Bullish momentum vs. bearish seasonality

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 26-Jul-2024)
• Trading model: Neutral (Last changed from “bullish” on 20-Aug-2024)

Update schedule: I generally update model readings on my site on weekends. I am also on X/Twitter at @humblestudent. 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 accompanying chart from Jeffrey Hirsch of Almanac Trader shows that the stock market pattern in 2024 has closely followed the historical election year seasonal pattern. We are about to enter a period of negative seasonality until late October. Is this a sign the S&P 500 could weaken back to its early August low?
 

 

Here are the bull and bear cases.
 

 

Momentum, momentum!

The short-term bull case rests on price momentum. The market came within a hair of a Zweig Breadth Thrust buy signal. As a reminder, the ZBT buy signal triggers when the ZBT Indicator surges from oversold to overbought within 10 trading days. Historically, such displays of strong price momentum tend to persist for at least a year.

The ZBT Indicator plunged to a near oversold condition on the day of the August panic. It reached an overbought condition last Monday, which was exactly 10 trading days later. It was a breadth thrust, just not a Zweig Breadth Thrust. Breadth thrusts deserve some respect.
 

 

Along with the impressive display of strong price momentum, sentiment readings are not stretched and could rise further. The CNN Business Fear & Greed Index has only recovered to neutral. Frothy markets don’t look like this.
 

 

 

The short-term bear case

The short-term bear case rests on a combination of overbought conditions and a series of negative divergences.

If the market is exhibiting strong price momentum, it’s not showing up at the stock or sector level. The accompanying chart shows the relative performance of the top five sectors in the index comprising 75% of index weight. If overall momentum is so strong, where’s the relative momentum at the sector level? The market can’t meaningfully rise without strong relative performance from a majority of these major sectors.
 

 

The sectors that are possibly showing signs of emerging leadership are the defensive sectors. They appear to be trying to make rounded bottoms (blue lines). While the evidence isn’t definitive, some of them began to turn up in relative strength slightly before the S&P 500 began to stall (red lines).
 

 

In addition, the NYSE McClellan Oscillator reached an overbought condition and recycled downwards, which is usually interpreted as a short-term sell signal.
 

 

 

What to watch

Short-term bullish or bearish? I believe the jury is still out on that score. Here is what I am watching.
How will breadth evolve? Even as the S&P 500 stalled just below the resistance level defined by its all-time high, the equal-weighted S&P 500 broke out to an all-time high, indicating that the average stock in the index is dragging the index upwards. That’s bullish, right?

Not necessarily. The small-cap Russell 2000 is well below its all-time high and its lack of momentum is disappointing. I am waiting for greater clarity to see how breadth indicators evolve.

 

 

Other risk appetite indicators are giving off mixed signals. Even though credit market risk appetite (green line) is holding up well, equity risk appetite (red dotted line) is flashing a negative divergence.
 

 

More ominously, Bitcoin prices continue to track the relative performance of the ARK Investment ETF (ARKK), which is an indicator of speculative growth stocks. Bitcoin can also be thought of as a liquidity proxy and its downtrend is bad news for the bull camp.
 

 

Over at the bond market, yields fell when Fed Chair Powell stated in his speech Friday that it was time to cut interest rates: “The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”
 

It was a dovish speech. Powell opened the door to half-point rate cuts by raising concerns about the cooling jobs market: “We do not seek or welcome further cooling in labor market conditions.” In particular, there were no coded signals of gradualism in the pace of cuts as “gradual”, “gradualism”, “measured (pace)” were notably absent from his speech.

I have many questions. The market is discounting a 1% decline in rates until year-end and a half-point cut at one of the three remaining FOMC meetings between now and December. Notwithstanding Powell’s dovish tone, can he even manage a September rate cut without any dissents?

Are market expectations overly ambitious? Both the 10-year and 2-year rates are testing key support zones. Is this as good as it gets? Bond bulls need to push yields below the support zones to sustain a risk-on rally.
 

In summary, I can think of two scenarios for the short-term path of stock prices. The market could continue to rise, supported by positive momentum and a neutral sentiment backdrop. On the other hand, overbought readings and a lack of leadership could resolve in the typical pattern of seasonal weakness. I am waiting for greater clarity as to how market internals develop in the coming days. Even if stock prices were to pull back, it doesn’t mean that the market is on the verge of a major top. My most cautious case calls for a period of consolidation and correction until late October, followed by a rally into year-end.