Page 11 – Humble Student of the Markets

The market’s upper BB roller coaster ride

Posted by Cam Hui - January 24, 2024

Mid-week market update: The S&P 500 has been riding its upper Bollinger Band. Historically, upper BB rides haven’t been all that bearish, but the current episode is occurring against a backdrop of negative RSI divergences.

While the S&P 500 may be on an upper BB ride, it promises to be a roller coaster.

Short-term technical warnings

I am seeing other short-term technical warnings that are concerning. The NYSE McClellan Summation Index has been rolling over. What’s more, its weekly stochastic is on the verge of recycling from an overbought reading to neutral, which would be a sell signal.

The stock market advance is occurring against a backdrop of stalling bond prices and narrowing breadth. When will rising yields begin to pressure equities? Stock prices began to sell off just after today’s bond auction. What about the narrow leadership? Will a bad earnings report of the Magnificent Seven drag the market down?

The Fear & Greed Index has reached euphoric levels to be concerning. I regard this as a warning condition and not an actionable sell signal.

However, the Goldman Sachs derivatives desk estimates that momentum traders, or CTAs, are expected to sell equities in “every scenario” next week.

Putting it all together, the market has experienced setbacks whenever the upper BB ride ends. In light of the negative divergences and technical warnings, a 5-10% correction wouldn’t be an unreasonable outcome. If that were to happen, it would be an opportunity to buy the dip.

Subscribers received an email alert this morning that my inner trader had taken profits on his long S&P 500 position. The trading model reading is now neutral.

Exhausted bears, tiring bulls

Posted by Cam Hui - January 21, 2024

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 “neutral” on 28-Jul-2023)
Trading model: Bullish (Last changed from “neutral” on 17-Jan-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.

Bearish capitulation

Last week, I suggested that the current market environment “argues for a buy the dip and sell the rip posture in trading”. When the S&P 500 fell a miniscule -1.8% on an peak-to-trough intraday basis, my models were registering signs of bearish exhaustion, which was a sign to buy the dip.

How could a -1.8% intraday drawdown spark such oversold extremes? One inter-market clue came from Asia, where Chinese and Hong Kong stocks cratered on bad news out of China. The Hang Seng Index skidded -4.1% on Wednesday to a new 52-week low, and there wasn’t a single advancing issue.

Jason Goepfert of SentimenTrader found that such episodes tended to resolve bullishly. It was therefore no surprise that the Hong Kong market rebounded the next day, and so did the S&P 500.

Back in the U.S., two of the components of my bottom spotting model flashed buy signals, and a third came within a hair of one. Historically, tradable bottoms have occurred whenever two or more components registered buy signals. The bullish components are the VIX Index, which spiked about its upper Bollinger Band indicating an oversold market; the NYSE McClellan Oscillator (NYMO), which fell to oversold levels; and TRIN, which rose to 1.95 Wednesday, which was just short of the 2.0 threshold that’s indicative of price-insensitive margin clerk and risk manager induced selling.

Hopefully, you bought the dip.

Fade the rally

The S&P 500 is tracing out a strongly bullish cup and handle breakout, which is an intermediate bullish pattern, but the short-term bull case is far from clear. That’s because the index is exhibiting a severe negative divergence on its 5-week RSI as it approaches its all-time high. While this doesn’t necessarily preclude further strength, the longevity of any bull move over the next few weeks may be in doubt.

In addition to the negative RSI divergence, I am concerned about the evidence of narrowing breadth and weakening bond prices, which were correlated to stock prices for much of their recent rally.

But respect the bounce

That said, it’s too early to short the market. Bears should respect the momentum of the price bounce. The NYSE McClellan Oscillator (NYMO) recycled from an oversold condition. Past episodes have seen NYMO recover to at least neutral before the relief rally petered out. While this is only a guesstimate, a typical bounce could see the S&P 500 reach slightly above 4900 before topping out.

As well, the Fear & Greed Index is elevated but not extreme, indicating further upside potential.

I remain long-term bullish. The monthly MACD of the NYSE Composite turned positive, which is a buy signal with a strong track record.

Sources of risk

Investors face several sources of risk in the coming weeks. Fed Governor Christopher Waller virtually single-handedly pushed back against market expectations of a March rate cut. Waller made it clear that while rate cuts are coming into view, market expectations of the timing and pace of rate cuts are overdone.

Recent Fed decisions have shown themselves to follow market expectations. If policymakers disagree with the market consensus, it has shown a pattern of coordinated speeches from Fed speakers to correct the market’s views. Already, the odds of a March cut fell from over 70% to about 55% today and the consensus timing of a first cut has been delayed to May.

As the Fed has entered the blackout period before the next FOMC meeting, investors won’t get any more official guidance until the meeting on January 31. However, the Fed could give unofficial guidance through leaks to the press if it felt that expectations are too out of line with its likely policy path.

As well, the coming two weeks will see the heaviest pace of company reports from Q4 earnings season. Investors face a higher than usual risk of earnings disappointment, as the pace of negative EPS guidance is elevated compared to historical averages.

In particular, most of the megacap growth stocks, which are mostly in the technology sector, are reporting in the coming two weeks. The risk is most of the negative guidance is coming from the technology sector.

The recent advance was driven almost entirely by P/E expansion of valuation that’s above its 5- and 10-year averages. The S&P 500 forward P/E ratio stands at 19.5. Earnings expectations need to grow in order for this rally to continue.

In conclusion, I believe that short-term outlook for stock prices may be limited, though I am bullish longer term. While the bulls may have temporarily gained the upper hand, many risks remain. The recent episode of price weakness was relatively shallow, and I don’t expect any change. Traders should continue to adopt a strategy of buying the dips and selling the rips.

My inner investor is bullishly positioned. My inner trader went long the S&P 500 last Wednesday but he has his finger on the sell button. The usual disclaimers apply to my trading positions.

I would like to add a note about the disclosure of my trading account after discussions with some readers. I disclose the direction of my trading exposure to indicate any potential conflicts. I use leveraged ETFs because the account is a tax-deferred account that does not allow margin trading and my degree of exposure is a relatively small percentage of the account. It emphatically does not represent an endorsement that you should follow my use of these products to trade their own account. Leverage ETFs have a known decay problem that don’t make the suitable for anything other than short-term trading. You have to determine and be responsible for your own risk tolerance and pain thresholds. Your own mileage will and should vary.

Disclosure: Long SPXL

At least 29 reasons to be bullish

Posted by Cam Hui - January 20, 2024

Exhibitions of powerful price momentum are rare. Since the market bottom in 2002, there have been eight occasions when the percentage of S&P 500 above their 50 dma has surged from below 15% to over 90% in a brief period. That latest episode occurred when stock prices soared off the bottom in October 2023. These price surges were usually resolved in either a short-term consolidation or setback, but the S&P 500 was invariably higher a year later with a 100% success rate.

I conducted a bottom-up scan of stock charts to look for technical uptrends and strong breakout formations. The scan isn’t meant to create a complete list of stocks with bullish technical outlooks.

My evaluation framework is based on two components: the simple analysis of a weekly chart of the stock in the top panel, and the relative performance of the stock against the S&P 500 in the bottom panel. U chose the weekly chart as a way of filtering out the noise from daily price movements and better show the intermediate price trend. Ideally, both should be either in uptrends or breaking out on both an absolute and relative basis.

I found at least 29 charts with bullish technical patterns, none of which should be considered to be buy recommendations without further individual fundamental due diligence. Taken together, I came away with a stronger conviction of intermediate bullishness for the stock market, sector and industries. As well, this bottom-up analysis also pointed to bullish macro conclusions about the economy.

The Magnificent Seven

No bottom-up technical scan of chart patterns would be complete without the analysis of the Magnificent Seven. I found that most of these stocks exhibited bullish patterns.
The star of the Magnificent Seven has to be NVIDIA (NVDA), which is in a well-defined uptrend and broke out to fresh all-time highs as investors have bid up the share price over the promise of AI-related demand for the company’s chips. As well, the stock staged double relative breakouts to new relative highs.

Close behind NVIDIA is Microsoft (MSFT), which is in both an absolute and relative uptrend.

While it is not in an uptrend, Meta Platforms (META) is a stock that’s exhibiting what will be a recognizable breakout from a long multi-month base, both on an absolute and relative basis.

The chart pattern of Amazon.com (AMZN) is less bullish, but nevertheless promising. The stock staged an upside breakout from a long base, but we have seen no relative breakout just yet.

Alphabet (GOOG, GOOGL) hasn’t staged upside breakouts just yet, but it is also testing resistance while exhibiting the now familiar saucer-shaped base.

One laggard within the Magnificent Seven is Apple (AAPL). The stock staged an upside absolute breakout, but it’s trading under a key relative resistance level.

The worst chart of Magnificent Seven stocks is Tesla (TSLA), which struggled because of concerns over its China exposure.

The latest BoA Global Manager Survey showed that institutions believe long Magnificent Seven is the most crowded trade. While the trade may be crowded, megacap growth stocks may have further potential to run. The normalized relative returns of the NASDAQ 100 (black line) is only in the middle of its 12-month range. I interpret this to mean that AI-related excitement could drive these stocks much further than many people might expect.

Technology winners

In general, the technical scan has thrown off numerous bullish patterns in the technology sector. In particular, the semiconductor stocks have been standouts, starting with Broadcom (AVGO), which is in a well-defined absolute and relative uptrend.

Here is Lam Research (LRCX), which staged upside absolute and relative breakouts of saucer-shaped bases.

An honourable mention goes to Advanced Micro Devices (AMD), whose chart is not shown. AMD is testing absolute and relative resistance levels out of multi-month bases.

Nutanix (NTNX) also staged an absolute and relative breakout out of multi-month bases.

Qualys (QLYS) staged a definitive upside breakout on an absolute basis. However, it has pulled back from its relative breakout level and it’s re-testing a key resistance level (bottom panel).

Other technology stocks of note include Salesforce.com (CRM), which staged an absolute breakout, but remains below its relative breakout level.

Guidewire Software (GWRE), has a similar technical pattern of upside breakouts through absolute and relative resistance levels.

Shopify (SHOP) has also staged absolute and relative breakouts from long bases.

Lastly, here is Affirm Holdings (AFRM) within the technology sector, which staged an absolute breakout, but remains below its relative breakout level.

A strong consumer

I also found numerous technically strong stock patterns in the consumer discretionary sector, which is the sign of a strong consumer. In particular, selected apparel and footwear stocks have gone bonkers.

Abercrombie & Fitch (ANF) is in a well-defined absolute and relative uptrend.

Decker Outdoor (DECK) is exhibiting a similar absolute and relative uptrend.

An honourable mention whose chart is not shown goes to lululemon (LULU), which staged an absolute upside breakout through resistance but pulled back.

Booking Holdings (BKNG), a travel stock, is also in an absolute and relative uptrend.

Expedia (EXPE) has staged upside breakouts on an absolute and relative bases out of long bases.

These are all signs of a healthy consumer. Costco (COST) has staged an upside and relative breakout to an all-time high. While Walmart (WMT), whose chart is not shown, did breakout on an absolute basis, its relative performance is not as strong.

Important cyclical winners

My technical scan also revealed strength in important cyclicals such as housing. DR Horton (DHI), a homebuilding stock, is in an absolute and relative uptrend.

A similar price pattern can be seen in Toll Brothers (TOL), though the stock has pulled back and consolidated its gains in the past few weeks.

Price strength isn’t just confined to homebuilding stocks. Boise Cascade (BCC), a supplier of building products, has also broken out to all-time highs on an absolute and relative basis.

TopBuild (BLD) is also exhibiting a similar pattern of strong absolute and relative breakouts.

Among the cyclically sensitive industrial stocks, General Electric (GE) staged upside absolute and relative breakouts out of multi-month bases. The chart pattern that differs industrials from other bullish patterns is the breakout occurred in early 2023, which was earlier than the others that I highlighted in this publication.

Caterpillar (CAT), another globally sensitive industrial stock, staged a similar upside in early 2023, but chopped sideways since the breakout. This is nevertheless a constructive pattern.

Fastenal (FAST) is a useful industrial bellwether as it’s a distributor of industrial and construction supplies. The stock broke out of a long base in late 2023 and soared last week after its earnings report.

Among the banks, which are also cyclically sensitive, JPMorgan Chase (JPM) is a standout. It staged an absolute breakout in late 2023 out of multi-month bases to an all-time high, though the relative breakout, which occurred at the same time, exhibited less strength.

By contrast, most of the bank stocks skidded badly at the time of the Silicon Valley Bank debacle, but retained their support levels in December 2023.

Special situations

My technical scan is not meant to be comprehensive and I apologize if I missed your favourite stock. It was meant to be a bottom-up technical review to highlight sector and industry strength. With that caveat in mind, I would be remiss if I didn’t point out the strength in a couple of special situations in outlier industries.

The first is Eli Lilly (LLY), whose stock price has gone from strength to more strength over investor excitement about the promise of weight loss drugs.

The absence of healthcare stocks in my technical scan was a bit of a puzzle in light of the sector’s constructive relative bottom pattern and improving relative breadth (bottom two panels). However, a bottom-up review of the technical pattern of the heavyweights in the sector shows that much of the sector’s strength can be attributed to LLY.

The other special situation stock to highlight is the strength in uranium producer Cameco (CCJ), which is in strong absolute and relative uptrends because of renewed enthusiasm over nuclear power. The strength in CCJ is occurring in spite of the weakness in materials stocks, which is a reminder that the specific fundamentals of any company can overwhelm the price factors that influence its sector and industry.

In conclusion, a bottom-up driven scan of stock charts shows numerous stocks with bullish technical patterns consisting of uptrends or breakouts from multi-month bases with strong potential upsides. Bullish patterns are broadly based, primarily concentrated in technology and cyclicals, which argue for a continuation of the AI-related bull and an economic rebound. This bottom-up analysis also pointed to bullish macro conclusions about the economy.

Why this should be a shallow correction

Posted by Cam Hui - January 17, 2024

Mid-week market update: I had been expecting a choppy January for stock prices, and current market action has not disappointed. Investors came into 2024 all bulled up, but rising rates eventually spooked stock prices. It all came to a head with Fed Governor Waller’s speech, in which he stated that the Fed is pivoting to an easing cycle, but the market expectations may have gotten ahead of themselves.

The S&P 500 has weakened into a support zone, while the 10-year Treasury yield is nearing a resistance zone.

Here are some reasons why I believe that the market will experience a shallow correction.

Bottoming signals

I had written that one of the conditions for a market bottom would see breadth, as measured by new highs-new lows, turn negative. They finally turned negative yesterday (Tuesday).

As well, two components of my Bottom Spotting Model have flashed buy signals. The VIX Index spiked about its upper Bollinger Band, and the NYSE McClellan Oscillator (NYMO) has fallen into oversold territory. Historically, the market has bottomed soon after two or more components flashed buy signals.

Independent from my analysis, Rob Hanna at Quantifiable Edges tweeted that his Capitulative Breadth Indicator (CBI) reached 11 yesterday, which is above the threshold of 10 for a buy signal. I would expect that today’s market weakness would push CBI even higher into buy territory.

Putting it all together, the latest bond market tantrum has rattled investors and sparked a risk-off episode. Short-term bearish psychology looks overdone and stock prices are poised for a bounce. The narrative is likely to turn from a focus on top-down macro conditions to the results of earnings season, which will begin in earnest next week.

Subscribers received an email alert that my inner trader had entered the market on the long side. I expect that this will be a short-term trade that lasts no more than one or two weeks. The usual disclaimers apply to my trading positions.

I would like to add a note about the disclosure of my trading account after discussions with some readers. I disclose the direction of my trading exposure to indicate any potential conflicts. I use leveraged ETFs because the account is a tax-deferred account that does not allow margin trading and my degree of exposure is a relatively small percentage of the account. It emphatically does not represent an endorsement that you should follow my use of these products to trade their own account. Leverage ETFs have a known decay problem that don’t make the suitable for anything other than short-term trading. You have to determine and be responsible for your own risk tolerance and pain thresholds. Your own mileage will and should vary.

A system glitch may have caused some subscribers to be unsubscribed from the email notification list. If you did, you would have received an email notification. Please click the link to re-subscribe. I apologize for any inconvenience.

Disclosure: Long SPXL

Beware of the riptide market

Posted by Cam Hui - January 14, 2024

Preface: Explaining our market timing models

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 “neutral” on 28-Jul-2023)
Trading model: Neutral (Last changed from “bullish” on 02-Jan-2024)

Subscribers can access the latest signal in real time here.

As good as it gets?

As the S&P 500 tests overhead resistance at its all-time high after staging a cup and handle upside breakout, it’s experiencing negative 5-week RSI divergences that have the fingerprints of a near-term top. Is this as good as it gets, at least for now?

Technical warnings

Numerous short-term technical warnings are appearing. Market breadth, which started broadening out in November, began to roll over into narrow leadership starting in mid-December.

Megacap NASDAQ leadership has recovered and it has especially been in evident in 2024. Viewed in isolation, narrow leadership isn’t a concern. But relative breadth indicators (bottom two panels) are in decline, which is a bearish warning.

Here is the good news and bad news on breadth. The good news is net new highs are still positive, which is a constructive sign. The bad news is the market has been deprived of positive price momentum, as evidenced by negative RSI divergences. Under such circumstances, the consolidation and corrective period is unlikely to end until net new highs turn negative.

Sources of volatility

Here is what the market is worried about for the remainder of January. The first and most immediate source of volatility is the results of the Taiwan election. Lai Ching-te, whose Democratic Progressive Party (DPP) is known to favour Taiwanese independence, has won the Presidency. However, the win wasn’t a resounding one, as the DPP has lost its majority in the legislature and any major initiatives may be challenging for the new President. Nevertheless, his win is certain to force China to react in some forceful way. While the odds of an immediate invasion is low, a show of force similar to the one in reaction to the visit by then House Speaker Nancy Pelosi could rattle markets.

Bloomberg Economics estimated that a China invasion of Taiwan would cost the world economy $10 trillion, which is about 10% of global GDP and far greater than the blow of the Ukraine war, COVID Crash and the GFC.

As well, the stock market is entering Q4 earnings season. Forward 12-month EPS estimates are rising going into earnings season and it’s best to keep an eye on how this evolves. The S&P 500 is trading at a forward P/E of 19.5, which is above its 5-year average of 18.9 and 10-year average of 17.6. Any negative surprises at elevated valuation levels could mean a disorderly shock to stock prices.

As well, the Quarterly Refunding Announcement (QRA) at the end of January could be a source of volatility. The last QRA sparked a global bond market rally when the U.S. Treasury announced that it was conducting most of its borrowings in short-dated paper, which alleviated the supply pressure on coupon-bearing bonds. What will Treasury do this time?

A pause in an uptrend

In conclusion, I reiterate my view that the stock market is undergoing a temporary pause in an uptrend. In the past, exhibitions of strong price momentum as measured by the percentage of S&P 500 above their 50 dma rising from below 20% to 90% have been long-term bullish. However, such episodes have also resolved in short-term consolidations or corrections.

The short-term outlook can be characterized as a riptide market. Everything looks good, but risks are lurking beneath the surface, namely negative technical warnings and several sources of volatility. Expect the rest of January to be choppy to down, which argues for a buy the dip and sell the rip posture in trading.

I don’t expect any corrective action to be too deep. Sentiment readings from the option market are cautious. In particular, the equity-only put/call ratio is approaching levels consistent with trading bottoms.

Don’t fight the Fed (or the macro trend)

Posted by Cam Hui - January 13, 2024

As the 10-year Treasury yield flirts with the 4% level and the yield curve steepens from its inverted condition, it’s worthwhile to keep in mind that the universe is unfolding as it should. Monetary conditions are tight, inflation is moderating, the jobs market, though tight, is weakening, and the economy is chugging along with no signs of a recession. Various Fed speakers have cautioned that while the inflation fight isn’t finished, the hiking cycle is over and the next likely interest rate move is down.

These conditions argue for a bull steepening of the yield curve, where bond yields fall while the curve steepens, and a conducive environment for stock prices. Why fight the Fed and the macro trend?

A dovish macro backdrop

Make no mistake, conditions are ripe for rate cuts, but in a good way. The Fed has engineered a skillful tightening cycle. The Fed Funds rate is well above the inflation rate. Falling inflation has done the heavy lifting in monetary tightening. As CPI falls, the real Fed Funds rate rises. At some point in the near future, the nominal Fed Funds rate will have to fall in order to avoid overtightening.

In addition, inflation data is trending in the right direction toward the Fed’s 2% target. December headline CPI came in ahead of expectations, but core CPI was in line. Even though core CPI rose 0.3%, only 42% of the CPI basket saw monthly gains of 0.2% or more. The combination of the CPI and tamer-than-expected PPI translates into the Fed’s preferred inflation metric of core PCE of 0.2% in December, which smooths the path to rate cuts.

Moreover, the New York Fed’s survey of consumer inflation expectations is back to pre-pandemic levels. One-year inflation is expected to rise 3.0, and 2.6% over three years, compared to 5% and 3%, respectively, one year ago.

The employment situation has seen frequent negative revisions to past nonfarm payroll releases. This is an indication of a jobs market that’s weaker beneath the surface.

A dovish Fed

As a consequence of the friendly inflation environment, Fed speakers have become increasingly dovish.

Fed Governor Michelle Bowman, who is regarded as a hawk, said that in a speech that her “view has evolved to consider the possibility that the rate of inflation could decline further with the policy rate held at the current level for some time. Should inflation continue to fall closer to our 2 percent goal over time, it will eventually become appropriate to begin the process of lowering our policy rate to prevent policy from becoming overly restrictive.”

New York Fed President John Williams used his now familiar metaphor of an onion to describe inflation in a recent speech. Inflation has three layers. The first represents globally traded commodities, which “have come down significantly from their peak levels” after the pandemic and Russo-Ukraine war related disruptions. The second layer is core goods, or goods ex-food and energy, whose inflation rate has “dropped to nearly zero”. The third and last layer, core services inflation, “has come down after peaking early last year”. Equally important is the progress on core services excluding housing inflation, which “has also slowed considerably”. He concluded that “it will only be appropriate to dial back the degree of policy restraint when we are confident that inflation is moving toward 2 percent on a sustained basis”.

Dallas Fed President Lorie Logan took a more hawkish note by expressing concern about markets getting ahead of the Fed on rate cut expectations: “We can’t count on sustaining price stability if we don’t maintain sufficiently restrictive financial conditions.”

However, she sounded a word of warning about the liquidity plumbing of the banking system as the overnight reverse repo account ON RPP falls rapidly [emphasis added].

Given the rapid decline of the ON RRP, I think it’s appropriate to consider the parameters that will guide a decision to slow the runoff of our assets. In my view, we should slow the pace of run-off as ON RRP balances approach a low level. Normalizing the balance sheet more slowly can actually help get to a more efficient balance sheet in the long run by smoothing redistribution and reducing the likelihood that we’d have to stop prematurely.

As a reminder, banking system liquidity is approximated the size of the Fed’s balance sheet – ON RRP – the Treasury General Account. All else being equal, a falling ON RRP increases banking liquidity. If ON RRP falls to zero, Logan is proposing tapering quantitative tightening, or the reduction in the Fed’s balance sheet, to compensate. QT is turning into QE. Logan’s words about the Fed’s balance sheet carries extra weight as she was the former head of the New York Fed’s trading desk. In the wake of Logan’s speech, market expectations are building that the Fed will begin to taper QT mid-year.The Fed is turning dovish. The market continues to expect a rate cut at the March FOMC meeting. The Fed hates surprising the markets. Unless Fed speakers push back strongly against the notion of a March rate cut and expectations of a cut stay above the 60–65% level, a March cut will be a done deal.

Don’t fight the Fed and the macro trend.

Key risk: Transitory disinflation

However, I continue to be concerned about the risk of transitory disinflation to the dovish Fed scenario. The New York Fed’s Global Supply Chain Pressure Index is rising again, indicating that progress in goods inflation is over. Is this just normalization or something more ominous?

Red Sea related disruptions are showing up in global shipping costs. While readings are nowhere near pandemic levels, it’s a lesson how global shocks can disrupt progress on inflation.

The Atlanta Fed’s wage growth tracker came in at 5.2% in December – and it’s been stuck at that level for three consecutive months. Even though there is growing evidence of a cooling jobs market, wage pressures aren’t falling.

In conclusion, the global disinflation trend is continuing in an uneven manner and both the macro trend and Fed speakers are pointing toward a dovish Fed pivot. This argues for a bull steepening of the yield curve and a bullish backdrop for stock prices. However, investors should be aware that the lurking risk is the re-emergence of the transitory disinflation narrative, which could derail the bullish scenario.

A time for patience

Posted by Cam Hui - January 10, 2024

Mid-week market update: There is a time for an aggressive posture in positioning and there is a time for patience. This is a time for investors to be patient.

In the aftermath of the rally off the October bottom, the S&P 500 is consolidating its gains after breaking out through resistance at 4600 to form a cup and handle breakout. However, it was rejected at all-time high resistance and it’s now working off an overbought condition, as evidenced by the 5-week RSI. The VVIX to VIX ratio, which has led past tactical peaks in stock prices, peaked out just before the January highs, but the lack of a negative divergence in this ratio is constructive inasmuch as this is not a signal of a major top. I interpret current conditions as a consolidation within an uptrend.

An extended condition

Short-term sentiment readings tell the story of an extended position. The Commitment of Traders report show that asset manager and leveraged funds are in a crowded long in equities.

As well, SentimenTrader reported that their “dumb money confidence” indicator surged to one of its highest historical levels in late December but plummeted by 10% in a week. These conditions argue for a short-term bounce, but the market may need to chop further in order for sentiment to normalize.

Indeed, Rob Hanna at Quantifiable Edges revealed that his Quantifiable Edges Capitulative Breadth Indicator (CBI) rose above 10 to 11 on Friday, which is a tactical buy signal. He went on report that CBI fell to 2 on Tuesday, which “essentially ending the short-term bullish indication that triggered on Friday”.

I agree. The VIX Index spiked above its upper Bollinger Band, which is a short-term oversold signal for stock prices, but recycled back to its 20 dma Tuesday, which is a take profits signal if you had bought on the oversold reading.

Focus on leadership

During such choppy periods, it’s useful to focus on the evolution of market leadership. Market breadth had been broadening out, but narrowed again since 2024 began and large cap growth stocks have led again.

The renewal of large cap growth leadership appears to be a counter-trend rally. Investors seeking better returns in a sideways market may be better served by looking for outperformance opportunities in a volatile market. We will have the all-important CPI report tomorrow morning, and Q4 earnings season is just starting.

I can think of two sources of opportunity. One is the financial sector, which is turning up on in relative performance.

The other sector is healthcare. While these stocks are extended in the short run, they are becoming another source of emerging leadership and likely superior relative returns. Consider taking positions on a pullback.

A pause that refreshes the uptrend

Posted by Cam Hui - January 7, 2024

Preface: Explaining our market timing models

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 “neutral” on 28-Jul-2023)
Trading model: Neutral (Last changed from “bullish” on 02-Jan-2024)

Subscribers can access the latest signal in real time here.

A pause in momentum

Call it what you want. A breadth thrust. A momentum surge. The percentage of S&P 500 stocks surged from below 20% to over 90% in a brief two months. In the past, such episodes have usually signaled the start of bull markets. At the same time, these overbought conditions have also resolved in short-term periods of consolidation or pullbacks.

The case for a pause

The case for a pause in the uptrend is building. One factor is the failure of the Santa Clause rally, which occurs during the window starting five days before Christmas and ends two days into the new year. Historically, when the stock market fails to exhibit a positive return during this period, it portends poor returns for the rest of the year. That’s why the late Yale Hirsch coined the expression, “If Santa should fail to call, bears may come to Broad and Wall”.

While I don’t put much stock in short-run patterns as predictors of stock market returns, there are a sufficient number of traders who follow such patterns. Ryan Detrick compiled past instances of Santa rally failures and found that they were usually followed by weak returns in January, along with subpar returns in Q1 and the rest of the year.

The current episode has also been characterized by a form of momentum failure. Stocks that had been the price momentum leaders have plummeted, as shown by the relative returns of the different price momentum ETFs. I interpret this as a sign of price exhaustion as past winners can’t sustain further upside, which is another indication that a period of consolidation and pullback is ahead.

Another headwind that the stock market faces is a decline in liquidity. In the past, financial system liquidity (blue line) has been correlated with the S&P 500 (red line).

As well, FactSet reported that Street analysts are cutting Q4 EPS estimates at a higher than average rate.

Too late to short

Tactically, it’s probably too late for traders to initiate a short position in the market. The usually reliable S&P 500 Intermediate Term Breadth Momentum Oscillator flashed a sell signal last week when its 14-day RSI recycled from overbought to neutral. However, it may be too late to short the market as the NYSE McClellan Oscillator (NYMO, bottom panel) has already fallen below the zero neutral level, which is an indication of limited downside potential.

In addition, the VIX Index spiked above its upper Bollinger Band last week, which is a short-term signal of an oversold market. While these conditions don’t constitute trading buy signals, they nevertheless indicate limited downside risk in the short run.

A three black crows market

In summary, current market conditions can be summarized by the “three black crows” candlestick pattern shown by QQQ. According to Investopedia, the three black crows pattern “consists of three consecutive long-bodied candlesticks that have opened within the real body of the previous candle and closed lower than the previous candle”, and it is indicative of a bearish trend reversal. However, the market is already oversold based on the 5-day RSI, indicating probable limited downside risk.

In conclusion, the stock market is poised for a period of consolidation or pullback after a powerful breadth thrust. I remain bullish on equities as such episodes of strong price momentum have usually led to higher prices 6–12 months ahead. In the short term, I advise against traders trying to short this market as downside risk is probably limited.

Instead, this should be regarded as a buy the dip and sell the rips choppy environment. Investment oriented accounts can consider utilizing such a strategy to enhance returns around a core set of holdings.

What the politics of 2024 tell us about 2025

Posted by Cam Hui - December 30, 2023

I am not fond of the ritual of “year ahead” forecasts. Street strategists’ forecasts are far more dispersed compared to past years. The 2024 year-end target for the S&P 500 varies from 4200 to 5200.

So let’s make this brief. Analysis from Ryan Detrick of Carson Group shows that the S&P 500 rises an average of 12.2% in an election under a new president. That sounds about right in light of the recent Zweig Breadth Thrust buy signal from early November.

Instead, I would like to offer a different kind of “year ahead” analysis. What does the political and economic landscape of 2024 mean for investors in 2025?

The Fed’s balancing act

One of the key questions for investors in 2024 is the direction of monetary policy. The Fed has already signaled that it plans to pause rate hikes, but when does it cut?

The market became very excited with Fed Governor Christopher Waller’s dovish pivot when he addressed the question of rate cuts: “If you see this [lower] inflation continuing for several more months, I don’t know how long that might be—three months? four months? five months? You could then start lowering the policy rate because inflation’s lower.”

Waller’s remarks shouldn’t have been a surprise. Fed Chair Jerome Powell said the same thing at the July post-FOMC press conference [emphasis added]:

So if we see inflation coming down credibly, sustainably, then we don’t need to be at a restrictive level anymore. We can, you know, we can move back to a—to a neutral level and then below a neutral level at a certain point. I think we would, you know, we would—we, of course, would be very careful about that. We’d really want to be sure that inflation is coming down in a sustainable level. And it’s hard to make—I’m not going to try to make a numerical assessment of when and where that would be. But that’s the way I would think about it, is you’d start—you’d stop raising long before you got to 2 percent inflation, and you’d start cutting before you got to 2 percent inflation, too, because we don’t see ourselves getting to 2 percent inflation until—you know, all the way back to 2—until 2025 or so.

There was some confusion after the December FOMC meeting. The Summary of Economic Projections, or “dot plot”, projected three quarter-point rate cuts in 2024 and Powell mentioned the Committee talked about rate cuts. On the other hand, New York Fed President John Williams appeared to walk back market expectations in a CNBC interview the following week by stating, “We aren’t really talking about rate cuts right now.”

Here’s the real story. First, Powell said during the press conference that policy is restrictive, “Our actions have moved our policy rate well into restrictive territory.” However, the FOMC was only discussing rate cuts in an informal and preliminary way. Rate cut decisions were not on the active formal agenda:

So it comes up in this way today. Everybody wrote down an SEP forecast. So many people mentioned what their rate forecast was, and there was no back and forth, no attempt to sort of reach agreement, like this is what I wrote down, this is what I think, that kind of thing. And a preliminary kind of discussion like that, not everybody did that, but many people did. And then, and I would say there’s a general expectation that this will be a topic for us looking ahead. That’s really what happened in today’s meeting.

Regardless of whether there was any formal discussion of rate cuts, it is becoming evident that disinflation is gaining the upper hand. As inflation decelerates, the Fed will need to lower nominal rates so that real rates stay steady. As monetary policy operates with a lag, Fed officials will also have to pre-emptively ease policy as inflation approaches its 2% target in order to avoid excessive tightness that plunges the economy into recession.As a consequence, the market is therefore discounting a series of rate cuts that begin in March.

I think that such an aggressive schedule of rate cuts is an unrealistic expectation. I differ from the consensus with the timing of the initial rate cuts as I believe it would be reasonable for the Fed to begin cutting in Q1 or Q2. I just don’t believe the Fed will cut in the second half of 2024, which is an election year.

Fed officials don’t want to be seen as partisan in an election year. If a case for cuts can be made because of rising real rates, the cuts will have to occur in the first half. In a crisis, the Fed can take other steps to support the economy, which translates into the return of a Fed Put.

As an example, the reverse repo account (RRP) has been steadily shrinking and has been providing liquidity to the financial system. Should a crisis erupt and RRP levels are too low, which threaten the level of banking reserves, the Fed could inject liquidity into the system by halting the shrinkage of its balance sheet (QT).

In summary, the Fed has to walk a fine line between its dual mandate of price stability and full employment, as well as its unspoken mandate of financial stability and its political neutrality.

Biden’s polling problem

Here is where the economic rubber meets the political road in 2024. Political polls have consistently shown that President Joe Biden trails the Republican frontrunner, Donald Trump.

Second-term elections are usually a referendum on the incumbent’s performance. In effect, voters are asking the question that Ronald Reagan asked in 1984 in his re-election campaign, “Are you better off than you were four years ago?” If so, let’s have more of the same.

Even as the hard data shows that the economy is improving, soft sentiment data is weak, which spells trouble for the incumbent. The U.S. is unique among other advanced economies in this divergence.

When questioned about the specifics of consumer sentiment, a partisan divide in opinion becomes very evident.

A similar divide can also be seen in the opinion of small business owners, who lean small-c conservative. But that’s not the entire story.

A New York Times poll of swing state voters shows widespread economic dissatisfaction among Biden supporters.

The question is why, and the answer could determine the results of the election in November.

The answer is a combination of inflation and the pandemic. Even though inflation has been decelerating, the inhabitants of Main Street aren’t the economic nerds on Wall Street. Bloomberg recently documented how much different price categories have risen since 2020, from energy, housing, groceries and other major household costs. Is it any wonder why the electorate is dissatisfied?

To be sure, incomes have kept pace with inflation, but perceptions have also suffered from households anchoring on the recent past. The accompanying graph shows the progress of real incomes, normalized to January 2019 at 100 (red line), which has been rising unevenly since Biden took office. However, real income with government transfers (blue line), which include all the COVID stimulus, spiked in 2021 when Biden took office but it’s fallen since then. The expiry of those payments, along with the additional burden of student loan payments, has made many householders feel poorer.

In summary, New Deal democrat discussed Biden’s political problem in a blog post on November 13, 2023. He concluded, “History shows that voters generally focus on the economy for the last 6 to 9 months before the election…If we get better news on inflation and interest rates next year, Biden will be in much better shape.” Much will depend on whether the Powell Fed achieves a soft landing of the economy in 2024.

In the end, all this hand wringing over consumer sentiment might be nothing. The University of Michigan Consumer Sentiment Index has begun to recover. Similarly, the Conference Board’s December Consumer Confidence showed a similar level of recovery.

Peering into 2025

What happens after the election? As much can happen between now and the election, here is a preliminary look at what 2025 might look like under a Biden administration and a Trump administration.

A Biden White House is more predictable using conventional economic analysis, so let’s start there. Much depends on whether the Fed can achieve a soft landing of the economy. Assuming there is no recession, the economy should continue to expand in 2025, which should be positive for stock prices.

The non-partisan Congressional Budget Office estimated that the economy can grow at 2.6% between 2022 and 2026. One driver of growth is growth in the labour force, which will be a function of the hot-button issue of immigration.

But most of the growth will be a function of productivity improvement. The CBO estimate is 1.6% and the recent surge in labour productivity is promising. In addition, the CBO estimate did not include any productivity gains from the implementation of AI, which has the potential to be a productivity game-changer.

The effects of a Trump administration are more difficult to forecast. Here are the bull and bear cases.

Let’s start with the bear case. The Trump team is known to be assembling an extensive list of potential hires in order to implement its policies so that a second Trump term would not be as chaotic as the first one. During his first term, it was felt that many of Trump’s initiatives were being stonewalled by the civil service, otherwise known as the Deep State, and a more committed group of adherents would affect Trump’s plans without interference. The Heritage Foundation’s Project 2025 is one of the most intensive screens of potential personnel based on ideological beliefs. While Wall Street is likely to be agnostic about changes in government personnel, it might not be rattled if Trump were to extend his reach into the Federal Reserve.

However, the biggest risks for asset returns under a Trump administration will be the effects of foreign policy.

Trade War: Trump has proposed an across-the-board tariff of 10% on all imports. Global trade would collapse under such a scenario. Any re-shoring initiatives will be slow (see TSMC in Arizona). More importantly, re-shoring will be hampered by the disappearance of local supply chains.
Ukraine: Trump has shown himself to be highly transactional in his foreign policy dealings. He has shown antipathy to NATO and he is unlikely to continue to support Ukraine in its war (see NY Times article). A Russian victory would create a refugee crisis in Europe as Ukrainians flee into the EU that collapses the European economy (see Bloomberg article outlining U.S. allies’ fears). In addition, the growing power of anti-EU and pro-Russia elements in Europe, such as Geert Wilders of PVV in the Netherlands, Marine LePen in France, AfD in Germany, Viktor Orbán in Hungary, and the new pro-Moscow government in Slovakia, have the potential to unravel the European Project.
The End of Pax Americana: Trump’s transactional approach to foreign policy will mean the end of Pax Americana and U.S. leadership. Devoid of the protection of the U.S. nuclear umbrella, Trump’s approach incentivizes G7 allies like Germany, Italy, Japan, as well as countries like South Korea and Saudi Arabia to consider the acquisition of nuclear weapons. The world will become far more multi-polar and unstable.
Invasion of Mexico: Trump, along with a number of other Republicans, have proposed an invasion of Mexico to deal with the drug cartels in the past. The U.S. military hasn’t had a strong counterinsurgency track record and an invasion has the potential to create a Vietnam-style quagmire on America’s doorstep. It would be an enormous drain on the federal budget and a shock to Wall Street.

Here is the bull case for asset prices under Trump:

Tax Cuts: Trump is a Republican, and Republicans enact tax cuts. All else being equal, tax cuts are bullish for stock prices.
An Everything Bubble: The potential for a significant decline in the USD is very real. But a collapse in the USD could spark an Everything Bubble like 2020–2021 that turbocharges tax receipts and asset prices.

In short, the effects of a Trump White House will be more difficult to predict. The only certain investment bet under a Trump administration may be to buy volatility.

Short-term technical warnings

Bearish capitulation

Fade the rally

But respect the bounce

Sources of risk

The Magnificent Seven

Technology winners

A strong consumer

Important cyclical winners

Special situations

Bottoming signals

As good as it gets?

Technical warnings

Sources of volatility

A pause in an uptrend

A dovish macro backdrop

A dovish Fed

Key risk: Transitory disinflation

An extended condition

Focus on leadership

A pause in momentum

The case for a pause

Too late to short

A three black crows market

Growth or Value?

Transitory disinflation?

Short-term caution

A decelerating economy

A revived bull

Election year seasonality

The risk of transitory disinflation

My 2023 report card

The week ahead

The Fed’s balancing act

Biden’s polling problem

Peering into 2025

A temporary blip

Short-term outlook

The challenges of 2024

Soft landing ahead

Key risks

Respect the breadth thrust

Santa rally ahead

Too early to short

A frothy Christmas

Bearish tripwires

Still bullish

Blowoff top ahead?

A possible Gamestop style risk scramble

Inevitable dovishness

A focus of financials

A soft landing

A positive reaction

A healthy consolidation

Bullish liquidity sparks animal spirits

Supportive positioning

No bull market without bulls

Supportive intermarket signals

Event risks ahead

Prepare for year-end seasonality

All systems green

The bulls’ challenge