Embrace the Market’s Animal Spirits

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: Bullish (Last changed from “bearish” on 27-Jun-2025)
  • Trading model: Neutral (Last changed from “bullish” on 26-Nov-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.

 

 

Relentless Momentum

The price momentum that I highlighted last week has been relentless. Even as the S&P 500 tests resistance at its all-time high, the equal-weighted S&P 500, the small-cap Russell 2000 and the MSCI All-Country World Index Ex-U.S. all surged to fresh highs.
 

 

There is nothing more bullish than a new high.
 

 

Supportive Breadth

Breadth indicators are supportive of the bull case. Both the S&P 500 and NYSE Advance-Decline Lines rose to all-time highs, which is intermediate-term bullish.
 

 

Breadth has also been broadening out, which is another constructive sign of a healthy advance. The Magnificent Seven has weakened to test a relative support zone, while the equal-weighted S&P 500 is outperforming the cap-weighted index.
 

 

 

The Animal Spirits Come Alive

The market’s animal spirits are coming alive. One of my favourite animal spirit indicators is the relative performance of IPOs, which is turning up in relative terms, but readings are not showing signs of froth.
 

 

Similarly, the relative performance of small caps are surging.
 

 

At this phase of the rally, I would tactically favour small caps. The Russell 2000 has beaten the S&P 500 for 10 straight days. Historical studies of such events saw the Russell 200 consolidate for about a week before resuming their outperformance.
 

 

The recent episode of bullish price momentum can be partly attributable to a positive banking system liquidity backdrop.
 

 

Another real-time indicator of liquidity is the price of Bitcoin, which has been correlated to the relative performance of the speculative growth ETF, the ARK Innovation ETF (ARKK). Speculative traders who want to embrace the tide of rising liquidity could take a ride on ARKK.
 

 

 

Don’t Overstay the Party

In conclusion, the stock market is exhibiting strong price momentum, supported by improving breadth and rising liquidity. Investors should tactically embrace the latest episode of price momentum with exposure to high-beta small-cap and speculative names. But don’t overstay the party, as outperforming small-cap stocks are exhibiting a negative breadth divergence, which is a warning that the risk-on rally is at risk of stalling in the coming weeks.
 

 

As is the case with short-term momentum-based moves, risk control is important for traders who adopt a tactical risk-on posture. Maintain a trailing stop and monitor the NYSE McClellan Oscillator (NYMO) for signs of an overbought condition as a signal to reduce long exposure. At the current pace of advance, I expect the rally to start stalling in late January or early February.

 

 

Addendum: Trump announced over the weekend that he is imposing an escalating tariff rate on European countries that are deploying troops to Greenland, which should come as a negative shock to risk appetite. This will be another test for the bulls. The market hiccuped last weekend when it was revealed that the Trump Administration had opened an investigation into Fed Chair Jerome Powell, and Powell pushed back with a strongly worded statement Sunday night. The stock market opened up down on Monday but ended the day in the green. This will be another test.