the invisible hand at work.
    The ZBT may be showing a buy signal but the dirth of containers coming from China and other countries tells another story. And about those 200 trade deals that are in the works…….

  5. I can only come up with the conclusion that it makes sense for China to drag things out a little longer until the supply shortages and also the rare earths export bans start to bite in a few weeks time, this will give them a much better position and it remains to be seen what each side really wants.

  6. We forget that if containers are not coming, someone in China is losing business too. China was in weaker economic situation. So who is hurting more and can wait it out?
    I think it will get resolved sooner than people expect and on favorable terms to US.
    Current system is not sustainable to US in the long term.

    1. yes, it is concerning when Torsten Slok is sure a recession is upcoming. One remembers how he was one of few who didn’t expect a recession in 2022-24. That said, nobody has a perfect success rate.

      In contrast, when Nouriel Roubini (who got it right, big time, in late 2006) says that “tech trumps tariffs, tech trumps Trump”, one wonders whether he’s not just hoping for another hit. (He’s been wrong several times since the GFC).

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