The bulls cross their fingers for January

Posted by Cam Hui -

Mid-week market update: The bulls are nervously getting ready for a party. Jeff Hirsch of Almanac Trader pointed out that two of his January indicators are positive. When all three are positive, the rest of the year tends to lean bullish. 
 

This year, the market has eked out a 0.8% gain for its Santa Claus rally. The returns in the first five days has been positive. The only indicator left is a positive return for the month of January.

 

 

Will the bulls succeed? Here are the challenges they face.

 

 

An extended advance

From a technical perspective, the S&P 500 is nearing resistance while exhibiting overbought readings. It’s already broken out through resistance at about 3950, with secondary and strong resistance at the falling trend line at about 4000.

 

 

In addition, the market is overbought according to the NYSE McClellan Oscillator (NYMO) and the NASDAQ McClellan Oscillator (NAMO). While overbought markets can become more overbought, the odds favor a pullback from here.

 

 

I issued a tactical sell signal on Monday morning based on the percentage of S&P 500 stocks above their 20 dma becoming overbought. The market weakened after I issued that warning and the indicator closed in neutral territory and negated the sell signal. This indicator rose back to an overbought condition today as the market advanced today. We have a bona fide tactical sell signal based on closing prices. Please note, however, that this sell signal is a “take profits on long positions” signal and it is emphatically not a short sale signal.

 

 

 

The CPI wildcard

BLS will report the December CPI tomorrow morning and the report has the potential to be the source of significant volatility. Market expectations call for monthly headline CPI to come in at 0.0% and core CPI at 0.3%.

 

 

By contrast, the Cleveland Fed’s inflation nowcast is showing headline at 0.12% and core at 0.48%. To be sure, the current environment of inflation deceleration has seen inflation readings undershoot the inflation nowcast, but do you want to keep playing those odds?

 

 

 

Earnings seasons ahead

As well, earnings season will begin in earnest when the banks start to report their results this Friday. Marketwatch reported a warning from Michael Darda, chief economist and market strategist at MKM Partners of an ominous divergence between S&P 500 operating profits and NIPA profits, as calculated by the government.
“The record divergence between S&P 500 operating earnings and after-tax [National Income and Product Accounts] profits from the GDP accounts during the year 2000 was a critical harbinger for a broader earnings recession, corporate accounting shenanigans, and a nearly three-year bear market,” he notes. There also was a divergence, though less severe, before the 2007 to 2009 stock-market plunge.

 

That divergence is seen in this chart, which deserves a little explanation. To compare the two, he indexed S&P 500 operating earnings per share and corporate profit data, back to the end of 1993

 

 

In summary, the bullish hopes of Hirsch’s January Indicator are tempered by several major challenges. I would conclude that the most likely near-term bias of the market for the remainder of the month is down.

 

New Year, New Fears

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: Sell equities
  • Trend Model signal: Neutral
  • Trading model: Bullish

Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at @humblestudent@toot.community. 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.
 

 

Waiting for clarity from earnings season

As the New Year dawns on investors, fresh concerns are bubbling up for the US equity outlook. The most immediate is the approaching Q4 earnings season reports, which begins in earnest when the banks report earnings this coming Friday. Already, forward 12-month EPS are rolling over across the board for large, mid, and small-cap stocks. Upcoming corporate guidance will determine the degree of valuation pressure stocks will face in the coming weeks and months.

 

 

A top-down macro analysis indicates growing margin pressures. A yawning gap has appeared between corporate profits as a percentage of GDP (blue line) and annual changes in average hourly earnings (red line, inverted scale). While these pressures are long-term, slowing economic growth in 2023 could be the catalyst for a collapse in corporate margins.

 

 

For now, margins don’t look like they’re in any imminent danger of a collapse. FactSet reported that the level of negative guidance for Q4 is elevated, but readings aren’t excessively high.

 

 

Earnings season could hold the key to the short-term direction of stock prices. I am not optimistic. As another sign of fundamental weakness, the WSJ reported that corporate insiders have not been buying despite the market’s recent weakness.

 

 

 

So long, Fed Put

The release of the December FOMC minutes did equity investors no favors. Fed officials affirmed their resolve to fight inflation

Several participants commented that the medians of participants’ assessments for the appropriate path of the federal funds rate in the summary of economic projections, which tracked notably above market-based measures of policy-rate expectations, underscored the committee’s strong commitment to returning inflation to its two per cent goal

More importantly, it telegraphed that it wants lower asset prices as a way of tightening financial conditions. If financial markets adopt a risk-on tone, the Fed will have to tighten further to counteract the loosening effects.
Participants noted that, because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the committee’s reaction function, would complicate the committee’s effort to restore price stability.
Financial conditions have begun to tighten again after loosening, but readings are far from extreme. The Fed has more work to do.

 

 

The IMF’s First Deputy Managing Director Gita Gopinath voiced support for the Fed’s tight monetary policy stance in a FT interview. She said that the Fed was correct to emphasize it would “maintain restrictive monetary policy” until there was a “very definite, durable decline in inflation” that was evident in wages and sectors not related to food or energy. She went on to echo the Fed’s concerns over the resilience of the labor market as a source service sector inflation.

 

So long, Fed Put.

 

 

One final flush?

These conditions are setting up for a final flush in stock prices. Dean Christians at SentimenTrader observed that the percentage of sub-industry groups with a positive one-year return fell to a low of 17% in 2022, but average bear market bottoms occur at a reading of 12%.

 

 

From a technical perspective, watch for the S&P 500 to decline while the NYSE Summation Index to either reach another oversold extreme, or exhibit a positive divergence/

 

 

 

What could go right

Despite the gloomy fundamental and macro outlook for US equities, here are a couple of non-US bullish factors to consider. 

 

First, the market has become very excited about the China reopening trade. Chinese stocks are on a tear and exhibited a V-shaped rebound. Continued positive momentum could see possible spillover effects as the reopening narrative become a global reflation narrative.

 

 

Another bullish tail-risk factor is the possibility of the collapse of the Iranian regime as protests continue to simmer. A regime change would be a bullish shock to risk appetite for two reasons. The most direct would be lower oil prices as Iranian supply become more freely available as sanctions ease, which amounts to an indirect tax cut to consumers. As well, Iranian weapons would no longer be available to Russia, which would put greater pressure on Moscow to end the war, which would compress the geopolitical risk premium. The Economist speculated that, as political pressures build in 2023, it will be the military have to decide whether Iran’s future lie with the ayatollahs or the revolutionary women.
Whoever wins, men with guns will exact a price as guardians of the Islamic or secular revolution. In the uneasy equilibrium between the three pillars of Iranian politics—the clerics, the people and the armed forces—it will be the military men who will have the casting vote on whether Iran’s future lies with the ayatollahs or the revolutionary women.

 

 

First, a counter-trend rally

That said, the usually reliable S&P 500 Intermediate-Term Breadth Momentum Oscillator (ITBM) flashed a short-term buy last week, signaling that a possible counter-trend rally is underway. The historical record of this model is remarkable. Of the 24 signals shown in the last five years, 20 resolved bullishly and only four failed. Subscribers received an alert that my inner trader had initiated a long position in the S&P 500 last Thursday.

 

 

As with all trading models, it’s useful to have both clear entry and exit signals. The buy signal occurs when the 14-day RSI of ITBM recycles from oversold to neutral. A useful rule for exiting the long trade is either the 14-day RSI becomes overbought, or the percentage of S&P 500 above their 20 dma becomes overbought. Current conditions suggest that while there is profit potential in the short-term trade, the duration of the trade is unlikely to last much more than a few days.

 

Tactically, the short-term bullish impulse is supported by evidence of positive breadth. Even as the S&P 500 tests the top of its range, the equal-weighted S&P 500, the mid-cap S&P 400, and the small-cap Russell 2000 have all broken out into minor uptrends.

 

 

Traders shouldn’t try to overstay their welcome. Investors should take advantage of any strength to lighten up equity positions.

 

Here are the usual disclaimers about 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

 

Three questions investors need to ask in 2023

Posted by Cam Hui -

IMF Managing Director Kristalina Georgieva recently said in a CBS Face the Nation interview that the IMF expects “one third of the world economy to be in recession”. She went on to outline the differing outlooks for the three major trading blocs in the world, the US, EU, and China, plus emerging market economies.

For most of the world economy, this is going to be a tough year, tougher than the year we leave behind. Why? Because the three big economies, U.S., E.U., China, are all slowing down simultaneously. The US is most resilient. The U.S. may avoid recession. We see the labor market remaining quite strong. This is, however, mixed blessing because if the labor market is very strong, the Fed may have to keep interest rates tighter for- for longer to bring inflation down. The E.U. very severely hit by the war in Ukraine. Half of the European Union will be in recession next year. China is going to slow down this year further. Next year will be a tough year for China. And that translates into negative trends globally. When we look at the emerging markets in developing economies, there, the picture is even direr. Why? Because on top of everything else, they get hit by high interest rates and by the appreciation of the dollar. For those economies that have high level of that, this is a devastation.
That said, the stock market isn’t the economy and looks forward past the IMF forecast, which is very similar to the consensus view of the global economy. From a relative performance viewpoint, US equities have skidded badly in the last two months, while European equities have soared. While the Chinese and Japanese Asian markets have staged relative rebounds in the same time frame, they remain range bound on a relative basis, and so does EM ex-China.

 

 

As investors bade goodbye to 2022 and look to 2023, here are some key questions to consider:
  • Can Europe, which the IMF considers to be in recession, maintain its leadership role?
  • How will China’s economy behave in light of it reopening initiatives? Global investors can’t get their Fed policy call right without getting the reopening trade call right/
  • Will the US enter into recession? The stock and bond markets are in disagreement. Stocks are expecting a soft landing, while bond yields have peaked and discounting substantial economic weakness.

 

 

European Renaissance?

I have highlighted the equity recovery in Europe before and it’s continuing. When the Russo-Ukraine war began, an energy shock hit Europe and cratered many industries sensitive to energy inputs but many have rebounded. As an example, both BASF and Dow Chemical are commodity chemical producers and their share prices have tracked each other closely. The BASF/Dow pair fell dramatically in February 2022 when Russia invaded Ukraine. The pair then based and staged an upside breaking in September and has been gaining ever since, indicating a relative recovery in European chemical competitiveness.

 

 

MSCI Poland can be thought of as a measure of geopolitical risk. Poland had been in a relative downtrend for most of 2022, but staged upside relative breakouts in late October and it hasn’t looked back since.

 

 

The question is whether Europe can continue to provide global leadership. In the short run, Europe has undergone a heat wave. It was 17C (63 F) when I left Berlin on New Year’s Eve at the end of my vacation and it reached 19C (66 F) on New Year’s Day. The heat wave has cratered energy prices and neutered Russia’s energy economic weapon. Gas storage levels are high by historical standards, but can the bullish backdrop continue?

 

 

In addition, the IMF has argued that if Europe properly supports the flood of Ukrainian refugees, it could enjoy a refugee dividend by boosting Europe’s economic growth and tax revenue while helping some countries facing labor shortages.

 

 

Europe’s Economic Surprise Index, which measures whether economic releases are beating or missing expectations, has been steadily climbing. In short, Europe is enjoying an economic tailwind. Can it continue?
 

 

Tactically, the relative performance of eurozone equities appears to be inversely correlated to energy prices. Equally disconcerting is the lack of small cap leadership in Europe. If European equities are truly assuming a global leadership role, small caps should also be leading as a sign of cyclical recovery in the region. While European equity leadership should be viewed positively, investors seeking exposure to this region may wish to wait for a cold snap and energy prices to spike so they can buy in at more attractive levels.

 

 

 

China rips off the COVID Band-Aid

China is reopening after abandoning its zero COVID policy. Calibrating the reopening trade is of utmost importance, not only for Asian investors, but also for global investors. A successful reopening has the potential to boost commodity prices and put upward pressure on inflation, which affects Fed policy.

 

Here are the bull and bear cases. Despite widespread reports of surging cases, overwhelmed hospitals and crematoriums, Bloomberg reported that “nearly a dozen major Chinese cities are reporting a recovery in subway use, a sign that an ‘exit wave’ of COVID infections may have peaked in some urban areas”, which is an indication that the COVID wave may be peaking. The WSJ echoed a similar analysis.
But the prospect of a large number of cases in January—a time of year when business activity is disrupted anyway, by the Lunar New Year holiday—has many in the manufacturing and service sectors optimistic that normalcy could come as soon as the beginning of February. 

 

“It sounds strange, I think it’s rather helpful than harmful,” said Andreas Nagel, Shanghai-based chief commercial officer at Stulz, a maker of climate-control equipment that was hit in December by a wave of Covid absenteeism. “We have a real chance of getting back to normal after Chinese New Year.”
On the other hand, China’s December manufacturing and services PMIs were all weak, indicating economic contraction.

 

 

Bloomberg reported that China Beige Book, a provider of independent data, estimates the economy only grew 2% in 2022, which is similar with Fathom’s estimate of 1.4% growth.

 

 

Marketwatch reported that Shehzad Qazi of China Beige Book sounded a guarded tone of optimism and left the door open for a reopening risk-on episode in the coming weeks.
While the sector is suffering a record contraction, with every subsector from housing to commercial property in distress, new credit data offers a glimmer of hope, said Shehzad Qazi, managing director of consultancy China Beige Book.

 

“Borrowing and bond sales are picking up, which suggests the much talked about policy turn may finally be approaching,” he said in an emailed statement.

 

“But forget a return to days of old: It will take considerable policy support in 2023 just to pull property out of the gutter.”
What does the market think of the reopening trade? Here the jury is still out on that score. A glance at the relative performance of the equity markets shows a V-shaped rebound in a number of regional markets, but the relative trend is still sideways.

 

 

Commodity markets are also not showing much sign of life. If the Chinese economy is truly rebounding, commodities should be rallying and not trading sideways. In particular, the cyclically sensitive copper/gold and base metals/gold ratios are flat to down.

 

 

These readings are consistent with China’s Economic Surprise Index, which has been skidding but may be trying to find a bottom.

 

 

The stars may be aligning for a China reopening risk-on episode in the near future, which has the tactical potential for short-term profits. However, keep in mind that reopening the economy does not address China’s property bubble debt imbalances. Until that problem is credibly addressed, the Chinese economy can only experience stop-and-start growth spurts.

 

 

 

US: Who is wrong, the stock or bond market?

As US investors bid good riddance to 2022 and look to 2023, a chasm in perception is appearing between the stock and bond markets. The S&P 500 is trading at a forward P/E of 16.7, which is elevated by historical standards when compared to the 10-year Treasury yield. Historically, past periods of similar yields have seen S&P 500 forward P/E ratios at slightly lower levels, though mid and small-cap stocks are more attractive. In addition, the 10-year yield has started to retreat, which is the bond market’s signal of a weakening economy. 

 

 

In effect, the elevated forward P/E of 16.7 is discounting a soft landing and no recession. The WSJ surveyed large investment banks for their 2023 forecasts and found only five of 23 professional economists expect no recession this year and next: Credit Suisse, Goldman Sachs, HSBC, JPMorgan Chase and Morgan Stanley. Why is the S&P 500 so richly valued?

 

By contrast, the 30-year Treasury yield peaked in October and past peaks have either led or coincident with peaks in the Fed Funds rate. The timing record of such peaks for stock prices, however, is mixed.

 

 

It’s hard to argue against the recession call. The St. Louis Fed observed that the Philly Fed’s coincident state indices showed that 27 states exhibited negative growth, which exceeds the historical average recessionary threshold of 26.

 

 

If there is a recession, history shows that recessionary equity bears don’t bottom until the economy is actually in recession, though the recession may not be officially declared. Currently, the Atlanta Fed’s Q4 GDPNow estimate is 3.8%, which is hardly a recessionary condition. If history is any guide, the ultimate market bottom is still ahead.

 

 

Can the Fed rescue the stock market? Don’t count on it. Supply chain bottlenecks have normalized and goods inflation is receding. The Fed’s focus has shifted from goods inflation to employment and wage growth as the key services inflation metrics to watch.

 

 

What equity bulls don’t recognize is the Fed won’t pivot until unemployment is strongly rising. Unemployment won’t rise until a meaningful credit squeeze, at which point households won’t respond to stimulus. That’s what a recession looks like. The US economy is nowhere near that point.
 

I am not overly fond of market analogs, but this analysis from Nautilus Research makes sense. The US market probably has at least one more leg down, driven by a realization of recession and earnings downgrades before the bear market is over.

 

 

In conclusion, the equity outlooks for the three major regions are diverging. Europe stocks are the leadership, but investors need to recognize that the leadership is sensitive to weather and energy prices. China may be undergoing a reopening rally, but a sustained advance is in doubt and a successful reopening would have significant disruptive effects on commodity prices and the global inflation outlook. The US stock market faces valuation headwinds, a deteriorating earnings outlook, and a Federal Reserve that’s determined to suppress asset prices as a way to fight inflation. As well, the latest political drama over the speakership in the House of Representatives more or less guarantees another 2011 style impasse over the debt ceiling later this year.

 

If Santa should fail to call…

Posted by Cam Hui -

Mid-week market update: Wall Street has many adages. One concern is the Santa Claus rally: “If Santa should fail to call, bears may come to Broad and Wall”. The Santa Claus rally window began the day after Christmas and ended today, two days into the new year. The S&P 500 has been range-bound since mid-December. Are the bears coming to the NYSE, which is located at Broad and Wall?
 

 

Let’s start with the good news. Even as the S&P 500 consolidated sideways, breadth and momentum indicators have been rising and exhibiting positive divergences. 

 

Credit market risk appetite is also showing positive divergences.

 

 

The usually reliable S&P 500 Intermediate-Term Breadth Momentum Oscillator (ITBM) is on the verge of flashing a buy signal, which should be good for a rally of at least a week. As a reminder, a buy signal is indicated when the 14-day RSI of ITBM recycles from oversold to neutral.

 

 

 

The primary trend is still down

Here is the bad news. The primary trend is still down. Even if a market rebound works out, and the short-term seasonal trend is positive for the next two weeks, don’t expect much more than a brief advance.

 

 

The weekly chart is still on a sell signal when the stochastic recycled from overbought to neutral in early December. The S&P 500 will remain on an intermediate sell signal even if the index stages a counter-trend rally up to the trend line at about 4000. Support can be found at the 200 wma at about 3670.

 

 

Moreover, the relative performance of defensive sectors is still strong, indicating that the bears are in control of the tape.

 

 

Enjoy what is likely to be a brief party, but don’t overstay your welcome.

 

A 2022 report card

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: Sell equities
  • Trend Model signal: Neutral
  • Trading model: Neutral

Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at @humblestudent@toot.community. 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.
 

 

Some hope for the future

Every market cycle is different, but all bear markets share some common elements, namely that asset prices fall. 2022 was unusual inasmuch as both stock and safe haven Treasury prices fell together. Nevertheless, there is some hope for the future.

 

Nine years ago, Jesse Livermore found that forward 10-year equity returns were inversely correlated to household equity positioning. The equity bear market has sent household equity exposure skidding. I would further argue that the normalized position is actually lower. Normally, bond prices rise during equity bear markets, which raise bond allocations and depress stock allocations. When stock and bond prices fell in tandem in 2022, the diversification effect was lost. Household equity allocations should have been lower in a “normal” bear market (see The hidden story of investor capitulation).

 

 

As investors bid goodbye to 2022, here is how my models performed during a difficult year.

 

 

Trading Model: A strong year

My inner trader had a good year in 2022. The model portfolio of the trading model turned in a return of 15.0%, compared to -19.4% for the S&P 500 (excluding dividends). To be sure, there were some ups and downs as the model suffered drawdowns in August, but it was a very good year overall.

 

 

 

Trend Asset Allocation Model: A rare underperformer

The Trend Asset Allocation Model experienced a rare year of underperformance in 2022, which was the first time this has happened since I began keeping records in 2013. The model portfolio had a return of -16.8% compared to -16.6% for a 60% S&P 500 and 40% 7-10 year Treasury ETF portfolio, which is only lagging only marginally. However, the return record was still strong for longer-term time horizons.

 

 

The underperformance can be explained by the unusual return pattern exhibited by the S&P 500 and the 10-year Treasury Note, whose prices fell together. In the past, bond prices have acted as a counterweight to falling stock prices during equity bear markets. The Trend Model was designed to reallocate equity positions to a diversifying asset, namely Treasuries, during difficult markets. In 2022, the diversifying asset didn’t diversify.

 

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Ultimate Market Timing Model

The ultimate market timing model was designed to be an extremely low turnover model that only flashes a signal every few years as a way of minimizing equity risk. It is known that trend following models that use moving averages can avoid the ugliest parts of the drawdowns during bear markets. The disadvantage to this class of models is they can flash false positive sell signals. The ultimate market timing model combines trend following with a macro overlay. It would only sell if the Trend Asset Allocation Model is cautious and top-down models indicate a growing risk of recession. This way, investors can avoid the worst of the market drawdowns during recessionary bears.

 

The ultimate market timing model flashed a sell signal in May. It is waiting for the Trend Model to turn positive before turning bullish again.

 

 

In conclusion, my quantitative model has shown mixed but generally positive results in 2022. I am generally equity bullish for 2023, though I am unsure of how much more downside risk remains. This looks like a plain vanilla recessionary bear market. It’s not the Apocalypse. Better returns are ahead.

 

Finally, I would like to take this opportunity to wish everyone a happy and prosperous 2023.

 

What to expect when you’re expecting (a recession)

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: Sell equities
  • Trend Model signal: Neutral
  • Trading model: Neutral

Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at @humblestudent@toot.community. 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.
 

 

A difficult 2022

2022 has been a difficult year for equity and bond investors. Both stock and bond returns have been abysmal this year.

 

 

As investors bid good riddance to 2022, here is what the market is expecting for 2023.

 

 

A remarkable consensus

A compilation of views and forecasts from selected Street strategists show a remarkable consensus mostly of a difficult first half and a bottom for equities, but stock prices end the year roughly flat to slightly down.
  • Morgan Stanley: Morgan Stanley strategists are forecasting the 10-Year Treasury yield to end 2023 at 3.5%, with upside potential in securitized products such as MBS. S&P 500 ends 2023 at 3900, but with considerable volatility. The USD declined in 2023. EM and Japanese equities could deliver double-digit returns. Brent oil will beat gold and copper and end 2023 at $110.
  • Goldman Sachs: Goldman’s equity strategists believe that the “global stock market’s ‘hope’ phase could start later this year” and “it is too early to position for a potential bull market transition”. Goldman’s head of asset allocation research Christian Mueller-Glissmann is cautious on bonds: “In the near term, bonds could remain more of a source of risk than of safety” but there is “potential for bonds to be less positively correlated with equities later in 2023 and provide more diversification benefits”.
  • BlackRock: BlackRock is calling for a “new regime of greater economic and market volatility” and advises clients to be more tactical as “2023 will require more frequent portfolio changes”. The fund management company is short-term cautious on equities: “Tactically, we’re underweight DM stocks as central banks look set to overtighten policy – we see recessions looming. Corporate earnings expectations have yet to fully reflect even a modest recession.”
  • Standard Chartered (Bloomberg interview): Market expectations of Fed rate cuts are overly ambitious. The USD has peaked, though severe economic growth challenges remain.
  • Charles Schwab: Strategist Liz Ann Sonders is calling for a rolling U.S. recession of a sector-by-sector downturn, though she concluded on a more optimistic note: “there may be more bumps in the road near-term given inflation is still noticeable (albeit in the rearview mirror), but the longer-term outlook via the windshield has improved.”
  • Stanley Druckenmiller (CNBC): His base case is a recession and hard landing in 2023. The caveat is Druckenmiller’s positioning can change at a moment’s notice.
  • Bill Ackman (YouTube): He is concerned about the effects of a tight Fed policy. Equity buying opportunities will appear in the latter part of 2023.
The unusual feature this year is the degree of pessimism among Wall Street strategists.

 

 

What’s more, the degree of dispersion in forecasts is historically high.

 

 

However, a Bloomberg survey of institutional investment managers shows that respondents are more bullish than sell-side strategists.

 

Specifically of interest to US equity investors, Callum Thomas pointed out that market positioning from the State Street survey from custodial data shows that North American managers are cautious, but not panicked.

 

 

 

What’s the pain trade?

To summarize, investors are cautious going into 2023 but expect a recovery later in the year. The view of one more leg down can be confirmed technically from historical evidence. Mark Ungewitter pointed out that the S&P 500 broke its 200 wma in most recessions. A recession in 2023 is a virtual certainty and the 200 wma currently stands at just under 3700. Will this time be any different?

 

 

So what’s the contrarian or pain trade here? Could it be the nascent signs of a new bull (see The stealth change in market leadership you may have missed)? Tactically, the coming week is the start of the Santa Claus rally window, which begins on the day after Christmas and ends two days after the start of the new year. We will get more clarity after the Santa rally window ends.

 

Happy Holidays to everyone and wishing you better returns in 2023.

 

How the BOJ disturbed my vacation

Posted by Cam Hui -

Mid-week market update: I know that I said that I wouldn’t publish a mid-week market update during my vacation, but the actions of the BOJ managed to disturb my R&R time, so this is just a brief note.
 

The BOJ’s announcement of a retreat from yield curve control by allowing the 10-year JGB yield to rise from 0.25% to 0.50% shocked markets. The widowmaker trade of shorting JGBs finally worked, but it happened when a lot of traders had shut down their books and went on holidays. The move cratered the JGB market, pulled down other major bond markets around the world, and sent the Japanese stock market reeling. Other equities markets fell in sympathy, but the contagion effect was limited as the bond rout steadied and stock markets rebounded.

 

My usually reliable S&P 500 Intermediate-Term Breadth Momentum Oscillator (ITBM) had flashed a sell signal on December 7, 2022 when its 14-day RSI recycled from overbought to neutral. I wrote that a reasonable exit strategy is to either wait for the 14-day RSI or the Zweig Breadth Thrust Indicator to become oversold. Coincidentally, both were triggered just before the BOJ announcement.

 

 

 

Santa readies his sleigh

It appears that the Santa Claus rally may be just starting. The traditional Santa rally begins the day after Christmas and lasts until the second day of the new year. It also coincides with the end of tax loss selling season. After investors dump their losing positions, which there were many in a dismal year, the sale candidates often rebound as selling pressure abates (see last week’s commentary, All that’s left to do is to wait for Santa Claus).

 

 

It appears that Santa is readying for his sleigh ride. Under normal circumstances, my inner trader would enter a speculative long position in small-cap stocks, which have recently underperformed. But I am traveling and I don’t really have time to monitor any positions so I’ll step aside, but that doesn’t mean that nimble traders who are still at their desks can’t be buying here.

 

In praise of the bond market

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: Sell equities
  • Trend Model signal: Neutral
  • Trading model: Neutral

Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at @humblestudent@toot.community. 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.
 

 

Time for bonds to shine

Last week, I highlighted how bond prices were reviving. The close positive correlation between stock and bond prices is breaking. This is the phase of the market cycle when recession fears grow, bond yields fall and bond prices rise, and the stock market weakens. 

 

 

 

Deteriorating equity market internals

Over in the equity markets, technical internals are deteriorating. The S&P 500 pulled back at its 200 dma after exhibiting a negative RSI divergence and it’s testing its 50 dma.

 

 

Equity risk appetite indicators are also exhibiting minor negative divergences. Most troubling is the behavior of the speculative ARK Investment ETF, which violated relative support and continues to weaken.

 

 

From a longer-term perspective, the weekly chart of the S&P 500 shows that it’s violated g support while the stochastic is rolling over after reaching an overbought level.

 

 

 

Nearing downside targets

That said, my usually reliable S&P 500 Intermediate-Term Breadth Momentum Oscillator model (ITBM) is nearing its downside target, as defined by either the ITBM 14-day RSI reaching an oversold condition or the Zweig Breadth Thrust Indicator becoming oversold.

 

 

As well, don’t forget that the S&P 500 is inversely correlated to the USD. The USD broke down through support and remains weak, which should be a bullish sign for risk appetite.

 

 

In conclusion, the stock market is experiencing downside volatility of an unknown magnitude. The best harbor in this storm is default-free Treasury bonds, which is resuming its role as a risk-off asset.

 

Wall Street is fighting the Fed, should you join in?

Posted by Cam Hui -

Fed Chair Jerome Powell made it clear at the post-FOMC press conference. The Federal Reserve is nowhere close to ending its campaign of rate increases. While last two CPI reports show “a welcome reduction in the monthly pace of price increases…It will take substantially more evidence to have confidence that inflation is on a sustained downward path.”
 

Moreover, the “dot plot” showed a median Fed Funds rate of 5.1%, which is above market expectations. In the aftermath of the FOMC meeting and press conference, Fed Funds expectations barely budged. The terminal rate stayed the same at just under 5%, though the expected path of rate cuts was pushed out by a month from the September to the November meeting.

 

Wall Street is fighting the Fed. Should you join in? Here are the bull and bear cases.
 

 

The bear case

The bear case can be easily summarized as, “Don’t fight the Fed”. The December Summary of Economic Projections (SEP) tells the story. The Fed revised down the median projected GDP growth for 2023, revised up unemployment and inflation rates, and raised the estimate of the Fed Funds rate to 5.1%. More importantly, the consensus range of the Fed Funds rate in 2023 is above 5%. While Powell spoke extensively about the path to a soft landing, the Fed’s version of a soft landing is an economy that essentially flatlines in 2023, with unemployment rising by nearly 1%, rising inflation, and higher interest rates. For many people and businesses, that’s a hard landing and not much better than a recession.

 

 

Powell also made it clear that the deceleration in CPI and PCE inflation was welcome news, it was not unexpected. The next inflation hurdle is the tight jobs market and wage growth. Powell made specific reference to wage growth in his recent Brookings speech. Since the publication of that chart, average hourly earnings accelerated upward, which was a worrisome surprise.
 

 

As well, Powell allowed that “many analysts believe that the natural rate of unemployment is elevated at this moment”, which is an expansion of the point he made in his Brookings speech: “Participation dropped sharply at the onset of the pandemic…[and] recent research by Fed economists finds that the participation gap is now mostly due to excess retirements…The data so far do not suggest that excess retirements are likely to unwind because of retirees returning to the labor force.” A smaller labor force and strong labor demand translate to a higher Non-Accelerating Inflation Rate of Unemployment  (NAIRU), which is supportive of stronger wage rates. 

 

 

Former Fed Vice Chair Richard Clarida warned investors not to become overly excited about easing financial conditions because the Fed might have to respond forcefully [emphasis added]:

Fed Chair Jerome Powell said at the Brookings Institution on 30 November, “We do not want to overtighten because we think cutting rates is not something we want to do soon,” but if financial conditions ease because markets price in such cuts, a peak policy rate of 5.25% may not be sufficient to put inflation on a path to return to 2% over time.

He also said the quiet part out loud. Wage growth is too high and, in all likelihood, the Fed will have to induce a recession to tame it.

Although recent readings on U.S. Consumer Price Index (CPI) inflation are moving in the right direction, wage inflation at present is running above a 5% annualized rate and underlying productivity is, charitably, estimated to be growing at around a 1.25% pace, implying that wage inflation would eventually need to decelerate by 1 to 2 percentage points for the Fed to be confident that its 2% inflation goal can be reached. Historically, declines in U.S. wage inflation of this magnitude have only occurred in recessions, and the Fed itself in the December SEP projects the unemployment rate will rise to 4.6% by the end of 2023, more than a percentage point higher than the 3.5% unemployment rate recorded in September of this year.

In summary, the FOMC remains hawkish. The bond market responded with a rally. Bond prices remain in a well-defined uptrend, with the 7-10 Treasury ETF (IEF) above its 10 dma, which is above its 20 dma

 

 

 

The bull case

For equity bulls, it’s not a case of fighting the Fed, but disbelief of the Fed’s projections. 2-year Treasury yields, which is a proxy for the expected Fed Funds rate, are already rolling over. Past peaks in the 2-year yield were coincident or led peaks in the Fed Funds rate.

 

 

It’s therefore no surprise that Wall Street is throwing a party. Yield spreads are narrowing and financial conditions are easing. Powell was asked about easing financial conditions at the press conference and he gave two slightly different replies. In response to Steve Liesman of CNBC, Powell said that “policy not sufficiently restrictive stance yet…[and to] expect ongoing hikes”. In response to Michael McKee of Bloomberg TV and Radio, Powell said, “Policy is restrictive…[and] getting close to sufficiently restrictive”. The lack of a strong pushback against easing financial conditions opens the door that the Fed could stand aside and allow a risk-on rally in asset prices.

 

 

Despite the widespread expectation of a recession, one unexpected development is the stabilization of earnings estimates. The latest update of S&P 500, S&P 400, and S&P 600 forward EPS estimates show upward revisions in two of the three indices. This development needs to be monitored. It could be just a data blip, or it could be the start of a welcome new trend.

 

 

The November 2022 NFIB small business survey also shows some green shoots. While readings are generally weak, they are showing signs of improvement.
  • Owners expecting better business conditions over the next six months improved three points from October.
  • The net percent of owners who expect real sales to be higher improved five points from October.
  • The net percent of owners raising average selling prices increased one point to a net 51% seasonally adjusted, a high reading but lower than earlier this year.
  • Forty-four percent of owners reported job openings that were hard to fill, down two points from October.
As a consequence, small business confidence edged up in November and it’s recovering from historically low levels.

 

 

The stage could be set for a melt-up. The BoA Global Fund Manager Survey showed that investment managers’ risk appetite was washed-out and turning up. If conditions continue to improve, asset prices could see a FOMO buying stampede.

 

 

The one possible caveat is valuation. The S&P 500 is trading at a forward P/E of 17.1, which is not cheap by historical standards when compared to the 10-year yield. However, the mid and small-cap S&P 400 and S&P 600 are trading at lower multiples when the 10-year yield was at similar levels.

 

 

 

Key risk: Rolling supply shocks

The key risk to the bullish outlook can be summarized by Fed Vice Chair Lael Brainard’s speech on November 28, 2022, at a BIS conference that highlighted the risk of rolling supply shocks to the global economy. Just when you think inflation is going away, it comes back from the dead like the monster in horror movies.
After several decades in which supply was highly elastic and inflation was low and relatively stable, a series of supply shocks associated with the pandemic and Russia’s war against Ukraine have contributed to high inflation, in combination with a very rapid recovery in demand. The experience with the pandemic and the war highlights the challenges for monetary policy in responding to a protracted series of adverse supply shocks. In addition, to the extent that the lower elasticity of supply we have seen recently could become more common due to challenges such as demographics, deglobalization, and climate change, it could herald a shift to an environment characterized by more volatile inflation compared with the preceding few decades
We don’t know where the next supply shock may come from, but since 2020 the global economy has been hit by a pandemic, a series of climate events like heat waves and floods, and a major war in Europe. What’s next? Brainard believes that central bankers need to stay more hawkish in order to keep inflation expectations under control.

A protracted series of adverse supply shocks could persistently weigh on potential output or could risk pushing inflation expectations above target in ways that call for monetary policy to tighten for risk-management reasons. More speculatively, it is possible that longer-term changes—such as those associated with labor supply, deglobalization, and climate change—could reduce the elasticity of supply and increase inflation volatility into the future.

An academic paper by Isabella Weber et al entitled “Inflation in Times of Overlapping Emergencies: Systemically Significant Prices from an Input-output Perspective” also raised the risk of shocks from overlapping emergencies. The academics studied which price shocks mattered and found that price shocks in about 10 sectors generate a much larger total inflation impact than all other sectors. These results will be important to policymakers should the rolling price shock scenario outlined by Brainard become a reality.

 

 

The most obvious source for a series of rolling supply shocks is climate change. While we can debate the global warming issue until we’re blue in the face, financial effects are already being felt. A Bloomberg podcast indicates that extreme weather events are forcing risk to be re-priced in the insurance markets.
 

 

Investment conclusion

I began this publication by rhetorically asking if investors should join the side that’s fighting the Fed. The bull case is persuasive, but recent signs of strength could represent a false start much in the manner of the China reopening trade. which retreated in response to rising COVID cases and a poor growth outlook. Historically, the Fed has always underestimated the severity of recessions as measured by the unemployment rate. Positive estimate revisions at this stage of the cycle seems overly ambitious.

 

 

In the face of a hawkish Fed and the risk of additional disruptions, it pays to be more cautious and maintain a balanced view of risk and return. Investors seeking exposure to US equities will find better value in mid and small-cap stocks.

 

All that’s left to do is to wait for Santa Claus

Posted by Cam Hui -

Mid-week market update: Let’s begin with an administrative note. In the absence of severe market volatility, this will be the last mid-week market update until the new year. I plan on taking a few days off at the end of the year. I plan to publish the usual two comments this weekend, follow by single comments each weekend after that.
 

It’s always difficult to make definitive market comments on FOMC day, as initial market moves are often reversed on the next day. We can say that the bulls were disappointed by the market reaction to the soft CPI report. The S&P 500 rallied up to test the falling resistance trend line but failed. While the bulls fell short of pushing the index about resistance at 4100, the bears were also unable to push the market below support at 3900. Tactically, all that’s left is to wait for the Santa Claus rally.

 

 

2022 has been a difficult year for investors. The silver lining is this environment conducive to tax-loss selling. When the tax-loss sales abate, it becomes a setup for the Santa Claus rally, which begins the day after Christmas and ends the second day of the new year.

 

 

Santa rally candidates

I can offer two sets of possible sets of candidates that could outperform during the Santa Claus rally window. The first is small-cap stocks. Small caps had been tracing out relative bottoms against the S&P 500 for most of this year. In November, their relative strength faltered and they began to lag again. Their underperformance is probably partly attributable to tax-loss selling pressures.

 

 

Another is crypto plays. I am on record that I believe crypto-currencies are nothing more than digital beanie babies. but crypto plays could be washed out here and enjoy a tactical bounce during the Santa Claus rally window. To begin, the recent cover of The Economist is a contrarian magazine cover indicator.

 

 

The arrest and subsequent indictment of Former FTX CEO Sam Bankman-Fried in the Bahamas could serve to put a bookend to the latest sorry episode of crypto implosion. While Bitcoin is holding long-term support, the shares of Coinbase (COIN) and Greyscale Bitcoin Trust (GBTC) have violated support. Moreover, the GBTC/Bitcoin ratio continues to decline, indicating further a widening discount. Keep in mind that the astronomical yield level of COIN’s debt is a market signal that in a disorderly windup, COIN common shareholders are likely to be wiped out. Nevertheless, the latest episode of market weakness could be a signal of a market washout that could see crypto-related plays stage a significant bounce.

 

 

Needless to say, the crypto space is a high risk/high reward trading opportunity. Size your positions accordingly, (though I am personally staying away).

 

My inner investor is roughly neutrally positioned against the asset allocation benchmark specified by his investment policy. My inner trader is holding to his S&P 500 short, but expect to opportunistically cover his position before the onset of the Santa Claus rally window.

 

 

Disclosure: Long SPXU

 

Mr. Bond, I expected you to die

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: Sell equities
  • Trend Model signal: Neutral
  • Trading model: Bearish

Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at @humblestudent@toot.community. 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.
 

 

A rejection and a breakout from resistance

Last week, I highlighted the key technical tests that the S&P 500 was about to undergo as it breached its 200 dma and it was nearing a falling trend line. Ultimately, the stock market failed at resistance and pulled back to a key support level. Long Treasury prices, which had been highly correlated with stock prices in 2023, underwent a similar technical test but staged an upside breakout. 

 

 

The stock/bond ratio is now weakening. Anyone who expected Mr. Bond to die in the face of hawkish Fed policy must be disappointed.

 

 

A change in tone

The change in tone in the Treasury market can be attributed to several factors. One is growing evidence in the jobs market. Initial jobless claims are rising, albeit slowing, from their April trough.

 

 

Unit labor costs, which were reported last week, decelerated and came in softer than expected. It was a welcome antidote to the upside surprise exhibited by average hourly earnings in the November Non-Farm Payroll report.

 

 

Before you get overly excited, the Atlanta Fed’s wage growth tracker showed that wage growth for job switchers rose from 7.6% in October to 8.1% in November while the overall wage growth rate stayed constant at 6.4%, indicating continued tightness in the labor market.

 

 

Oil prices broke a key technical support level, which was a surprise in light of the expected strength in demand from the China reopening narrative.

 

 

As well, used car prices continue to weaken, which is positive for disinflation.

 

 

Moreover, the Bank of Canada’s dovish rate hike raised hopes of a possible pause in the global rate hike cycle. The BoC increased rates by 50 basis points, but signaled a possible pause in its statement: “Looking ahead, Governing Council will be considering whether the policy interest rate needs to rise further to bring supply and demand back into balance”.

 

 

Asset market implications

The divergence between Treasury and equity prices has bearish implications for risk assets. Much of the recent market relationships can’t be relied on anymore.

 

As an example, the relative performance of large-cap growth stocks has been inversely correlated to Treasury yields because of the long-duration characteristic of growth stocks. As the bond market begins to discount a growth slowdown and probable recession, don’t expect growth to outperform under these circumstances.

 

 

Indeed, both the absolute and relative performance of technology stocks are struggling, and relative breadth indicators (bottom two panels) are also lagging behind the S&P 500.

 

 

Despite the Treasury market rally, investors should be cautious about high-yield credits. While the relative performance of junk bonds is tracking the performance of the S&P 500, leveraged loans (red dotted line) are flashing warning signs of rising credit risk.

 

 

 

The week ahead

Looking to the week ahead, investors will be watching the November CPI report on Tuesday and the FOMC decision Wednesday. The Cleveland Fed’s inflation nowcast of 0.47% and 0.51% for headline and core CPI respectively are ahead of consensus expectations of 0.3% and 0.4%. The risk of a hot negative surprise is elevated and the market reaction to the PPI print on Friday was a potential preview of the market reaction.

 

 

The market is discounting a 50 basis point hike in December, a terminal rate that’s just over 5%, and rate cuts in mid 2023. Keep an eye on expected inflation, and the unemployment rate that will be published in the December Summary of Economic Projections after the FOMC meeting. While the inflation rate will determine the pace of rate hikes, the Fed’s perception of the labor market will determine the timing of rate cuts.

 

 

I have argued the lack of recovery in the labor force participation rate by older workers translates into a higher natural unemployment rate, which will keep the job market tight. Market expectations of rate cuts in mid 2023 would be unrealistic under such a scenario. The prospect of a prolonged tight Fed as the labor market stays tight would be bullish for bonds but bearish for stocks.

 

 

In conclusion, the Treasury bond market is turning up while the stock market is turning down, which is a condition that hasn’t been seen for much of this year. I believe that this market action is the market’s signal of weaker economic growth, which should be bond bullish and equity bearish. However, much of the short-term outlook will depend on next week’s CPI report and FOMC meeting.

 

As a reminder, I reiterate my discussion of my trading position exposures from last week:
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 SPXU

 

The stealth change in market leadership you may have missed

Posted by Cam Hui -

It’s time to conduct one of my periodic market leadership reviews. The review will be done through different viewpoints, starting from the top from an asset lens, a global equity lens, and finally through a factor, or style, lens.
 

The primary tool for my analysis is the Relative Rotation Graph, or RRG chart, which is a way of depicting the changes in leadership in different groups, such as sectors, countries or regions, or market factors. The charts are organized into four quadrants. The typical group rotation pattern occurs in a clockwise fashion. Leading groups (top right) deteriorate to weakening groups (bottom right), which then rotate to lagging groups (bottom left), which change to improving groups (top left), and finally completes the cycle by improving to leading groups (top right) again. All of the RRG analysis is conducted in USD and therefore includes all currency effects in the returns.
 

The benchmark for the asset RRG analysis is the Vanguard Balanced Index Fund (VBINX). It shows leadership by virtually all equities except China. Non-US bonds are in the improving quadrant. EM equities are only in the improving quadrant, dragged down by China in the lagging quadrant, which also contains US large-cap growth and Treasuries.

 

 

Here are my main takeaways from this analysis:

  • The market is discounting a global recovery as equities are generally leading the rotation.
  • The recovery is more advanced in non-US markets, as evidenced by the superior performance of non-US bonds over Treasuries.
  • China is a laggard and dragging down the performance of emerging market equities.
  • US large-cap growth is dragging down the performance of US equities, as shown by the poor performance of the NASDAQ 100 compared to the S&P 500.
In addition, the bond market is starting to discount a pause and possible pivot in the Fed Funds rate. Past peaks in the 30-year Treasury yield have either been coincident or led peaks and pauses in the Fed Funds rate. However, the timing record for the stock market for these signals has been spotty.

 

 

Tactically, the uptrend shown by both the iShares 20 year+ Treasury ETF (TLT) and iShares International Treasury Bond ETF, as evidenced by the price above the 10 dma, which is above the 20 dma, and above the 50 dma, are constructive signs that uptrends are in place and global bond prices have turned.

 

 

 

Global equity rotation themes

Viewing global equities on a region and major country basis, the following themes stand out:
  • Europe is a clear leader, along resource sensitive countries like Australia and Canada. 
  • Mexico is also a market leader, probably because it is a beneficiary of the near-shoring of production to the NAFTA bloc. On the other hand, Brazil has also become a major drag on Latin American stocks.
  • China and Hong Kong are major drags on emerging markets, though other Asian markets such as Japan, Korea, and Taiwan are in the improving quadrant. 
  • The US market is losing steam, as large-cap growth stocks have lagged.

 

 

The break in US equity performance is not a surprise. US equities have been trading at a premium P/E to the rest of the world for about a decade. The strong performance was attributable to the fundamental dominance of FANG+ stocks, which are now in retreat.

 

 

The lag in performance of US large-cap stocks can also be seen in the chart of regional relative performance. The NASDAQ 100 peaked in August relative to MSCI All-Country World Index (ACWI) and the S&P 500 peaked in early November. Consistent with the more detailed RRG chart of region and country rotation, European equities have been on a tear since September, while Japan, China, and EM have gone nowhere in the past few months.

 

 

 

US factor rotation themes

An analysis of the US factor rotation chart tells a story of the devastation of growth stocks and the emergence of value stocks. Growth factors are in the bottom half of the chart, indicating weakness, while the top half is dominated by value factors of different descriptions.

 

 

I would warn, however, that the apparent superior relative performance of value stocks is more attributable to the poor performance of FANG+ stocks. While US value has outpaced growth since September, EAFE value has gone nowhere against growth during the same time period.

 

 

In addition, many of the value sectors, which have a high degree of cyclical exposure, appear to be extended in the short run and they are prone to a relative pullback.

 

 

More disturbing is the relative performance of defensive sectors, which have been in relative uptrends since August despite the market advancing during that period.

 

 

That said, the relative performance pattern of small-cap value sectors appears to be constructive.

 

 

 

Investment conclusions

In conclusion, bond markets are discounting a global growth slowdown. Different regions of global equities are in various phases of recovery. I reiterate my conviction to overweight Europe on a FIFO basis of entering and exiting recession. European equities are attractively priced on a forward P/E basis and FactSet reported that forward 12-month EPS for MSCI Europe has risen to a new cycle high.

 

 

Callum Thomas also reported that EU equity positioning is still extremely defensive and the cyclical bull trade has only barely begun.

 

 

China and Asia still needs time to consolidate and digest their relative gains after the recent China reopening rally. 

 

 

The next shoe in the reopening drama is about to drop. China’s National Health Commission announced 10  measures that amount to a pivot from zero-COVID containment to mitigation. Bloomberg reported that China faces the risk that infection rates will rise rapidly, along with underreporting risk as testing requirements are eased.

With requirements for frequent lab testing dialed back significantly, anecdotal evidence suggests undetected cases are on the rise. Some health experts are predicting actual infections will far surpass the official tally.

The Financial Times also reported China is bracing for COVID outbreaks among medical staff and migrant workers. 

 

Q1 growth is likely to be challenging for China. Already, China’s Economic Surprise Index, which measures whether economic statistics are beating or missing expectations, is falling. A spike in COVID infections will be a further drag to the economy. Expect some bumpiness in the coming months.

 

 

Investors who are focused on the US market by mandate are advised to focus on value and quality factors. Mid and small-cap stocks are more attractive on a valuation basis compared to large-caps.

 

 

The US market appears to be undergoing a secular rotation from growth to value and from large-caps to small-cap leadership.

 

 

Tactically, a strategy of buying Treasuries and non-US stocks could have considerable upside potential. An analysis of the holdings of the iM DBi Managed Futures ETF (DBMF), which is a proxy for CTA futures programs, shows that the fund is short bonds and roughly neutral on equity positioning. Should bonds and non-US equities rip, buying potential from CTAs could drive prices quite a bit higher.

 

 

Making sense of the market’s risk reversal

Posted by Cam Hui -

Mid-week market update: So much for the S&P 500 testing the 200 dma and falling trend line resistance. The index reached its resistance zones late last week and pulled back to test a key support level.
 

 

What’s puzzling is the lack of a fundamental driver for the market weakness. While I have been cautious, this kind of market action even surprised me.

 

 

Fear of recession

A narrative has crept up this week that the market is pivoting from a fear of rate hikes to a fear of recession. As stock prices weakened, bond prices rallied, which broke the 2022 pattern of the synchronization of stock and bond prices. This could be interpreted as the bond market discounting a growth slowdown while the stock market is anticipating an earnings slowdown.

 

Take a look at how commodity prices and the Treasury yield curve have behaved. Commodities took a nosedive this week in the face of the China reopening news, which I interpret to mean that the market is expecting slower global growth. Indeed, last night’s reports of China’s imports and exports missed expectations, which is a signal of weak global demand. In addition, different yield curve spreads have been inverting, indicating that the bond market expects slowing growth. The 10s30s yield curve (bottom panel) is nearly inverted. In the last two sell-offs this year, the stock market didn’t bottom until the 10s30s started to turn up, which means that we could be early in this latest pullback episode.

 

 

 

A reliable sell signal

The usually reliable S&P 500 Intermediate-Term Breadth Momentum Oscillator (ITBM) flashed a sell signal last night when its 14-day RSI recycled from overbought to neutral. There have been 21 such signals in the past five years, the market fell on 16 occasions (pink vertical lines) and advanced on five (grey lines). 

 

 

How do the bears know when to cover their shorts? I can offer two guidelines. In the past, trigger points to unwind bearish exposures occur whenever either the 14-day RSI of ITBM falls into oversold territory, or when the Zweig Breadth Thrust Indicator becomes oversold. The market has overshot these signals before, but most of the losses have been seen when these buy-cover signals have occurred. 

 

As for timing, successful ITBM sell signals typically have lasted 10-14 days until the buy-cover signal. This would put us right near the end of the tax-loss selling period just before Christmas and just in time for the Santa Claus rally (via Mark Hulbert). 
The several-day period beginning after Christmas does exhibit abnormal strength. According to the Stock Traders Almanac, this genuine Santa Claus rally period lasts from the first trading session after Christmas and continues through the second trading session of the New Year. The Dow over this period has risen in 77% of the years since the index was created in 1896, and produced an average gain of 1.5%. Across all other periods of equal length over the last 126 years, the Dow has risen 56% of the time and produced an average gain of just 0.2%. These differences are statistically significant.
In the meantime, investors will have to look forward to the CPI report next Tuesday, followed by the FOMC decision Wednesday, which will be sources of volatility.

 

My inner investor remains roughly neutrally positioned at the asset allocations specified by investment policy. My inner trader remains short. He is enjoying the latest round of market weakness but keeping an eye out for the exit.

 

 

Disclosure: Long SPXU

 

Second time lucky, or Fooled me once?

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: Sell equities
  • Trend Model signal: Neutral
  • Trading model: Bearish

Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at @humblestudent@toot.community. 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.
 

 

Here we go again

Here we go again. A previous “can’t miss” breadth thrust indicator of a new bull market just flashed a buy signal. The percentage of S&P 500 above their 50 dma rose from below 5%, which is an oversold extreme, to over 90%, an overbought extreme. Such a breadth had been a buy signal with a 100% success rate until this year. This indicator flashed a buy signal in August, which failed badly and it recycled back to below 5%.

 

 

Is this latest buy signal a case of second-time lucky, or fooled me once, shame on you, fooled me twice, shame on me?

 

 

The bull case

The equity bull case rests strictly on historical studies of price momentum. While there are many variations of the bullish resolutions of breadth thrusts and price momentum, I offer the following examples.

 

Ryan Detrick pointed out that the S&P 500 just put in two back-to-back gains of 5% or more. These examples of strong price momentum have tended to resolve bullishly.

 

 

Steve Deppe observed that the S&P 500 ended November with a monthly close with a trailing 2-month return of 10% or more and negative trailing 6-month returns. Such instances of strong momentum after a bear trend have also tended to be bullish.

 

 

Jonathan Harrier published a historical study that defended the bullish conclusion of the breadth thrust signal based on the percentage of S&P 500 stocks above their 50 dma. All were higher six and 12 months later.

 

 

The devil is in the details. When the first buy signal from the breadth thrust signal appeared in August, I pointed out that while the technical and price momentum outlook was positive, the macro outlook was negative. Moreover, the Zweig Breadth Thrust, which was the rare granddaddy of breadth thrust signals, only flashed six buy signals in the out-of-sample period since Marty Zweig published his book in 1986. While the S&P 500 was higher 12 months later in all cases, the market sputtered immediately after the buy signal in two instances during periods when the Fed was raising rates.

 

 

The lesson here is that while technical analysis does add value, top-down macro analysis also matters. In the current case of the breadth thrust buy signal, what would the investor be discounting if he were to buy the market?

 

 

What are the bulls discounting?

One positive macro development is a softening of inflation indicators. However, analysis from Goldman Sachs found that an inflation peak is only equity bullish if it’s not followed by a recession. If you’re bullish, you’re betting on a soft landing.

 

 

New Deal democrat, who maintains a modeling discipline of keeping coincident, short leading, and long leading indicators, has some bad news. Starting with his analysis of ISM data:
Going back almost 75 years, the new orders index has always fallen below 50 within 6 months before a recession. Recessions have typically started once the overall index falls below 50, and usually below 48.

 

Which means that today’s report for November comes very close to meeting all of the above criteria. The overall index declined below 50 for the first time since May 2020, at 49.0. The new orders subindex declined -2 to 47.2, the 5th time in the past 6 months that it has been below 50, and only 0.1 above its September low of 47.1:

 

 

Even though the November Jobs Report was stronger than expected, his analysis of the high-frequency initial jobless claims data is coming close to a recession signal:
In the past, if the 4 week average is more than 5% higher YoY for any significant period of time, and less reliably, if the slightly lagging continuing claims are higher YoY, a recession is almost always close at hand:

 

The first marker could be met by January 1. The second marker could be met by February.

 

 

From a global perspective, the South Korean economy is a sensitive bellwether of global growth. South Korea’s October industrial production fell -3.5%, which was the biggest decline since April 2020. In addition, the SCMP reported that:
  • Shipments to China have fallen for six consecutive months, but November’s decline was the sharpest since mid-2009
  • South Korean shipments worldwide fell by 14% to US$51.91 billion last month compared to November 2021

 

 

 

What did Powell say?

The market adopted a risk-on tone after Fed Chair Jerome Powell’s speech at Brookings Institution last week (also see video of the speech and Q&A). Market participants appeared to have focused on Powell’s confirmation that the Fed will temper its December rate hike to 50 basis points and he did not want to overtighten. 

 

There were several points that the bulls may have missed. First, Powell revealed that the natural rate of unemployment, or Non-Accelerating Inflation Rate of Unemployment (NAIRU), has risen strongly since the pandemic, and the labor force participation rate (LFPR) has not fully recovered. The weakness in LFPR was mainly attributable to early retirement as older workers left the workforce and to a lesser extent a slower growth in the working population, and lower rates of immigration. Powell observed that older workers have not retired and they are unlikely to return. 

 

This sets up a jobs market dynamic of a higher NAIRU and a persistent tighter labor market. While the Fed may be correct to slow the pace of its rate hikes, it will be more difficult to cut interest rates if NAIRU is still elevated and the job market stays tight. The market is expecting a Fed Funds plateau to begin in early 2023 and next summer or fall. An elevated NARIU makes that scenario less likely.

 

 

In the Q&A discussion about the r*, or the natural rate of interest, Powell revealed that the Fed is monitoring how the market responds to monetary policy to measure whether how the tightness of monetary policy. He also stated in his speech that “ongoing rate increases will be appropriate in order to attain a policy stance that is sufficiently restrictive to move inflation down to 2 percent over time”. 

 

The Chicago Fed National Conditions Index has been easing and financial conditions eased further in the aftermath of Powell’s speech. Did the Fed Chair overdo the dovish tilt? Did he inadvertently ease financial conditions with his speech? (Asking for a friend).

 

 

In summary, Fed policy in 2023 can be summarized as raise and hold. In the current circumstances, the odds of rate cuts later in the year are relatively low, which is contrary to market expectations.

 

 

 

The bear case

Notwithstanding the macro case to be cautious on stocks, here are the technical and sentiment bear cases. Insider activity has seen a recent surge of selling.

 

 

Jay Kaeppel at SentimenTrader found that similar past episodes have been short-term bearish but longer-term bullish for stock prices.

 

 

Don’t forget that the Fed’s quantitative tightening program is still operating in the background. Liquidity conditions are starting to roll over, and they have been strongly correlated to the S&P 500.

 

 

The S&P 500 is testing key resistance levels, as defined by its 200 dma and falling trend line, while it is overbought on the percentage of stocks above their 20 dma. The market has been behaving in an unusual way. It failed to rally significantly on Thursday after the tame PCE report and it rallied to nearly even after the stronger than expected Jobs Report on Friday. Do you feel lucky?

 

 

Finally, 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 SPXU

 

How the World Cup almost unraveled China

Posted by Cam Hui -
The Chinese authorities were stuck between a rock and a hard place. On one hand, COVID caseloads were skyrocketing; on the other hand, after two years of a series of on-again-off-again of lockdowns, it was unsurprising that Chinese citizens, many of them young, got a case of cabin fever and protested the government’s COVID policies in a series of nationwide demonstrations. A podcast from the Economist argued that the combination of strict lockdowns and ubiquitous government monitoring led to widespread dissatisfaction.

 

Two incidents were believed to be the final straws that were the catalysts for the unrest. The first was an apartment fire in the city of Urumqi in western Xinjiang, where 10 people died, in which fire exits were locked because of COVID restrictions that trapped occupants inside, and COVID barriers prevented firefighters from reaching the building. In addition, broadcasts of the World Cup showed numerous unmasked spectators in the stands, which ran counter to the government’s narrative that China was controlling the pandemic much better than the West.
 

 

Protests are relatively common in China, but it’s rare to see them erupt spontaneously and in different cities. While the authorities appear to have the protests under control, it could be argued that broadcasts of the World Cup were a spark that almost unraveled China.

 

 

The evolution of China’s COVID policies

About a year ago, a patient in Wuhan was diagnosed with an affliction known as a novel coronavirus. The outbreak spread and medical staff and researchers didn’t really know how to react. There was no known cure. The only treatment at the time was isolation and, if necessary, intubation. The fatality rates were horrendous. As the pandemic spread out of China, the West was overwhelmed. Who could forget the devastation in northern Italy, which was the richest and most industrialized part of the country, and when it first cases landed in America in Washington State? China reacted by putting the entire country into quarantine and voluntarily shutting down its economy. The measures worked, and they allowed China to return to some semblance of normality.
 

Fast forward to 2022, vaccines are widely available and served to control the effects of the pandemic. However, Chinese vaccines are less effective than the mRNA vaccines in the West and vaccination rates are low among the vulnerable elderly. The authorities reacted with the same-old draconian tactic of lockdown and quarantine to control the pandemic. Despite these steps, caseloads are skyrocketing.

 

As a consequence of the lockdowns and restrictions, dissatisfaction bubbled up and protests appeared. While protests are not unusual in China, the grievances were usually localized, such as peasants objecting to having their land taken away by corrupt officials or protests over environmental issues. These protests are unusual inasmuch as they are nationwide and in objection to a specific Xi Jinping policy initiative. At the extreme, the dissent became overtly political and some even called for Xi Jinping to step down or for the CCP to cede power. 

 

 

The economic fallout

Moreover, the economic effects are worsening. China’s PMI came in below expectations and in contraction territory. 

 

 

Lockdowns are intensifying and they cover nearly 60% of GDP.

 

 

Bloomberg reported that the virus is rapidly spreading and affecting production, with over half of firms reporting a case among their employees this month.
About 53% of companies surveyed by China Beige Book said they’d had a case in their workforce this month. That was more than double the 24% who reported a case in October and the highest level in data back through January last year, according to the report. 
It is no surprise that household confidence skidded badly.

 

 

The low level of household confidence has exposed the fault lines in the all-important real estate market and cratered the finances of the over-leveraged property development companies.

 

 

 

The policy response

In response to the protests, which are reportedly ongoing, the authorities have opted for a three-pronged approach.
  • Adopt a more conciliatory tone;
  • Reinforced the police presence on the streets; and
  • Use the State’s ubiquitous monitoring apparatus to discourage individual dissidents.
Jiang Jiang, a reporter at China’s official media Xinhua, recently recounted an official article, “‘People first’ is not ‘Covid control first'”. While the title sounds conciliatory, it explains the dilemmas that the authorities face in addressing the protesters’ grievances.

 

 

Here are some key excerpts. The initial tone is conciliatory.

Epidemic prevention and control is to prevent the virus, not to prevent people; there is no such thing as “epidemic prevention first” but “people first”. No matter what kind of prevention and control measures are taken, they should be aimed at returning society to normal ASAP and getting life back on track as soon as possible. All options are “bridges” and “boats” to this goal, not simply to restrict people, regardless of the cost of blind brute force. 

But later the account addressed the issue of the unmasked spectators at the World Cup and outlined the tradeoffs.
During this period, the World Cup in Qatar is in full swing. The crowd in audience didn’t wear masks, look at the scene of the revelry, everything seems to be no different from before the epidemic. Some people ask: “Many countries in the world now have everything as usual.
Up to now, there are 636 million new confirmed cases and over 6.6 million cumulative deaths worldwide, with 230,000 new confirmed cases and 428 deaths in a recent day. Among them, Japan, which has 126 million people, sees 98,000 new confirmed cases per day; South Korea has a population of more than 50 million people. It sees 47,000 new confirmed cases per day.
Simply put, China doesn’t have the medical capacity to open up 
Regarding medical resources, this year China has 6.7 medical beds per 1,000 population, compared with 12.65 in South Korea, 12.63 in Japan and 7.82 in Germany in 2020. In 2020, China has 4.5 ICU beds per 100,000 people, Germany 28.2, the U.S. 21.6, France 16.4 and Japan 13.8, a global average of 10. Earlier this year, covid critically ill patients occupied 32.7% of the total ICU capacity in the U.S., and about 7 ICU beds per 100,000 people were crowded by covid critically ill patients, the number of which has exceeded the total number of ICU beds per 100,000 people in China. As of the end of 2021, China’s population aged 60 & above reached 267 million, & the population of children exceeded 250 million, so the size of “the elderly and the children” group is huge.
Opening up would be a medical disaster for China.
According to the latest data from Singapore, the mortality rate of infection among the elderly aged 60-69, 70-79 and 80 years old and above with vaccine protection is 0.014%, 0.064% and 0.54% respectively; the mortality rate of infection among the elderly in the three age groups without vaccine protection is 0.19%, 0.29% and 2.5% respectively. And the three age groups of elderly people who have not completed vaccination in China are about 22.64 million, 16.16 million and 14 million respectively.If we completely lift all the restrictions now, according to the estimated mortality rate of infection in Singapore, the number of deaths in our country will reach about 600,000 for the elderly over 60 years old only.
In support of the 600,000 fatality projection, a separate analysis from The Economist concluded that a disorderly reopening could lead to 680,000 deaths.

The Economist has modelled the likely progress of China’s current outbreak. If it is allowed to proceed unchecked, even assuming all patients who need intensive care receive it (which they would not), some 680,000 people are likely to die.

Jiang Jiang concluded with some comments of his own [emphasis added]:
The piece focused on the expression of empathy with the public under epidemic prevention & control (which might explain why it enjoys some popularity now), explained the logic behind the current “Dynamic Zero-Covid” policy and listed many wrong actions of the local governments in implementing the policy. No signal can be seen from the article that China will change the overall policy soon, though the article mentioned the “iteration” and “optimization” of the policies. To me, it is a message to the public that the central government is aware of the various problems including “some interest groups 利益群体” behind the epidemic (though it was published by a local account), but it is not realistic to change the policy entirely now due to the reasons I highlighted in the last thread/
Despite the conciliatory tone from the authorities, no full de facto opening up is in the cards in China this winter. However, there may be some localized semi-loosening. Local authorities are allowing positive cases and close contacts to quarantine at home under certain conditions. As well, China is expected to reduce the frequency of mass testing and regular PCR tests, But any full exit from China’s zero-COVID policies will be a long process and dependent on how it manages increases in case counts, which are skyrocketing right now.

 

 

Investment implications

How should investors think about the current protests in China? How risk appetite reacts to events such as the unrest in China depends on how they are perceived. Will it be viewed as political instability, financial or economic instability, or will be shrugged off as business as usual? While history doesn’t repeat itself but rhymes, here are some historical templates to consider. 

 

The widespread nature of the unrest is reminiscent of the Tiananmen Crisis of 1989, though the level of dissent does not appear to be as deep as it was then. Chinese markets were highly immature at that time, and even Deng Xiaopeng’s Southern Tour, in which he pivoted to a more capitalistic friendly policy, would not occur until three years later in 1992. One of Xi Jinping’s first policy speeches as a new leader 10 years ago was about how the Soviet Union betrayed a fatal weakness in dealing with perestroika in the 1985-91 era. The current protests are a direct challenge to Xi and cannot be allowed to succeed. If other methods fail, watch for harsh means of repression. However, I believe a Tiananmen-style crackdown is unlikely. The more recent Hong Kong protests, which were far more serious and conducted without much censorship, were slowly smoldered by the authorities. Today, China’s surveillance state and its use of technology have become far more developed.

 

In 1989, Hong Kong’s Hang Seng Index, which was the best proxy for China, skidded -27.0% in the two months ending in June and recovered strongly for the rest of the year. By contrast, other major market indices hardly reacted at all to the political turmoil in China. In the spirit of the adage “buy to the sound of cannons, sell to the sound of trumpets”, 1989 was an illustration that political instability fears are generally good buying opportunities.

 

 

By contrast, an example of the financial and political instability scenario can be seen during the COVID Crash of 2020. The COVID-19 pandemic spread unchecked around the world. Had it not for the quick response of global fiscal and monetary authorities, the global economy could have collapsed into another Great Depression. Global equities were far more correlated than they were in 1989.

 

 

The combination of the Chinese authorities’ more conciliatory tone and harsh police measures may have served to keep a lid on the dissent. The markets took a risk-on tone in the hopes of the relaxation of zero-COVID measures, which may be fleeting. MSCI China has staged an upside relative breakout from a falling trend line, and so have a number of stock markets of China’s key Asian trading partners. From a technical perspective, China and China-sensitive markets may need some time to trade sideways and consolidate their relative gains. 

 

 

Investors are faced with the dilemma of missing out on the end of the zero-COVID bandwagon FOMO rally, while managing the reality that zero-COVID will not end immediately, nor are there any signs of a recovery in the Chinese economy. As well, they should be prepared for more near-term volatility, but keep in mind the outcomes from the 1989 and 2020 tail-risk scenarios.

 

“50 bps in December”, or “Stay the course until the job is done”

Posted by Cam Hui -

Mid-week market update: In the long awaited Powell speech, the Fed Chair signaled, “It makes sense to moderate the pace of our rate increases…[and] the time for moderating the pace of rate increases may come as soon as the December meeting”. The market reacted with a risk-on tone and began to discount a series of rate cuts in Q3 2023.
 

 

Every Fed speaker this week has said that the Fed isn’t going to cut rates. Powell concluded his speech with:

 

It is likely that restoring price stability will require holding policy at a restrictive level for some time. History cautions strongly against prematurely loosening policy. We will stay the course until the job is done.
The change from 75 bps to 50 bps has long been anticipated. Is the risk-on reaction appropriate in this instance? Should investors buy “the 50 bps in December”, or sell the “stay the course until the job is done” nattative?

 

 

Analyzing Powell’s speech

Powell covered the topics of inflation and the labor market. On inflation, he found the October inflation data to be encouraging, but “it will take substantially more evidence to give comfort that inflation is actually declining. By any standard, inflation remains much too high.” Powell observed that goods inflation is falling. The housing services component is accelerating, though he acknowledged that it is a lagging indicator. Core services less housing has been flat, which is a function of the labor market.

 

 

However, the labor market is still too tight, and “a significant and persistent labor supply shortfall opened up during the pandemic—a shortfall that appears unlikely to fully close anytime soon”. He added, “A moderation of labor demand growth will be required to restore balance to the labor market.”

 

Wage growth has also begun to decline, “but the declines are very modest so far relative to earlier increases and still leave wage growth well above levels consistent with 2 percent inflation over time. To be clear, strong wage growth is a good thing. But for wage growth to be sustainable, it needs to be consistent with 2 percent inflation.”

 

 

While he confirmed market expectations that the Fed will raise rates by 50 bps at the December meeting, he cautioned that “Given our progress in tightening policy, the timing of that moderation is far less significant than the questions of how much further we will need to raise rates to control inflation, and the length of time it will be necessary to hold policy at a restrictive level.”

 

In other words, don’t expect rate cuts anytime soon. In fact, there was no discussion of easing in his speech.

 

 

Other warnings

There are other warning signs. In addition to Powell’s speech, Vice Chair Lael Brainard made a speech to the BIS that highlighted the risk central bankers could face more inflationary volatility from climate change, demographics, and deglobalization.
In addition, to the extent that the lower elasticity of supply we have seen recently could become more common due to challenges such as demographics, deglobalization, and climate change, it could herald a shift to an environment characterized by more volatile inflation compared with the preceding few decades.
While bond market based measures of inflation expectations have been relatively stable, other metrics present a more disturbing picture.

 

 

The Central Bank Research Association is maintaining an experimental inflation expectations indicator, or indirect consumer expectations (ICIE), based on research from the Cleveland Fed.
Surveys often measure consumers’ inflation expectations by asking directly about prices in general or overall inflation, concepts that may not be well-defined for some individuals. In this Commentary, we propose a new, indirect way of measuring consumer inflation expectations: Given consumers’ expectations about developments in prices of goods and services during the next 12 months, we ask them how their incomes would have to change to make them equally well-off relative to their current situation such that they could buy the same amount of goods and services as they can today.
The good news is ICIE is in retreat. The bad news is the absolute reading of 7.56% is very high compared to conventional surveys.

 

 

In conclusion, the knee-jerk risk-on reaction of the market to the Powell speech seems unwarranted. The Fed will stay the course until the job is done.

 

 

Market technicals

From a technical perspective, the S&P 500 is testing key resistance at the 200 dma and the descending trend line while the NYSE McClellan Oscillator flashes a series of negative divergences.

 

 

As well, equity risk appetite indicators peaked in mid-November. Equally disturbing is the violation of relative support by the highly speculative ARK Investment ETF.

 

 

Despite the recent show of market strength, defensive sectors are all in relative uptrends.

 

 

I am inclined to stay cautious. My inner trader is holding to his short position and he has a stop placed just above the descending trend line. 

 

 

Disclosure: Long SPXU

 

Waiting for clarity from the Nov 30 Powell speech

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: Sell equities
  • Trend Model signal: Neutral
  • Trading model: Bearish

Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at @humblestudent@toot.community. 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.
 

 

Marginally more dovish

Fed policy is still moving markets. The release of the November FOMC minutes confirmed what Fed officials had been telegraphing in the past few weeks, namely that “a substantial majority of participants judged that a slowing in the pace of increase would likely soon be appropriate”. However, “the target range for the federal funds rate…had become more important …than the pace of further increases in the target range”. Fed Funds expectations turned marginally more dovish in the wake of the release and the S&P 500 rallied. 

 

 

Despite the market’s excitement about the slowing in the pace of rate hikes, Fed Chair Powell sounded a more hawkish tone and said during the November FOMC press conference that he’s “never thought of [a series of milder inflation readings] as the appropriate test for slowing the pace of increases or for identifying the appropriately restrictive level”. Fed Chair Jerome Powell is scheduled to speak at the Brookings Institution on November 30 on the economy and labor markets, just two days before the  start of the blackout window for Fed speeches ahead of the December FOMC meeting. That speech is likely to set the tone for the markets for the coming weeks.

 

 

Why QT and liquidity matters

As well, investors may have forgotten about the FOMC’s decision to “continue the process of reducing the Federal Reserve’s securities holdings, as described in the Plans for Reducing the Size of the Federal Reserve’s Balance Sheet that the Committee issued in May”, otherwise known as quantitative tightening (QT). While correlation isn’t causation, the size of the Fed’s balance sheet has closely tracked the S&P 500 in the post-COVID Crash era. That’s because liquidity matters to stock prices.

 

 

Despite the ongoing quantitative tightening program that’s reduced the size of the Fed’s balance sheet, liquidity conditions have improved because of changes in reverse repos and rundowns in the Treasury General Account. Liquidity conditions are highly correlated to the S&P 500, but the conditions that boosted liquidity should be temporary.

 

 

Indeed, Cross Border Capital has argued that the Fed liquidity is exhibiting a staircase pattern, and it’s correlated to the S&P 500. 

 

 

Analysis from Pictet Asset Management shows that the S&P 500 is trading at a premium to liquidity-implied fair value.

 

 

Moreover, non-US M2 growth has been plunging precipitously, which creates headwinds for equity prices..

 

 

A recent OECD simulation found that when all countries hike rates in concert, the impact on inflation is less while the negative effect on inflation is higher. These factors may act to keep the Fed more hawkish than what the market expects.

 

 

 

Waiting for Powell

That’s why Powell’s upcoming speech could set the tone for asset prices. Fed policy has affected Treasury yields and the USD, and the S&P 500 has been inversely correlated to the USD for all of 2022. 

 

 

You can tell a lot about the psychology of a market by seeing how it reacts to news. The S&P 500 rose only 0.6% after the release of the FOMC minutes. The index is nearing two key resistance levels, its 200 dma at about 4060, and its falling trend line at about 4080-4100 while exhibiting overbought conditions, as measured by the VIX Index recently breached its lower Bollinger Band and the percentage of S&P 500 stocks above their 50 dma is within a hair of 90%. As well, the NYSE McClellan Oscillator (NYMO) flashes negative divergence through a series of lower highs and lower lows. I interpret these conditions as the market advance is poised to stall.

 

 

While there is undoubtedly a dovish contingent within the FOMC, the message from recent Fed speakers has emphasized the risk of under-tightening and allow inflation to get out of control. Powell has sounded a more hawkish tone than other members in the past. his speech sets up a potential pivotal turn for risk appetite into the end of 2022.

 

The subject of Powell’s speech is the economy and labor markets. I expect that he will reiterate his determination to maintain a tight monetary policy until there is “clear and convincing evidence” that inflation is falling. As well, he will also focus on the labor market, which is still tight, and probably cite low unemployment and strong wage growth as hurdles for pausing interest rate increases. As a reminder, the Chicago Fed National Financial Index is slightly lower, or looser, than the readings at the time of Powell’s Jackson Hole speech that cratered the S&P 500 -3.4% in one day. 

 

 

In addition to the Powell speech, which is on Wednesday at 1:30 pm ET, the market will see a number of key inflation and labor market data points that could be sources of volatility, namely the PCE report and JOLTS report on Wednesday and the Non-Farm Payroll report Friday.

 

 

Disclosure: Long SPXU

 

A cyclical rebound mirage?

Posted by Cam Hui -

I highlighted a widening gulf between the technical and macro outlook in August (see “Price leads fundamentals”, or “Don’t fight the Fed”?). At the time, the technical indicators were wildly bullish because of strong price momentum, while the macro outlook was cautious. The macro view eventually won out.
 

A similar divide may be appearing again, albeit not as wide. Technical internals has been pointing to a shift in leadership to value and cyclical sectors, indicating the emergence of cyclical green shoots. Further analysis of technical internals, as well as the macro picture, indicate that hope of a cyclical rebound may be an illusion.

 

 

Here’s why.

 

 

Technical deterioration

Here are some signs of technical deterioration to ponder. If the market is discounting a cyclical revival, why have the relative performance of defensive sectors been in minor uptrends since the S&P 500 rallied off its October low. Should defensive sectors be losing ground on a relative basis under such circumstances?

 

 

Further analysis of the relative performances of individual sectors reveals inconsistencies. Historically, the relative returns of Financials have been correlated to the shape of the yield curve. Banks tend to borrow short and lend long. A steepening yield curve enhances profitability while a flattening yield curve reduces profitability. As the yield curve flattens, this leads to a negative divergence in the relative strength of Financials. As well, the relative breadth of the sector (bottom two panels) have been flat to down, which is not a positive sign for sector leadership.

 

 

The Industrials sector enjoyed a strong recent rally and the sector appears a bit extended. Relative breadth is also weakening, which is another warning sign.

 

 

Energy stocks staged upside absolute and relative breakouts, which are positive signs, but relative breadth has been weakening since mid-October.

 

 

I interpret these charts as the market having second thoughts on the prospect that a cyclical rebound is just around the corner. The US value/growth rebound can be explained mainly by weakness in large-cap growth stocks. Developed international value/growth, as represented by the EAFE Index, has been trading sideways since early September.

 

 

 

Recession ahead

From a top-down macro perspective, the idea of a bottom and cyclical rebound doesn’t make sense. Signs of an impending recession are everywhere. The November FOMC minutes indicate that “the staff…viewed the possibility that the economy would enter a recession sometime over the next year as almost as likely as the baseline”. New Deal democrat, who maintains a set of coincident, short-leading, and long-leading indicators, is warning about a recession in H1 2023.
  • A significant majority of the short leading indicators, as codified by both the Conference Board and previously by Prof. Geoffrey Moore, have all declined from their peaks.
  • This decline has been long enough and strong enough, per past experiences with the onset of recession, to justify a warning that a recession is more likely than not to begin in the next 6 months.
The Conference Board’s Leading Economic Indicators Index just fell into recession territory.

 

 

The NDR Index of Coincident Economic Indicators is also flashing a recession signal.

 

 

 

Valuation and earnings risk

Notwithstanding the risk of deteriorating fundamentals from a recession, the S&P 500 is slightly overpriced based on current earnings estimates. The index is trading at a forward P/E of 17.5, based on bottom-up derived EPS estimates. The last time the 10-year Treasury yield was at similar levels, the market was trading at a P/E range of 13-15, though it fell to a high single-digit multiple during the 2008 panic.

 

 

Bottom-up EPS estimates are only starting to fall, but the decline is nowhere near the 15-20% peak-to-trough basis seen in a garden variety recession. According to FactSet, consensus bottom-up derived S&P 500 EPS estimates for 2023 is $232. Bloomberg reported that the average Wall Street strategist estimate is $215, with a high of $232 from Jefferies and a low of $185 from Morgan Stanley. It’s not unusual to see top-down estimates diverge from bottom-up estimates at major economic turning points. Strategists can estimate the economic impact from their top-down models, while individual company analysts have to wait for company guidance to change their estimates. This is a signal that bottom-up aggregated estimates have much further to fall. The combination of an elevated forward P/E ratio with the prospect for further cuts in earnings outlook is an indication that a valuation air pocket is ahead for equity investors.

 

 

 

The bull case

Even though the economic and valuation outlook appears dire, here is the bull case, or at least some mitigating circumstances indicating that any downturn should be mild.

 

The first is a high level of household savings in developed economies.

 

 

A Federal Reserve study confirmed the findings of high savings. While low income households are stressed, middle and high income consumer balance sheets are in good shape.
 

 

I would warn, however, that while elevated levels of household savings could act to cushion the effects of a recession, the magnitude of the effect could be relatively minimal. Consider, for example, how the housing market has become the economic cycle. As mortgage rates have surged, strong levels of savings will have a relatively minor effect on the deterioration of housing affordability. As a consequence, housing permits, which lead housing starts, have plummeted.

 

 

As property prices have risen dramatically around the world, housing affordability has been a problem in many countries.

 

 

Another factor that has raised hopes on Wall Street is the China reopening narrative. It is said that China is undergoing a process of relaxing its Zero COVID policy. As well, Beijing unveiled a 16-point plan to stabilize its property market.

 

Despite all of the hopes about a COVID policy relaxation, the barriers to a full reopening are considerable. China has taken a different course to address the pandemic compared to the rest of the world as it continues to pursue the lockdown as a primary tool of disease control. Vaccination rates are relatively low compared to other Asian countries, especially among the vulnerable elderly population. A relaxation of COVID restrictions will also require a significant expansion of hospital and ICU capacity, which is not at all evident. The recent steps at relaxation have predictably collapsed. China’s daily case count reached an all-time high and the city of Beijing has relapsed back into the strictest level of quarantine.

 

 

Equally concerning is a Bloomberg report that the Street consensus has shifted to turn bullish on China. The China reopening narrative is extremely vulnerable to disappointment.

 

 

On the property front, I am monitoring the Premia China USD Property Bond ETF (3001.HK). The ETF measures the USD-denominated bonds of Chinese property developers, whose price slide has begun to stabilize, but it’s not showing signs of a strong recovery.

 

 

There is one green shoot and right-tailed risk on the horizon that hasn’t been discounted by the markets. The protests in Iran have become more serious and widespread. Tehran has shifted from a counter-protest approach to a counter-insurgency approach, which is an indication that the regime feels it is increasingly threatened. The IRGC has been deployed instead of regular police and it is resorting to deadly force in some instances. 

 

While this is not my base case, a collapse of the Iranian regime would have dramatic geopolitical and financial consequences for the region and the world. It would deprive Russia of a key arms supplier and create more pressure on the Kremlin to sue for peace. As well, a less belligerent government in Tehran would allow Iranian oil to flow more freely and put downward pressure on energy prices, which would be a welcome relief for global central bankers concerned about inflation, and act as an enormous risk-on catalyst for asset prices. Indeed, oil prices have begun to moderate, even without the collapse of the Tehran regime, which I would characterize as a green shoot.

 

 

In conclusion, a more detailed analysis of market internals indicates that hopes of a cyclical rebound are beginning to fade. Macro and valuation risk are weighing on equity prices and downside risk remains. As the expectations of a recession are becoming consensus, investors may be better served in a greater allocation to Treasury bonds than stocks over the coming months.

 

 

 

Things are breaking beneath the surface

Posted by Cam Hui -

Mid-week market update: I thought that I would publish an early mid-week market update in light of the shortened US Thanksgiving trading week. As the S&P 500 consolidates in a narrow range between 3900 and 4000, things are breaking beneath the surface.
 

Let’s begin the analysis at the extreme risk part of the market. As the crypto world teeters, Bitcoin is weakening, Coinbase shares (COIN) have broken support, and the Bitcoin to Greyscale Bitcoin Trust (GBTC) ratio erode, indicating a widening NAV discount.

 

 

I haven’t conducted a full analysis of Coinbase, but consider the market’s signals on the company. Its debt is trading at nearly 50c on the dollar. If the entire edifice were to collapse, will the common shareholders receive anything in liquidation?

 

 

Then we have the cult favorite, Tesla. TSLA broke neckline support on a head and shoulders formation on the monthly chart. The measured downside objective is *gasp* about $20.

 

 

Another warning can be found in the relative performance of defensive sectors. Even as the S&P 500 rallied off the October bottom, defensive sectors were all in relative uptrends during that period.

 

 

Finally, the VIX Index just breached the bottom of its Bollinger Band, which is usually an indication of an overbought stock market. Past occurrences have foreshadowed market stalls in the last six months. 

 

 

I recognize that Thanksgiving Week is normally thought of as a period of positive seasonality for stock prices. But analysis from Jeff Hirsch shows that the seasonality win rate on Tuesday and Wednesday has been positive, upside potential was been relatively weak.

 

 

In the short run, the key trigger for market direction may be the release of the FOMC minutes tomorrow. Stay cautious.

 

 

Disclosure: Long SPXU

 

Sentiment whipsaws are masking the bear trend

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: Sell equities
  • Trend Model signal: Neutral
  • Trading model: Bearish

Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at @humblestudent@toot.community. 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.
 

 

A risk-on stampede?

I pointed out in the past that risk appetite in 2022 can largely be attributable to changes in the USD. The S&P 500 has shown a close inverse correlation to the greenback. Now that the USD has decisively violated trend line support, does that mean that it’s time for investors to stampede into a risk-on trade?

 

 

What are the fundamentals that explain the technical breakdown in the USD? Has the Fed signaled that it is about to out-dove the European Central Bank and other major central banks, which would narrow interest rate differentials and weaken the dollar? Will other central banks out-hawk the Fed?

 

 

A positioning whipsaw

The risk-on rally since the soft October CPI report can mainly be attributable to the combination of a positive surprise and a crowded short, which led to a price whipsaw based on excessive positioning.

 

Respondents in the latest BoA Global Fund Manager Survey agreed that the most crowded trade for the fifth consecutive month is a USD long, which is a risk-off position.

 

 

The survey also showed a crowded underweight in equity positioning, with the caveat that respondents were correctly cautious the last time sentiment reached similar lows during the 2008 bear market.

 

 

The holdings report of the DBMF active ETF provides a useful window into the positioning of managed futures commodity trading advisers or CTAs. DBMF is short Treasuries and rates, long the USD, and roughly flat equities. It was therefore no surprise that a soft CPI report sparked a risk-on stampede in bond prices.

 

 

The bond price surge is probably on its last legs. Garfield Reynolds, Chief Rates Correspondent for Bloomberg News in Asia, observed that the market reaction to St. Louis Fed President Jim Bullard’s remarks that the Fed Funds policy rate needs to reach at least 5% put an abrupt end to the bond  buying stampede as bond market volatility turns up.
A look at the action for implied volatility gauges underscores the potential for further wild moves. The classic MOVE Index, based on one-month volatility, tumbled to well below the three-month gauge and has since rebounded. The last two times that happened, in August and June, both indexes soared to fresh highs. Get ready for a wild year-end, because it looks like the bond market is gearing up for one.  

 

 

 

A stall ahead?

The equity market’s technical internals indicate that the rally is losing momentum. The S&P 500 advance stalled at the key Fibonacci retracement level of 4000 with a spinning top candlestick on the weekly chart, indicating a possible inflection point. This is the perfect spot for the bears to become more active.

 

 

The NYSE McClellan Oscillator recycled from an overbought condition, which is an ominous sign that price momentum is rolling over.

 

 

The 5-day correlation between the S&P 500 and VVIX, which is the volatility of the VIX, spiked while NYMO is positive. There were 26 such signals in the last five years, of which 18 resolved bearishly and eight bullishly.

 

 

Sentiment isn’t excessively bearishly anymore. The Fear & Greed Index has evolved from an extreme fear reading to greed.

 

 

Similarly, the NAAIM Exposure Index, which measures the sentiment of RIAs managing retail investor funds, has steadily recovered from a bearish extreme.

 

 

 

Negative seasonality

The stock market will also face short and intermediate-term seasonal headwinds. While US Thanksgiving week has a record of positive seasonality, Mark Hulbert pointed out that the 2022 FIFA World Cup begins on November 20 and stock returns tend to be weak during the tournament.

 

 

Looking into 2023, conventional seasonality analysis shows that stock prices tend to be strong during the third year of a Presidential cycle. However, Jeroen Blokland pointed out that the US economy has never experienced a recession during the third year of a Presidential term. 2023 will be the likely exception, which will create headwinds for stock prices in the first half of next year.

 

 

In conclusion, the recent risk-on episode is attributable to the combination of excessively bearish sentiment and a positive inflation surprise. Most of the effects of the buying stampede have likely dissipated. Technical conditions are weak and the bear market is poised to resume.

 

Subscribers received an alert on Thursday that my inner trader had re-entered a short position in the S&P 500.

 

 

Disclosure: Long SPXU