A bull market with election year characteristics

This model first flashed a buy signal in June 2023, but MACD turned negative in September. As the market rallied off its recent October lows, the monthly MACD turned bullish again. There have been two other similar episodes of these MACD buy signalisakeouts. Once in 1999, and the other in 2012. Both traced out brief range-bound price patterns before breaking out to new highs. If the limited past (n=2) is any guide, stock prices should also rally to new all-time highs in the near future.

 

 

Election year seasonality

While I am bullish on equities, I don’t think that trees grow to the skies and prices don’t rise in a straight line. This is an election year. While history doesn’t repeat itself but rhymes, chances are that equity returns will be flat to choppy in the first few months and the majority of the gains will be seen in the latter part of the year.
 

 

 

The risk of transitory disinflation

In the wake of a powerful rally, what could derail the bull run? I think that the biggest risk is the transitory disinflation narrative.

The current market consensus features falling inflation and continued economic growth for the U.S. economy. In other words, a soft landing. The market is not discounting a series of Fed rate cuts that begin in March.
 

 

Even though the rate of inflation has been falling, some early worrisome signs that continued disinflation progress are stalling, which would halt the expected path of decline in the Fed Funds rate. Consider, for example, that the Atlanta Fed’s wage growth tracker is stuck for a second month in November at 5.2%, which is far too high in comparison to the Fed’s 2% inflation target.
 

 

As well, the Philly Fed’s prices paid index is has been edging up. While readings are not alarming, it nevertheless signals that inflationary pressures may be reappearing.
 

 

For a broader look, the New York Fed’s Global Supply Chain Pressure Index is rising again. This is a signal that the disinflationary pressures on goods may be over. In addition, the recent shipping disruptions in the Red Sea is likely to put additional pressures on supply chains and elevated the prices of goods.
 

 

None of these data points are worrisome in their own right. However, they do indicate that the “last mile” disinflation problem of moving inflation from 3-4% to 2% may not be more difficult than the market is expecting. This has the potential of pushing out the timing of rate cuts, which has the potential to unsettle the bond market and risk assets in general. The average hourly earnings print in the coming Jobs Report on Friday will be a key test of the transitory disinflation narrative.
 

 

My 2023 report card

At year-end, it’s time to publish a review of the results of my models, starting with the Trend Asset Allocation Model. As a reminder, the trend model applies trend following techniques to a variety of global equities and commodities to arrive at a composite score that yields a buy, hold, or sell signal for equities. We’ve had an out-of-sample record of weekly signals since December 2021.

I constructed a model portfolio that either overweights or underweights the S&P 500 by 20% against a 60/40 benchmark of 60% SPY and 40% IEF based on trend model signals. The model portfolio had another good year with a total return of 17.6%, which was ahead of the 60/40 benchmark of 16.7%.

As the accompanying chart shows, the long-term track record of the model portfolio showed almost equity-like returns with balanced fund-like risk

My trading model had a good year. The model portfolio of the trend model was up 28.9% excluding dividends, which was ahead of the S&P 500 capital return of 24.2%.