A cresting tide?

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: Neutral (Last changed from “neutral” on 16-May-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.

 

 

Weak Breadth and Narrow Leadership

As the S&P 500 tests a key resistance level, the underlying market action is starting to feel like a cresting tide. Beneath the surface, the equal-weighted index has yet to reach its own resistance level, indicating poor breadth and narrow leadership.
 

 

 

Growing Valuation Risk

First, the S&P 500 faces valuation risk. The CAPE earnings yield to cash yield spread is flashing a warning sign. While this isn’t an exact market timing indicator, relative valuation poses some downside risk to stock prices. I don’t expect a major bear market, as recession risk is relatively low. However, a growth scare wouldn’t be surprising as the full economic effects of the trade war become evident.
 

 

 

Challenging Trade Negotiations

President Trump held a phone call with Chinese President Xi Jinping last week. You can tell a lot about the progress of the trade negotiations by comparing and contrasting the readout from each side, with the caveat that each can’t be taken at face value.

 

Trump’s readout of the call had a constructive tone.

 

 

China’s readout of the call was more detailed and nuanced. While the tone was constructive, it did highlight sources of friction that have yet to be resolved. China acknowledged that the Geneva meeting “marked an important step forward in resolving the relevant issues through dialogue and consultation, and was welcomed by both societies and the international community.” But asserted that China “has its principles” and “always honor and deliver what has been promised”, which it interprets as there was either no agreement to end the rare earths export curbs or Beijing’s practice of slow walking approvals of the critical minerals conformed to the terms of the deal. Further, it said that the U.S. should “remove the negative measures”. In addition, China revealed that there was movement on the U.S. side on the Chinese student visa ban, as Trump promised that the “U.S. loves to have Chinese students coming to study in America”.
 

In other words, the discussion was cordial and both sides agreed to keep talking. China held firm to its stated position. There were no major breakthroughs other than Trump relenting on the Chinese student visa ban.

 

Prior to the phone call, the WSJ reported that Xi had appointed Vice Premier He Lifeng as China’s lead trade negotiator. His mandate is to play hardball and his appointment is a signal that Xi doesn’t intend to give in to Trump’s demands to import more American agricultural products and other goods as she did under Trump 1.0.

 

Trade war fears eased in the wake of the news of the phone call. The American and Chinese negotiation teams are expected to meet on Monday in London. It remains to be seen how the market will react to the next set of meetings.

 

 

 

A Softer Jobs Market

The May Payroll report headline beat expectations, but it was weaker on an overall basis. The economy added 139,000 jobs, which was ahead of the consensus forecast of 126,000. However, combined job growth in March and April was revised down by a net of -95,000. The unemployment was steady at 4.2% and would have risen had the participation rate not retreated from 62.6% to 62.4%.
 

Leading indicators, such as the quits to layoffs ratio from the April JOLTS report and temporary jobs, plunged. The report reflected the wait-and-see caution cited by business surveys. Employers outside of the service industries of healthcare and hospitality are hesitant to hire. Professional services, which are high paying jobs, manufacturing, construction, transportation, and even retail show little or no job growth.
 

 

Even before the publication of the May Payroll report, continuing jobless claims rose to a 3.5-year high, and so did the category of “not in labor force but want a job”. These are signals that the jobless are experiencing growing difficulty in finding new employment.
 

 

Analysis from Renaissance Macro highlighted other signals of job market weakness from the NIFB small business survey. Compensation pressures are down and so were “labour quality” concerns, indicating that bargaining power is shifting to employers.
 

 

The May report was the worst of all worlds for Trump and anyone expecting the Fed to cut rates soon. It as mildly expansionary but soft beneath the surface. However, it’s not soft enough to warrant the Fed to cut rates. Instead, this data point is likely to reinforce Fed policy makers’ view of taking a wait-and-see attitude by focusing on the inflation fighting part of the Fed’s mandate. Such a policy path also raises the risk that the Fed will be behind the curve should growth sputter later in the year. Keep an eye on the inflation prints next week, which may shed more light on the Fed’s reaction function.
 

 

Signs of Froth

One of my concerns is that the recent advance was mainly driven by retail buying, which correctly bought the dip. MarketWatch reported that retail buyers have mainly been chasing price momentum, which is a sign of a frothy market.

 

Panmure Liberum analysts Joachim Klement and Susana Cruz, say the recent U.S. stock rally is standing on shaky ground. “While retail investors are becoming more bullish in U.S. equities again, hedge funds continue to increase their bets against U.S. markets and in favor of international stocks. Historically, this was the worst time to invest in U.S. stocks,” they wrote.
In emailed comments, Klement as retail investors tend to follow past performance rather than the fundamentals when it comes to fund flows, their excitement is often viewed as a “good contrarian indicator.”
 “When hedge funds and retail investors disagree, it is usually the hedge funds that win in the end,” he said.
The leadership in the rebound has mainly been the NASDAQ 100, which is extended, based on the percentage bullish on P&F. While this isn’t an actionable sell signal but a conditional warning signal, the odds favour a downside resolution in the near-term.
 

 

Other signs of froth can be seen in the performance of small cap speculative stocks, as measured by the ARK Investment ETF (ARKK). The relative performance of ARKK is historically correlated with Bitcoin. While Bitcoin has pulled back, ARKK has surged, indicating speculative behaviour.
 

 

As well, keep an eye on small cap stocks. The Russell 2000 staged an upside breakout of the neckline out of an inverse head and shoulders pattern, which is bullish. However, the S&P 600 remains below its neckline. S&P has a profitability inclusion criteria for its indices while Russell does not, which is an indication that lower quality stocks are leading the small cap rally.
 

 

In addition, risk appetite indicators of the market’s animal spirits are rolling over even as the S&P 500 advanced. The relative performance of IPOs is flagging, and so is the relative performance of equal-weighted consumer discretionary stocks, which minimizes the large weight of Tesla in the sector, has followed a similar pattern of weakness.
 

 

Klement and Cruz pointed out that retail investors are chasing price momentum. There are many ways of measuring the price momentum factor, which is based on the thesis that stocks which outperform continue to outperform. Of the five momentum ETFs that I monitor, the relative performance of some continue to rise while others are stalling. I interpret this to mean that price momentum is starting to falter — another possible sign of a cresting tide.
 

 

In conclusion, the U.S. equity rally may be stalling as a frothy market encounters negative divergences. It faces the combination of valuation pressures, challenging trade negotiations with China and early signs of economic weakness. The last shoe to drop is price momentum, which may be in the process of rolling over.

 

1 thought on “A cresting tide?”

  1. If hedge funds are net short, this also provides fuel for a melt up if they are wrong. I often wonder about what and why of the spin Wall Street sends us.
    JNK is making all time highs, and the charts of the SPY and JNK are very similar. So do we get a divergence or does SPY also make an ATH. The volume on JNK is low, so this is one of those making new highs on diminishing volumes that makes on cringe. But on several occasions when there was an intermediate term top, JNK topped out before SPY.
    So we’ll see, but one thing to watch is if JNK tops out and SPY keeps grinding up.
    Of course there is the Washington news unpredictability factor, which I dare say “This time could be different”

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