Page 4 – Humble Student of the Markets

Here comes the end-of-year positioning season

Posted by Cam Hui - December 11, 2024

Mid-week market update: We are entering the time of year when investors and traders position themselves for the end of the year. These conditions have made it more challenging for anyone trying to trade based on conventional technical analysis.

The most obvious is tax loss selling, when investors harvest losses to offset their (likely) considerable gains of 2024. Another is hedge funds shutting down their books in order to avoid the thin and potentially volatile market environment during the last two weeks of December.

We likely saw some hedge fund profit taking this week when Bespoke observed that winners were being sold and losers were being bought. This is consistent with market-neutral or long-short funds squaring their books for the year.

The anti-momentum, or price reversion, trade continued this week. The relative performance of price momentum ETFs all reversed sharply downward across the board.

Market cross-currents

End-of-year market positioning has also disrupted breadth indicators. Jason Goepfert pointed out that even there have been more declining than advancing stocks for seven consecutive days even as the S&P 500 is only 3% off its all-time high. This has only happened twice in the last 25 years. Even though such episodes seemed to have occurred shortly before major market tops, I am not sure that such readings lead conclusively to a bearish view in light of the low sample size and the unusual seasonal effects in December.

As I expected, the S&P 500 began to consolidate sideways and stage a shallow pullback after it ended its upper Bollinger Band ride (see Bitcoin 100K: Buy or Fade the Animal Spirits). What’s unusual about the current condition is even as the S&P 500 remains elevated, breadth internals are weak and oversold. The percentage of stocks above their 20 dma reached levels consistent with short-term bottoms when the market was in an uptrend.

A benign CPI report

Does that mean the short-term decline is over and stocks will start to rally into year-end from current levels? Equity bulls received a boost from the benign CPI report this morning, but selling pressure may not end until hedge funds wind up their profit taking. In addition, there may be further downside pressure from tax loss selling, though it will likely be reduced because there are fewer losses to harvest.

CPI and core CPI came in right at market expectations and inflation did not rise more than expected. This sets up a quarter-point rate cut at the December FOMC meeting. However, Powell may have to adjust market expectations about the pace of rate cuts in 2025 during the post-meeting press conference.

In conclusion, stocks are likely to begin a rally into year-end soon. Current conditions are difficult to navigate in light of severe seasonal cross-currents. I’ll be watching to see how price momentum behaves for signs that hedge fund profit taking is over. Be prepared for more near-term choppiness.

Bitcoin 100K: Buy or fade the animal spirits?

Posted by Cam Hui - December 8, 2024

Preface: Explaining our market timing models

We maintain several market timing models, each with differing time horizons. The “Ultimate Market Timing Model” is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Asset Allocation Model is an asset allocation model that applies trend-following principles based on the inputs of global stock and commodity prices. This model has a shorter time horizon and tends to turn over about 4-6 times a year. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don’t buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
Trend Model signal: Neutral (Last changed from “bullish” on 15-Nov-2024)
Trading model: Bullish (Last changed from “neutral” on 15-Oct-2024)

Update schedule: I generally update model readings on my site on weekends. I am also on X/Twitter at @humblestudent and on BlueSky at @humblestudent.bsky.social. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.

Subscribers can access the latest signal in real time here.

Crypto leads the stampede

Now that Bitcoin has exceeded the psychologically important 100,000 mark, it is becoming evident that the FOMO risk-on stampede is in full force. The risk-on mood can also be seen in the relative performance of speculative growth stocks, as measured by the Ark Investment ETF (ARKK), which has shown a roughly correlation with Bitcoin. In addition, ARKK has staged an upside breakout from a multi-month base.

Is it too late for traders to hitch a ride on the risk-on train or should they fade the rally? Here are the bull and bear cases.

Bullish breadth

The bull case mainly rests on the strength of intermediate breadth indicators. Advance-Decline lines recently made fresh all-time highs, which is a sign of bullish price momentum. While there are some short-term blips that may be of concern that I’ll discuss later, the strength of the A-D Line is an indication that no top is in sight.

Technical analyst Willie Delwiche confirmed my observation of intermediate-term strength by observing that over half of S&P 1500 industries are making new 52-week highs, which is an indication of broad-based strength.

The price momentum factor, which measures the propensity of rising stocks to keep on rising and leading the market, has also been strong. The relative performance of different momentum ETFs are all rising.

An extended advance

The bears will argue that the market’s price advance appears extended. The 10 dma of the CBOE put/call ratio has reached the froth zone. Past instances have generally resolved in market pullbacks.

The post-election rally has been impressive. The S&P 500 (top panel) reached the top of its Bollinger Band last week, which is an overbought condition. The market has often gone on upper BB rides under such circumstances in the past, but the market has either consolidated sideways or staged shallow retreats whenever the upper BB ride was over. One warning of possible weakness can be seen in the equal-weighted S&P 500 (bottom panel), which never reached the upper BB in the last advance. I interpret this development as a sign of short-term underlying weakness that calls for a period of consolidation or minor weakness.

A case of narrow leadership

The recent S&P 500 rally has been marked by narrow leadership. Even as the S&P 500 reached all-time highs last week, both the equal-weighted S&P 500 and the Russell 2000 are lagging the S&P 500 in the latest advance. Similarly, the percentage of S&P 500 above their 50 dma were declining. Even though intermediate breadth indicators remain strong, these breadth negative divergences could be warnings of short-term weakness ahead.

The narrow leadership has been characterized by a sudden rotation from value into growth, whose dominance has been global in scope.

I have some doubts as to the short-term sustainability of growth leadership. Semiconductor stocks, which have been the growth bellwethers, are exhibiting a series of lower highs and lower lows, both on an absolute basis and relative to the market.

I conclude that the risk-on FOMO stampede that’s driving the animal spirits is on the verge becoming exhausted. Stock prices are due for a short breather. However, intermediate breadth indicators are supportive of further advances. My base case calls for a brief period of consolidation or shallow weakness, followed by a rally into year-end.

Investing during an era of American Exceptionalism

Posted by Cam Hui - December 7, 2024

As 2024 draws to a close, it is becoming clear that the U.S. equities have led the way for most of the year. The accompanying chart shows the relative returns of equities by major region against the MSCI All-C ountry World Index (ACWI). The U.S. has been the only safe-haven of growth as the economies of other regions sputtered.

This was the year of TINA (There Is No Alternative) for American equities. Can it continue into 2025?

The story of American Exceptionalism

Much of the strong returns shown by U.S. equities is attributable to the Magnificent Seven.

Here is an example of how U.S. megacap growth has been dominant. NYU Stern professor Aswath Damodaran, who is considered to be the “dean of valuation”, characterized the Magnificent Seven as cash machines in a Bloomberg TV interview, “As a value investor, I have never seen cash machines as lucrative as these companies are. And I don’t see the cash machine slowing down.” He went on to advise investors to buy Magnificent Seven stocks on a correction, “I’d suggest that when that happens you find a way to add at least one, maybe two or three of these companies because these are so much part of what drives the economy and the market.”

Across the Atlantic, Germany has been beset by manufacturing weakness and falling employment. France, the other major axis of Europe, is mired in a budget crisis as the yield spreads on French OATs blow out.
Asia isn’t faring much better. The Chinese economy continues to sputter. The BoJ is trying to normalize interest rates, but by tightening monetary policy in the face a trend of global easing, it is risking a disorderly unwind of the Yen carry trade. In addition, South Korea is facing a political crisis that’s rattled markets.

As a consequence, the USD is following the path set in 2016 after Trump won the election.

A different kind of cycle

For some perspective, here is why the current cycle is different and some of the conventional rules of thumb of investing are not applicable.

Global central banks are undergoing an easing cycle. In the past, instances of co-ordinated easing were signals of weakening growth. Instead, monetary easing is occurring against a backdrop of a reasonable global growth outlook, which is very different from past aggressive easing cycles.

This time, the easing response to excessively tight monetary policy. Inflation, which had spiked in the wake of the COVID pandemic response, is now normalizing. Fed Chair Powell stated last week that the economy is strong and signaled the Fed is likely to slow the pace of easing, “The good news is that we can afford to be a little more cautious as we try to find” the neutral rate. The market interpreted his remarks as the Fed will cut by a quarter-point at the December FOMC meeting and ease on a gentler path in 2025.

Inflation surprises around the world have stabilized, which may be a concern as most inflation measures haven’t fallen to their 2% targets.

Financial markets have responded with a risk-on tone to these conditions. Most global stock markets are at or near either recovery or all-time highs. Yield spreads, with certain exceptions like France, are tight.

A year of transition

I had a number of discussions in last week’s publication that projected flat to low single-digit returns for the S&P 500 in 2025 (see 2025 Outlook: Cautious But Not Bearish).

Here is the back-of-the-envelope math for my reasoning. The S&P 500 trades at a forward P/E of 22, which is highly elevated by historical standards, meaning that earnings growth will have to do most of the heavy lifting if stock prices are to advance. As there is no recession on the horizon, let’s pencil in 8–12% earnings growth, which is roughly nominal GDP (3% real + 3% inflation) plus 2–6% margin improvement. Subtract from earnings growth of 8–12% a P/E compression of 1–3 multiple points, you arrive at flat to slightly positive return expectations.

Despite the subpar S&P 500, investors can find pockets of opportunity. Regular readers know that I am a long-term gold bull, but the accompanying chart shows the big picture macro shifts in perspective. Here are the key takeaways:

The Gold/S&P 500 is undergoing a multi-year bottom process, which is a signal of a slow shift from disinflation to reflation.
Similar synchronized bottoming processes can be seen in size (small vs. large caps), value/growth and small-cap value/large-cap growth.
While equity factor returns such as size and value/growth cycles are evident, gold is still dominant, as shown by the gold/S&P 600 small-cap chart (bottom panel).

I believe 2025 will be a year of transition for global markets: from large caps to small caps, from growth to value and from paper assets to hard assets, and gold in particular. From a contrarian perspective, even the perennially bearish David Rosenberg has thrown in the towel on his bearish stock market call and cited an “AI-induced model shift” as part of his reasoning.

What about the dominance of the Magnificent Seven that Aswath Damodaran gushed about? Analysis from FactSet shows that earnings growth expectations between the Magnificent Seven and the other 493 stocks in the S&P 500 are expected to narrow, especially in H2 2025. This argues for a gradual rotation from growth to value in the coming year. A similar dynamic can also be found in small cap against large caps, which much of the latter is dominated by the Magnificent Seven.

From a global perspective, U.S. equities are richly valued. The equal-weighted S&P 500 trades at a forward P/E of about 20, which isn’t cheap. Any way you look at it, if you exclude the Magnificent Seven or on an equal-weighted basis for the S&P 500, the price-to-book ratio of U.S. stocks is far higher than other developed markets, as measured by MSCI EAFE.

Opportunities are starting to appear in Europe. Historically, spikes in eurozone spreads have been good entry points into European assess. Tactically, it’s probably too early as the French contagion hasn’t spread to the rest of the eurozone. Wait for the panic over the next euro crisis. France is too big to save, which is precisely why the Eurocrat Establishment will save it.

As for Asia, I would prefer to wait for greater clarity on the Chinese growth outlook and how the BoJ normalizes monetary policy before becoming overweight in the region.

In conclusion, 2024 was a year of American exceptionalism and asset return domination, led by the leadership of the Magnificent Seven. I believe Magnificent Seven leadership is likely to fade in 2025. I expect that 2025 will be a year of transition from growth to value, large caps to small caps and paper to hard assets.

Seasonal weakness ahead?

Posted by Cam Hui - December 4, 2024

Mid-week market update: Jeffrey Hirsch of Almanac Trader recently indicated that the first part of December sees a period of seasonal weakness, followed by small cap leadership into year-end.

I regard seasonality as informing me about the climate, while the weather can vary day-to-day. Here is my assessment of the weather ahead.

The case for a pullback

Here is the case for some minor weakness. Urban Carmel pointed out that the market is overdue for a 3% pullback, especially when the put/call ratio is exhibiting signs of complacency.

Breadth indicators, as measured by NYSE and NASDAQ net 52-week highs-lows, as well as the percentage of S&P 500 stocks above their 20 dma, are rolling over. While instances in the past year have been inexact market timing signals, they have tended to resolve in periods of consolidation or minor pullbacks.

The first crack in the technical condition of the market may have been NVIDIA, which breached a rising trend line in late November. The stock is now trying to rally to regain the trend line. The strength of this bellwether could be an important indicator of market strength.

I am keeping an open mind, but I am not optimistic. The Semiconductor Index, which includes NVDIA, is exhibiting a series of lower lows and lower highs, both on an absolute basis and relative to the S&P 500.

Can small cap lead the way?

I am also watching to see if smaller stocks can lead the way. On one hand, the Russell 2000 is exhibiting a minor relative uptrend against the S&P 500 (bottom panel). On the other hand, the equal-weighted S&P 500 has been flat against the S&P 500 since early August.

Another question to consider is the 14-day RSI of the S&P 500 reached an overbought condition. This has either been signals of an imminent pullback, or the start of a “good overbought” advance. How will conditions resolve themselves?

Subscribers received an alert yesterday that my inner trader had exited his long position in the S&P 500 and stepped to the sidelines. Risk and reward is becoming more balanced. It’s time to watch and wait.

Stock market clues from the bond market

Posted by Cam Hui - December 1, 2024

Preface: Explaining our market timing models

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
Trend Model signal: Neutral (Last changed from “bullish” on 15-Nov-2024)
Trading model: Bullish (Last changed from “neutral” on 15-Oct-2024)

Subscribers can access the latest signal in real time here.

Clues from the bond market

The S&P 500 made a marginal all-time high last week and pulled back. However, investors may find insights about the near-term outlook for equities from the bond market.

The accompanying chart shows how the VIX Index (middle panel, red dotted line, inverted scale) and MOVE Index (middle panel, black line, inverted scale), which is the VIX of the Treasury market, have mostly normalized their episode of pre-election anxiety. However, MOVE hasn’t fully normalized compared to VIX. I interpret this to mean that there is more room for Treasury yields to fall (bottom panel), which would be supportive of equity valuation.

The combination of sentiment returning to pre-election levels and the S&P 500 remaining in a well-defined uptrend leads me to believe that stock prices can continue to rise into year-end.

A bond market turnaround?

After a brief pullback that began in September, bond prices may be poised for a turnaround. Nautilus Research documented that we are approaching a period of a positive seasonality for the price of the 20+ Year Treasury ETF (TLT).

Bloomberg also reported that option traders are betting on a deep Treasury sell-off, which is contrarian bullish for bond prices from a sentiment viewpoint.

Bessent’s 3-3-3 plan

Trump’s announcement of Scott Bessent as Treasury Secretary seems to have cheered the bond market. Bessent’s 3-3-3 plan for the second Trump term has calmed the markets. The 3-3-3 plan consists of reducing the fiscal deficit to 3% of GDP from 6.3% today by 2028; boosting real GDP growth to 3%; and raising U.S. energy production by 3 million barrels per day.

Bessent has shown himself to be a fiscal hawk and supporter of an independent Fed, which should be a relief to Wall Street. Since the news of his proposed nomination, reporters have scoured the internet for his views during his tenure as a hedge fund manager.

When Trump began to criticize the Fed for raising rates in 2018 in the wake of his tax cut bill, Bessent told the Australian Financial Review that the “late cycle stimulus” was like “throwing nitroglycerine in the engine” and compared the episode to LBJ’s guns and butter stimulus of the late 1960s. At the time, not only did he support the Fed’s decision to raise rates, but he also believed that the Fed was late in its rate hike cycle: “The Fed wanted to be behind the curve, but now they are behind the curve.”

In response, the 10-year Treasury term premium, which is the increased yield investors demand to hold long-dated debt, has steadied at elevated levels. Gold prices also pulled back, though the decline could be partly explained by a compression of the geopolitical risk premium from the news of the Israel-Lebanon ceasefire agreement.

In reality, Bessent’s views are a mixed bag, and they may not be as market friendly as conventional wisdom would have it. His hedge fund quarterly letter dated January 31, 2024 revealed a view that’s bullish on the Trump agenda: “Our base case is that a re-elected Donald Trump will want to create an economic lollapalooza and engineer what he will likely call ‘the greatest four years in American history’” and dismissed the threat of “the tariff gun will be always loaded and on the table but rarely discharged.” Instead, “Trump will pursue a weak dollar policy rather than implementing tariffs. Tariffs are inflationary and would strengthen the dollar – hardly a good starting point for a U.S. industrial renaissance. Weakening the dollar early in his second administration would make U.S. manufacturing competitive…and plentiful, cheap energy could power a boom.” Weakening the currency instead of using tariffs as a blunt instrument of trade policy – that’s the good news.

The bad news is he is unlikely to be overly bond market friendly. In a separate podcast, Bessent revealed that he is a gold bull: “I think we’re in a long-term bull market in Gold. We’re seeing reserve accumulation by Central Banks. I follow it closely. It’s my biggest position. Even I was surprised when the Central Bank of Poland said they want to take their Gold reserves to 20%.”

As well, a WSJ profile indicated that he plans to extend the TCJA tax cuts using pay-fors by “freezing nondefense discretionary spending and overhauling the subsidies for electric vehicles and other parts of the Inflation Reduction Act.” In other words, don’t expect any massive fiscal stimulus that provides fuel for equity prices.

Bessent faces additional pressure from refunding policy changes at the Yellen Treasury. When Biden took office, the average maturity of Treasury debt was about seven years, which means that financing rates are locked in for seven years before they have to be refinanced. Treasury Secretary Yellen has been changing the Treasury debt profile by issuing more T-Bills than coupons and the average maturity is now about four years. With rates now higher, Bessent will face inevitable interest rate costs in the budget as the U.S. Treasury refunds its debt. If he were to extend the term of Treasury issuance, it would put upward pressure in the mid and long end of the curve, putting downward pressure on both stock and bond prices.

Party now

In conclusion, investors can enjoy the party during this quiet interregnum period. Jeffrey Hirsch at Almanac Trader documented how price momentum can beget more momentum. Strong price gains before U.S. Thanksgiving tend to resolve in average gains of 2.4% into year-end.

Party now. January and beyond may be a different story.

My inner trader remains tactically long the S&P 500. The usual disclaimers apply to my trading positions.

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

Disclosure: Long SPXL

2025 outlook: Cautious, but not bearish

Posted by Cam Hui - November 30, 2024

This is the season when investment strategists publish their outlooks and forecasts for the coming year. This year, the message from investment banks is mostly the same: “We are bullish for stocks in 2025, but there are these policy risks of the new Trump Administration.”

This time last year, I expected returns of about 12% for the S&P 500, which is the average return during an election year. The S&P 500 has more than doubled that figure on a YTD basis. This year, I am expecting equity returns to be flat or in the low single-digits. I am cautious for 2025, but not bearish.

The main headwind facing stocks is valuation. The S&P 500 is trading at a forward P/E of 22, which is highly elevated by historical standards and ahead of the P/E valuation when Trump first took office in 2017. This doesn’t mean that the stock market can’t rise, but earnings growth will have to be the driver of price growth. Investors shouldn’t expect P/E expansion to boost stock prices. The combination of elevated valuation and no recession on the horizon that craters earnings expectations translates into a roughly flat stock market in 2025.

“This will not end well” warnings

Students of market history are well aware that valuation matters to equity returns over time horizons of less than 5–10 years. Elevated valuation can only be regarded as a “this will not end well” warning for equity investors.

I am seeing other “this will not end well” warnings with no obvious immediate bearish triggers.

As an example, Warren Buffett’s Berkshire Hathaway reported an unprecedented cash hoard of $325 billion for Q3 2024, which rose by $48 billion compared to Q2 2024. Cash levels are at record highs, even when normalized by total assets, and exceed the reserves built ahead of the GFC. When questioned, Buffett responded, “We don’t have any idea how to use it (cash) effectively.”

As the accompanying chart shows, Berkshire’s cash levels tend to spike ahead of periods of significant market dislocation, such as the Dot-com crash and the GFC. On the other hand, it is an inexact market timing indicator.

Other indicators of market excesses can be seen in the fixed income markets. Mark Zandi, chief economist at Moody’s Analytics, observed that “the high-yield corporate bond yield spread is wider than the fixed rate mortgage spread”.

As another sign of the times, volumes on leveraged ETFs are spiking, which is a contrarian bearish condition with no obvious trigger.

No sell signals in sight

In summary, I am seeing signs of froth in risk appetite. However, I am not seeing any immediate bearish triggers that warrant defensive portfolio positioning.

From a technical perspective, market breadth is strong, which argues for a continued stock market advance. Both the S&P 500 and the NYSE Advance-Decline Lines made all-time highs last week. If history is any guide, the A-D Line turns down several months ahead of a major market top.

Similarly, my long-term market timing model hasn’t flashed a sell signal. This model buys when the monthly MACD turns positive and sells when the 14-month RSI flashes a negative divergence. RSI is nearing an overbought condition, which is a pre-condition for a sell signal, but there are no signs of a lower RSI on higher stock prices that is the basis for a sell signal.

As well, the high yield market is not flashing any signs of distress. I use high yield as an “extreme” equity risk premium indicator to measure the level of stress in the higher-risk portion of the equity market.

The accompanying chart shows the high yield spread plus a notional 5-year Treasury yield (blue line), the actual high yield index (red line) and the NASDAQ 100 (black line) as a measure of the higher risk and higher reward part of the U.S. equity market. Historically, rising funding costs, or equity risk premiums, have risen sharply in conjunction with major bear markets. While funding costs have slightly edged up, readings are nowhere near levels that signal distress.

Cautions, but not bearish

In conclusion, I would describe my 2024 U.S. equity view as cautious, but not bearish. The U.S. market is facing a number of “this will not end well” valuation-based warnings. However, I see no immediate bearish triggers that warrant defensive portfolio positioning. I am therefore expecting S&P 500 returns to be roughly flat or in the low single-digits for 2025.

This view is consistent with Ryan Detrick’s observation that the third year of bull markets, which we are in, tends to be weak. If the bull market were to continue, 2026 and 2027 should be strongly positioned.

In addition, Mark Hulbert highlighted a similar valuation warning based on Value Line’s estimated 3-5 year appreciation of the stock market (VLMAP).

The latest reading VLMAP stands at 35%, which has historically led to subpar returns in the year ahead.

Equity returns in 2025 is likely to be accompanied by above average volatility. Trump’s surprise announcement that he would impose a 25% tariff on Canada and Mexico, along with an additional 10% on China the first day he takes office, is a preview of the probable volatile market environment. Along with the headwind of the of elevated equity valuations against a backdrop of continuing non-recession growth, this makes the risk-adjusted U.S. equity outlook challenging for 2025.

All-time highs are bullish

Posted by Cam Hui - November 27, 2024

Mid-week market update: It is said that there is nothing more bullish than a stock or a market making a new high. The S&P 500 made a marginal all-time high yesterday and pulled back today. Yesterday’s high was more convincing as both the Dow and equal-weighted S&P 500 decisively broke out to all-time highs. This […]

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An insightful interview with Scott Bessent

Posted by Cam Hui - November 25, 2024

RenMac hosted an interview with Scott Bessent, who is Trump’s announced nominee for Treasury Secretary, in early 2021. While Bessent did not talk about policy or politics, I found it highly insightful as he described his career path and his investment process.

The interview is useful to listen to in its entirety, but here are some highlights.

Global macro manager

Bessent is a global macro hedge fund manager who apprenticed with some hedge fund legends, such as Jim Chanos, Stan Druckenmiller, George Soros, and others. He described his career path in the interview and what he learned from each of his mentors.

What stood out for me was his process in looking for investment ideas, which consists of:

Forming a theory;
Looking at the data to see if it confirms the theory; and
Consider the charts and market positioning to see if they are early or late in the trade.

Bessent related the story of an “aha” moment in 1997-98, when he was in the Soros London office watching a U.S. tech bubble forming. Looking at the charts, he found that the European telecoms were all breaking out to the upside. Analysts told him that there where AOLs embedded in European telecoms, which meant that it was a signal to be buying France Telecom, Telecom Italia, Telefonica, and others. The rest, as they say, is history. It was a case of listening to the market through the charts to form a theory and using the rest of the process to validate the theory.

He was also open-minded as an investor and politically agnostic. Even though he heavily supported Trump in his latest campaign, he related the story of a speech he went to by Stephanie Kelton, the high priestess of Modern Monetary Theory (MMT), which posits that deficits aren’t as big a constraint on fiscal policy as conventional wisdom would have it. Kelton rhetorically asked if 5% inflation for the next 10 years would be too high a price to pay if the earth were to burn up in year 11. Bessent was prepared to jump on the inflation trade if the political consensus were to shift in that direction, which it didn’t.

These are all approaches that I have aspired to and I can admire. It also shows his financial pragmatism, which is a quality that will comfort Wall Street during his term as Treasury Secretary.

All hail the bullish reversal

Posted by Cam Hui - November 24, 2024

Preface: Explaining our market timing models

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
Trend Model signal: Neutral (Last changed from “bullish” on 15-Nov-2024)
Trading model: Bullish (Last changed from “neutral” on 15-Oct-2024)

Subscribers can access the latest signal in real time here.

The bulls seize control

The S&P 500 printed a bullish reversal last week. It began with a decline that was halted at the 20 dma and that’s just above a large price gap, followed by an outside reversal day when it exhibited a bullish engulfing pattern. The bullish reversal was confirmed when the index rose and filled a price gap that was acting as resistance.

The market action was a test for both bulls and bears. Gap fills, and how quickly they are filled, are a sign of the strength of the underlying trend. The filled upper gap is a signal that the bulls are seizing control of the tape once again.

Magnificent Seven leadership

Even as the S&P 500 struggled to fill the upside gap, the Magnificent Seven ETF (MAGS) signaled its leadership quality by filling the gap before the index. Moreover, MAGS has been in a relative uptrend since mid-October.

For traders, the market highlight of the week was the NVIDIA earnings report, which came in Wednesday after the bell. The stock has been in a well-defined uptrend that began in August and it’s now testing overhead resistance. The price reaction to the earning report turned out to be a non-event. Most notably, the stock has been roughly flat against the Magnificent Seven since early October, indicating that Magnificent Seven leadership is not just NVIDIA (bottom panel).

No breadth divergences

Under normal circumstances, Magnificent Seven leadership would be a sign of narrowing breadth, which would be a negative divergence and a warning of an unsustainable advance. Those concerns are alleviated by the sideways relative return pattern of the equal-weighted against the cap-weighted S&P 500 (middle panel) and the minor relative uptrend exhibited by the Russell 2000 in the past month (bottom panel).

An analysis of different Advance-Decline Lines shows that breadth is relatively healthy. Only the S&P 500 A-D Line has made an all-time high. The accompanying chart shows that breadth appears weaker as market cap decreases, as evidenced by the weaker performance of mid- and small-cap A-D Lines.

Another bullish data point can be found in the behaviour of risk appetite indicators. Both the relative performance of junk bonds (green line) and the relative performance of consumer discretionary to consumer staples (red line) is confirming the S&P 500 advance.

A possible sentiment warning

However, one key risk that appeared is a warning of excessively bullish sentiment from the option market, which is contrarian bearish. The 10 dma of the CBOE put/call ratio fell below its 1-standard deviation Bollinger Band, which has been a signal of a short-term top in the past.

However, other sentiment indicators, such as the AAII Bull-Bear spread, show a reading of 19.4, which is considered to be neutral and not wildly bullish.

Similarly, the NAAIM Index, which measures the sentiment of RIAs who manage individual investor funds, is elevated but well off the highs set in the last two years.

In conclusion, the S&P 500 arrested its decline at its 20 dma and exhibited a bullish reversal and this reversal was confirmed by bullish internals. My base case calls for a rally into year-end. The coming week is the start of the seasonally bullish period to year-end. One key risk is option sentiment is showing signs of froth, though other sentiment indicators remain in neutral territory.

My inner trader is staying bullish. The usual disclaimers apply to my trading positions.

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

Disclosure: Long SPXL

Deciphering Trumponomics 2.0

Posted by Cam Hui - November 23, 2024

The year is nearly over and the U.S. will see Donald Trump in the White House in 2025. Ryan Detrick’s analysis of historical equity returns found that stocks historically do better in the first two years of a president who was re-elected versus a new president in office. The key question is whether Trump 2.0 represents a re-election or a new term.

I unpack that question by focusing on the economic effects of Trump’s key initiatives, namely the TCJA tax cut extension, tariffs and immigration.

TCJA extension = Inflation?

Now that the Republicans have swept the White House, Senate and House, Trump is certain to push through legislation to extend the 2017 TCJA tax cuts that expire in 2025. He also made a series of tax cut promises on the campaign trail, such as no taxes on tips, overtime pay, social security benefits, car loan payments, and no federal taxes for police, fire fighters, military service members and veterans. As well, there is hope that the corporate tax rate would be cut further. At a minimum, the good news for CFOs is corporate tax rates are unlikely to rise.

The prospect of large increases in fiscal deficits is already rattling markets. Both the term premium (blue line), which is the spread investors demand to hold longer dated Treasuries, and inflation breakeven rates (red line) have risen.

The silver lining is that readings are near the top of historical ranges and inflationary expectations are not unanchored. Nevertheless, this is not good news for the bond market.

How inflationary are tariffs?

Trump campaigned on slapping 60% tariffs on all goods from China and 10% on all other countries. At first glance, such a proposal sounds highly inflationary, but the historical evidence indicates that tariffs may not be as inflationary as feared.

In 2018, the Trump Administration announced a 25% tariff on about half of the imports from China. The Chinese yuan fell about 10%, which roughly offsets all of the tariff effects. In effect, China absorbed the tariff increase through exchange rate depreciation.

A Fed study found that the volume decline occurred in tariffed goods.

However, Trump’s efforts to re-shore production into the U.S. was unsuccessful. Imports shifted to other countries in response.

In a different study, Fed economists modeled the effects of a tariff increase on economic activity and inflation in September 2018. To make a long story short, the study suggested that the Fed could decline to react to tariff-induced inflation under two key assumptions. First, inflation expectations have to stay anchored, and the pass-through of the cost shocks is short lived.

Undoubtedly, the Fed will be monitoring how the term premium and inflation breakeven rates evolve.
Stephen Miran, Senior Strategist at Hudson Bay Capital, made an intriguing proposal on how the Trump Administration could implement tariffs (see A User’s Guide to Restructuring the Global Trading System). He estimated that a 10% across-the-board tariff and a 10% appreciation of the USD as a currency offset would amount to a 0.3–0.6% increase in inflation.

Miran offered the following steps to mitigate tariff effects. First, he proposed a gradual tariff implementation policy, much like the steps taken during the 2018–2019 trade war. Tariff increases would be conditioned on “credible forward guidance, similar to what is used by the Federal Reserve across a range of policies, to guide expectations. The U.S. Government might announce a list of demands from Chinese policy—say, opening particular markets to American companies, an end to or reparations for intellectual property theft, purchases of agricultural commodities, currency appreciation, or more.”

In addition, he suggested forming a coalition of willing countries to create a trade wall around China by “putting countries into different groups based on their currency policies, the terms of bilateral trade agreements and security agreements, their values and more. Per Bessent (2024), these buckets can bear different tariff rates, and the government can lay out what actions a trade partner would need to undertake to move between the buckets.”

What about the strengthening USD, which makes U.S. exports less competitive?

Here, Miran suggested a Mar-a-Lago Agreement, in the manner of the Plaza Accord, to weaken the greenback. Participants would be encouraged to sell their Treasury assets to weaken the USD, offset by U.S. issuance of 100-year century bonds. This is the part of the proposal that sound the most dubious.

Immigration and deportation

Another key part of the Trump platform is restriction of immigration. In fact, he promised a mass deportation of undocumented immigrants from the U.S.

The Peterson Institute estimated the effects of Trump’s major promises in a study. It modeled the effects on GDP and inflation of light (1.3 million people) and severe deportation (8.3 million), as well as different tariff rates and the revocation of Fed independence. Surprisingly, the largest effect on GDP was deportation. The magnitude of the effect of deportation is significantly higher than either tariffs or the revocation of Fed independence.

Axios reported that the two industries with the largest share of undocumented immigration employment are construction and agriculture. Deportation will create labour shortages, spark wage inflation and push up food prices.

For investors, mass deportation heightens the cyclical risk of the stability of the construction industry. Housing has been a key long-term indicator of economic health and any downturn could foreshadow a recession. Keep an eye on the relative performance of homebuilding stocks, which had been outperforming the S&P 500 in a choppy fashion since 2022. Elevated mortgage rates, which could be exacerbated by rising inflationary expectations that push up bond yields, along with rising labour costs from deportations, could sink this industry.

Investment conclusions

Looking to 2025, capital market returns are likely to be more uncertain than they have been in the past. The degree of dispersion in the range of forecasts is wider than usual. On one hand, Stephen Miran made the case that the effects of Trump tariffs could be relatively benign. On the other hand, Marketwatch reported that BCA Research set the probability of a U.S. recession at 75% in response to Trump’s victory.

There will be some losers, namely bonds, and construction stocks because of their sensitivity to both rising rates and heightened labour costs from deportation.

As for the stock market, the S&P 500 is trading at a forward P/E of 22, which is high relative to its own history and significantly higher than the level when Trump first took office in 2017. The good news is earnings estimates are rising and economic indicators don’t show significant recession risk. The bad news is earnings growth will have to bear most of the burden if stock prices were to advance.

Equity investors will have to weigh the balance of risks. Upside potential can be found in corporate tax cuts and deregulation. The sources of downside risk are trade wars and the negative effects of deportations on short run economic growth. For what it’s worth, the stock market may have a Trump Put in place. Various news outlets, such as the NY Times, have reported that “Trump is seeking a Treasury secretary who will carry out his unconventional plans while still having the credibility to keep markets buoyant”. In other words, support his tariff plan and keep stock prices rising. Trump’s pick for Treasury, Scott Bessent, seems to fit that bill.

Waiting for the gap fill

Posted by Cam Hui - November 20, 2024

Mid-week market update: The decline in the S&P 500 seems to have been arrested at its 20 dma (blue line). The next question is which price gap gets filled first. A fill of the upside gap (in grey) would be positive for the bull case, while a fill of the downside gap (in pink) would indicate that the bears have seized control of the tape.

As investors await the market’s verdict, here are some clues on how the future may develop.

Magnificent Seven

The Magnificent Seven seems to be leading the market upward again. While the S&P 500 shows upside and downside gaps, there is no outstanding upside gap in the Magnificent Seven ETF (MAGS), which has been in a relative uptrend since mid-October.

Magnificent Seven leadership usually translates into narrow market leadership, which would be cautionary flag. An analysis of the relative performance of the equal-weighted S&P 500 and Russell 2000 shows that smaller stocks are either flat or slightly outperforming the S&P 500, which is a healthy sign for the bull case.

The NVIDIA elephant

Then there’s the NVIDIA elephant in the room, which is scheduled to report earnings after the bell today. Without trying to forecast what might happen in the short-term, here are some big picture thoughts on NVIDIA.

First, the current AI mania sentiment cycle is not yet fully mature compared to the Tech Bubble of the late 1990’s. The stock price of Cisco Systems, which had been the internet darling of the day, had become disconnected from its earnings. By contrast, the stock price of NVIDIA is still keeping pace with its earnings.

To be sure, the pace of AI sales growth is expected to decelerate in the coming months. Hyperscaler capex is expected to grow in 2025 and 2026, but growth won’t happen at the same torrid pace as the past.

The bears will argue that this is a sign of impending disappointment. As well, we are already seeing accounting tricks, such as large company X investing a significant sum into an AI startup, and the AI startup turns around to use those funds to pay the parent investor for cloud and other services, which grows the parent’s revenues and valuation.

The bulls will argue that if this is indeed a bubble, which it probably is, we haven’t seen the low-quality IPOs and nonsensical deals that come to market as everyone rushes to cash in on the bubble. I can recall a peak internet mania episode during the privatization roadshow of ENEL, the Italian electric utility. ENEL was forced to sell off several power generation plants for anti-monopoly reasons. At the same time, the company had announced an initiative to build a fibre optic cable network using their existing cable infrastructure. The CEO was asked at an institutional roadshow in Boston the reasoning behind the fibre optic network plan. The replay was, “Well, we had to do something with the EBITDA we lost from selling the power generation plants.”

The room fell silent. The level of excess today is nothing link the late 1990’s.

From a tactical perspective, Renaissance Macro pointed out NVIDIA is their “buyer’s frenzy” indicator is flashing cautionary signs of excessive optimism going into the latest earnings report. Even then, the record of this indicator shows that too much bullishness has tended to resolve in flat price reactions, rather than large downdrafts.

My inner trader remains bullishly positioned. The NVIDIA report is a coin flip whose results I cannot call. But the stock is in a well-defined uptrend. Even if it were to disappoint today, its relative performance against the Magnificent Seven has been flat (bottom panel), and the stock market can continue to rise into year-end even under those circumstances.

As well, you can tell about the nature of market psychology the way it reacts to news. Equity futures fell overnight Monday when Russia rattled its nuclear sabre when it unveiled a news doctrine lowering the threshold for first use (see NY Times article for details). The market recovered during the day to close positive. Had it been ready to fall, the downdraft would have been far worse.

The usual disclaimers apply to my trading positions.

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

Disclosure: Long SPXL

2025 high conviction idea: Gold

Posted by Cam Hui - November 17, 2024

Preface: Explaining our market timing models

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
Trend Model signal: Neutral (Last changed from “bullish” on 19-Jul-2024) [correction
Trading model: Bullish (Last changed from “neutral” on 15-Oct-2024)

Update schedule: I generally update model readings on my site on weekends. I am also on X/Twitter at @humblestudent and on BlueSky at @humblestudent.bsky.social. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.

Subscribers can access the latest signal in real time here.

Why gold will beat stocks

Looking ahead to 2025, I am reiterating my bullish call on gold from a long-term viewpoint. The recent pullback represents a buying opportunity in the metal from an asset allocation perspective.

Going back to 1980, we can see several distinct gold bull-bear cycles. Gold topped out at 850 in early 1980 and began a bear market that bottomed in 1985. It traded sideways and made a second bottom in 1999 and broke out to new recovery highs in 2004 and topped in 2011. It subsequently broke out again at 2,100 in early 2024. More importantly, it is tracing out saucer-shaped multi-year bases against different regional equity indices. The gold/Dow ratio is the weakest owing to the strength of U.S. stocks, but it is nevertheless distinctive. The Gold/EAFE ratio (all ratios are in USD) is about to stage a relative breakout, and the gold/EM ratio has marginally broken out of a 12-year base.

These technical patterns argue for a bullish commitment to gold for 2025 and beyond for all investors in all major currencies from an asset allocation perspective.

A detailed technical picture

Here is another long-term technical reason to be bullish. Not only did gold prices stage upside breakouts in USD, but also in all major currencies. The accompanying chart shows long-term breakouts to all-time highs in selected currencies, and even in the Swiss Franc (CHF), which is considered to be a “hard” currency.

The bottom panel shows the silver/gold ratio as an indicator of speculation in precious metals. The last major gold peak was accompanied by a spike in this ratio, which is not in evidence today. Sentiment readings are not in place for a major gold top.

The accompanying chart shows a close-up of the recent corrective action in gold. The violation of the rising trend line in USD is concerning, but gold did not violate the rising trend line in most other currencies, except for CNY. Arguably, the recent spike in the silver/gold ratio in October was a sign for traders that sentiment had become overly frothy and a pullback was due. Nevertheless, the overall technical structure of price action remains bullish and the correction should be regarded as a buying opportunity.

The end of disinflation?

Gold is useful as a diversifier in a portfolio because it’s a hedge against unexpected inflation. Bloomberg columnist John Authers recently made the point that the latest October CPI report is showing signs that the disinflation trend is fading. Different measures of CPI are above the Fed’s 2% target and they may have stopped falling (see Inflation Needs Subtlety Right Now. It’s Getting Trump). In particular, Authers observed, “Both core services excluding shelter (the Fed’s so-called supercore, which has been given much emphasis over the last couple of years) and shelter ticked up very slightly and remain above 4%”.

Authers went on to cite CPI diffusion analysis by TS Lombard’s Steven Blitz showing that the pace of disinflation has slowed and turned up.

As well, there may be signs that the pace of increase in average hourly earnings are accelerating.

Authers concluded:

Taken together, the data probably don’t justify another rate cut next month. However, the Fed has a dual mandate. The latest employment figures showed weakness, and so on balance the path of least resistance is to cut again, but only by 25 basis points. Further, there’s a general expectation in the market that another cut is coming, and it might be dangerous to disappoint those hopes when the post-election markets are already volatile.

Fed Chair Powell agreed with Auther’s assessment. He signaled in a speech that the Fed may not need to cut rates at the December FOMC meeting: “We are moving policy over time to a more neutral setting…we will carefully assess incoming data, the evolving outlook, and the balance of risks. The economy is not sending any signals that we need to be in a hurry to lower rates.” [Emphasis added]

All of these trends are in place even before Trump takes office and none of them are attributable to his policies. Trump’s program of raising tariffs, extending tax cuts, and his stated intention of interfering with the Fed’s conduct of monetary policy is inflationary (see my analysis Revisiting the Trump Trade). Even as gold prices corrected, inflation expectations, as measured by the 5-year breakeven rate, have been rising.

Waiting for the bottom

Tactically, I am waiting for the gold correction to bottom. Here is what I am watching.

Jason Goepfert at SentimenTrader that gold has tended to bottom when it falls 2% below its 50 dma, which just happened now. Will history repeat?

Another way of spotting a possible corrective bottom is to monitor the technical conditions of gold mining stocks. Gold Miners (GDX) are in a clear corrective phase and their 14-day RSI is oversold. The gold miner-to-gold ratio is near the bottom of its historical range, but readings are not at levels seen at recent bottoms. In addition, I would watch for percentage bullish to decline into, or at least near, the oversold zone before becoming turning tactically bullish.

Lastly, keep an eye on the USD Index. The Dollar rallied in the wake of Trump’s victory to the top of a range that began in 2023 and technical conditions appear extended. If it were to be rejected at resistance, a decline would be a tailwind for gold prices as the two tend to be inversely correlated.

In conclusion, gold prices have staged multi-year breakouts in multiple currencies, indicating a long-term bullish outlook. In addition, gold is on the verge of staging relative breakouts against global equity markets that point to multi-year outperformance ahead. The macro outlook calls for a re-acceleration of inflation, which is also positive for gold. Investment-oriented accounts should be accumulating gold in anticipation of superior returns in the years ahead.

Equity trading outlook

Looking to the week ahead, my inner trader is giving the bull case the benefit of the doubt and he is staying in his long S&P 500 position. The S&P 500 formed a probable bearish island reversal (box) last Friday, though the sharp drop could be attributable to option expiry hedging flow, and the index reached its downside target Friday (dotted line). The market remains in an uptrend, with potential support at the solid blue rising trend line, with secondary support at the breakout level (grey support zone). My inner trader’s line in the sand is the rising trend line. A breach of the line would be a stop-loss signal.

The usual disclaimers apply to my trading positions.

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

Disclosure: Long SPXL

Can Trump Make Equities Great Again?

Posted by Cam Hui - November 16, 2024

U.S. equity prices rose strongly in the wake of Trump’s victory. As the accompanying shows, both the S&P 500 and NASDAQ 100 surged on a relative basis, while other regions tanked.

Donald Trump promised to Make America Great Again. While he may have accomplished that task in the short run for U.S. stocks, can he do the same for all equities?

European and Asian weakness

Even as the S&P 500 and NASDAQ stocks soared to all-time highs, the price action for the rest of the world doesn’t look as bullish.

In Europe, both the Euro STOXX 50 and FTSE 100 are flat to down as both indices are trading below their respective 50 and 200 dma, indicating a loss of price momentum.

Over in Asia, the relative performance of Asian markets are also flat to down. Don’t expect global leadership to emerge out of Asia, especially in light of the well-known economic headwinds that faces China.

Commodity prices, which are market-based signals of global cyclical strength and Chinese cyclical strength in particular, are not showing any signs that a strong reflationary cycle is under way. The cyclically sensitive copper/gold and base/metal gold ratios (bottom panel) have traded sideways since August.

My Trend Asset Allocation Model applies trend-following principles to global equity and commodity markets to arrive at an overall risk appetite signal. It is therefore no surprise that the Trend Model is showing a neutral reading under these circumstances.

Can America stand alone?

The U.S. is the only exception to the sideways pattern of major markets around the world. Both the S&P 500 and NASDAQ stocks recently reached all-time highs. In other words, America stands alone, at least from the viewpoint of stock prices.

Can the bull continue? Here are the bull and bear cases.

The bull case is simple. Equity bulls care about two things: earnings growth and the cost of capital. Tax cuts will boost earnings growth. Deregulation could ignite the animal spirits in the markets. Specifically, less regulation should provide boosts for the technology, financial and energy sectors.

Falling interest rates lowers the cost of capital. The Fed began its rate cut with a half-point cut in October, followed by a quarter-point in November. Estimates of the neutral rate vary and range between 3% and 4%. Indicating there is more room for rates to fall.

Fiscal policy is stimulative and there are no signs of a recession on the horizon. The U.S. economy is firing on all cylinders. Real GDP growth is about 3%. The unemployment rate is about 4%. The AI revolution will boost productivity. Economic momentum is positive, as measured by the rising Economic Surprise Index, which measures whether economic statistics are beating or missing expectations.

What’s not to like?

The bear case rests mostly on valuation concerns. The S&P 500 is trading at a forward P/E of 22, which is highly elevated relative to its own history.

This is nothing like Trump 1.0 of 2017. When Trump first won the White House, the S&P 500 forward P/E was about 17. The corporate tax rate was 35% on its way to 21%, which was not expected by the market. The debt/GDP ratio was 98%.

Today, the S&P 500 trades at a forward P/E of 22. An extension of the TCJA, even with tweaks, is mainly a cancellation of an increase in the corporate tax rate. The debt/GDP ratio is 124% and expected to go even higher.

Trump’s tariff plan is not a free lunch. There will be retaliation. In addition, the interaction of TCJA and tariffs have had some unexpected results. While Trump’s tariff plan is to incentivize companies to re-shore manufacturing to the U.S., Brad Setser observed the enactment of TCJA sparked a surge in EU pharmaceutical exports, probably the results of strategies that offshored the production of drugs intended for the U.S. market to low-tax Ireland.

Moreover, tariffs are expected to be inflationary, which will tie the Fed’s hands in its easing cycle. As for Trump’s plan to incentivize companies to re-locate manufacturing facilities back to the U.S., the devil is in the details of any plan. Consider the decisions facing corporate boards that contemplate a plan to invest in manufacturing the U.S., or any location. Investment involves costs, which is relatively well-known, and an uncertain payoff. The risk/reward ratio has to be sufficiently favourable for a board to undertake such a decision. As well, companies have to consider secondary factors, such as the availability of trained labour, the productivity of the labour, and the existence of a supply chain ecosystem. After years of hollowing manufacturing, supply chains and trained personnel disappear. Technological leadership doesn’t just magically happen overnight.

This is a useful framework to think about how a re-industrialization process may play out. Investors need to consider a range of possibilities and how the demands of capital markets may drive corporate investment initiatives.

Cautious, but not bearish

Despite these risks, I am not bearish, but intermediate-term cautious on U.S. equities.

Stock prices depend on earnings growth and corporate funding costs. For now, forward 12-month earnings estimates are rising – and these figures were mostly taken before the election results were known.

While valuation concerns are valid, here are a range of possibilities of how earnings may change under Trump. Examples of conventional investment bank analysis from BoA and Goldman Sachs projects that cutting the corporate tax rate to 15% would boost S&P 500 EPS by 4%. All else being equal, today’s forward P/E of 22 would fall to 21.

Uber-bull Ed Yardeni raised his S&P 500 targets to 6100 for year-end 2024, 7000 to year-end 2025 and 8000 for year-end 2026. He raised his S&P 500 2025 and 2026 EPS from $275 to $290 and from $300 to $320, compared to a current consensus of $275 and $308, respectively, based on the promise of a corporate tax cut, deregulation and faster productivity growth. Similarly, Yardeni’s projections lower the forward P/E from 22 to 21.

Moreover, I am not seeing any signs of funding cost headwinds for stock prices. The accompanying chart shows estimates of the extremes of fund costs, as represented by junk bond yield spreads plus the 5-year Treasury rate (blue line) and the actual junk bond yields (red line). Overlaid on top of these yields is the NASDAQ 100 (black line), which is a proxy for the leading-edge public companies in the U.S. In the past two cycles, major NASDAQ bear markets were accompanied by increases in funding cost, which is not in evidence today.

In the short run, animal spirits are dominant in the U.S. I recently pointed out that the S&P 500 was testing the upper end of a rising trend line, and it was likely to pause and consolidate its gains. With the caveat that the NASDAQ Composite and the Russell 2000 have already overrun their rising trend line resistance, a projection of the S&P 500 trend line until year-end comes to about 6300, which could be an upside target should the combination of a FOMO buying stampede and Treasury liquidity flood continues.

Seth Golden came to a similar conclusion based on a study of post-election returns.

In conclusion, U.S. equities have surged in the wake of Trump’s electoral victory while stock markets in the rest of the world have been flat to down. While the combination of narrowing global leadership and elevated U.S. valuation are concerns, I remain cautious but not bearish on the U.S. and global equity markets. Fundamental and macro momentum are strong, and there are no signs of reversal in funding costs.

However, should the S&P 500 reach about 6300 by year-end, valuation pressures could put downward pressure on equity prices in 2025.

How far can the post-election rally run?

Posted by Cam Hui - November 13, 2024

Mid-week market update: The latest BoA Global Manager Survey shows that institutions have stampeded into U.S. equities in the wake of Trump’s victory. The apparent crowded long position is concerning from a contrarian viewpoint.

I had suggested on the weekend that it was time for the S&P 500 to pause and take a breather. The market duly consolidated and trade sideways this week. How far can the post-election rally run?

Bullish factors

The rally would have occurred no matter who won the election. The market was over-hedged for downside risk going into the election. When catastrophe didn’t happen, market participants scrambled to unwind their hedges.

Nomura derivatives analyst Charlie McElligott described it as “the risk event that never was”. Hedges became “[a] smoldering pile of ash,” as crash protection was “absolutely decimated”. He believes the rally has more room to run: “We’re just not ‘long enough’ quite yet…We need to get ‘longer’ first with more ‘spot up-vol up’ before we are exposed to a big pullback.”

In addition, I also pointed out that Treasury is likely to take extraordinary measures to keep the federal government solvent by drawing down the Treasury General Account ahead of the debt ceiling deadline in early January. TGA drawndowns have the effect of injecting liquidity into the banking system and create tailwinds for stock prices.

I continue to be short-term bullish into year-end. The usual disclaimers apply to my trading positions.

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

Disclosure: Long SPXL

How to trade the Trump euphoria rally

Posted by Cam Hui - November 10, 2024

Preface: Explaining our market timing models

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
Trend Model signal: Bullish (Last changed from “neutral” on 11-Oct-2024)
Trading model: Bullish (Last changed from “neutral” on 15-Oct-2024)

Subscribers can access the latest signal in real time here.

A cloudy crystal ball

As a quantitative equity manager, I employed diversified and uncorrelated groups of factors to pick stocks, including technical analysis, earnings expectations, valuation, growth and growth at a reasonable price. During my tenure, different markets would experience external shocks, such as financial crises (Asian Crisis) and natural disasters (Fukushim). The quantitative factor response playbook would always follow the same script.

It begins with a price shock as everyone scrambles to assess the market implications. During this period, none of the stock picking factors worked because of the new information that isn’t reflected in the factors.

As the market begins to settle down, technical analysis factors would show alpha. This would be followed by estimate revision. That’s because company analysts don’t revise their earnings estimates until they can quantify the effects of the shock. This would be followed by the fundamental factors, such as value and growth. As an example, I flattened all my positions in an equity market-neutral portfolio in the wake of 9/11 as I knew I would only be trading on noise until there was greater clarity on fundamentals.

While the Trump victory doesn’t qualify as a disaster in the manner of Fukushima or 9/11, it does represent a discontinuous external shock to market expectations whose effects are difficult to quantify. While the direction of policy changes are known, the magnitude of their effects are difficult to estimate without knowing the exact details.

It is in that spirit I would assert the only guidance investors can rely on are market price signals, or technical analysis. That’s why it’s difficult to predict how the markets are likely to behave under the Trump Administration before he takes office.

My crystal ball is cloudy beyond a few weeks, but I can still take a look at the price response to the news.

A factor leadership review

The factor response has been surprisingly mixed. Among the Trump factors that I outlined in the past, only the relative performance of domestic companies and inflationary expectations are rising. The shares of Trump Media & Technology Group (DJT) surprisingly fell.

Among the value and cyclically sensitive sectors, the relative performance of financials and industrials surged but fell back. Energy, which should benefit from a “drill, baby, drill” policy, saw a very muted response.

The relative performance of growth sectors was similarly unenthusiastic with the exception of a pop in consumer discretionary stocks (thanks to heavyweights Amazon and Tesla).

To be sure, the weakness in the relative performance of defensive sectors is a signal that the surge in stock prices may have further to run.

Momentum, momentum!

I pointed out last week that the term structure of the VIX was inverted going into the election, indicating a high level of market anxiety. The subsequent market rally reflects a positioning unwind of over-hedged positions. The no-surprise FOMC decision also provided a tailwind for stock prices in the short run.

Jason Goepfert at SentimenTrader studied the history of 1% gaps after elections. While the sample size is extremely small (n=2), exhibitions of strong positive price momentum after elections is a promising sign for the bulls.

U.S. equities have surged in relative performance from a global perspective. They have the potential to rise further into year-end supported by performance chasing and buybacks after the end of the quarterly reporting blackout window.

Three factors are supportive of this tactical bull case. The first is the expectation of corporate tax cuts. As well, the BoA Global Fund Manager Survey shows that global managers are not excessively overweight the U.S., which can be supportive of a FOMO-driven performance chase.

In addition, the U.S. Treasury is expected to draw down its Treasury General Account (TGA) at the Fed as an extraordinary measure as the Administration negotiates with Congress ahead of the January debt ceiling deadline. Drawdowns of TGA has the effect of injecting liquidity into the banking systems, which is positive for equity prices.

Tactically, the S&P 500 is currently testing the top of a rising trend line. Don’t be surprised if it consolidates at these levels and cool off in the next few days. That doesn’t mean it will significantly decline from here because of the reasons already mentioned. The index hasn’t stopped rising when it reached trend line resistance during advances in the past 12 months.

That said, I expect further gains once any consolidation or pullback is complete. Sentiment readings are not excessively bullish, which allows more room for stock prices to run.

Awaiting clarity

I would expect the stock market to rally into January and consolidate or pullback just before Inauguration Day. That’s when many of the unknowns of the Trump Administration’s initiatives are better defined. As a reminder, the three key planks of Trump’s platform are:

Tariffs
Immigration restrictions
Extensions of the 2017 tax cuts

Trump can accomplish the objectives in the first two with executive orders, but he needs Congress to enact the tax cut extensions. The market is waiting for answers on many questions.

Tariffs: What levels will be set at? Will there be a phase-in period? How much retaliation will there be?
Immigration: It is said that Trump is planning mass round-ups and deportations on the day he takes office. If millions are being rounded up, where will the resources come from? What happens if the countries the deportees are sent to won’t accept them? Where will the government put the detainees awaiting deportation? How much will the operation cost? What are the effects on labour market and how will the Fed react to growing its growing tightness?
Tax Cut Extension: While the odds favour a Republican sweep, it’s not known whether the Republicans will control the House of Representatives. For investors, the key issue will be how the bond market vigilantes react to the skyrocketing deficit from the tax cut extension. Will we see a Liz Truss moment in the Treasury market?

For now, the technical action of the stock market is dominant. Look for an equity rally into January, followed a period of consolidation and pullback as markets assess the full impact the details and effects of Trump’s policies.

The S&P 500 is already trading at a forward P/E ratio of 22.2. Even a 5% advance in the index would push the P/E ratio to extreme levels and offer little valuation support should the details of Trump’s policies disappoint. By comparison, the market’s forward P/E was considerably lower when Trump first took office in 2017, which gave room for multiples to expand.

Party now, but be prepared for a possible hangover.

My inner trader remains long the S&P 500. The usual disclaimers apply to my trading positions.

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

Disclosure: Long SPXL

Europe, alone?

Posted by Cam Hui - November 9, 2024

Perhaps it is fitting that this report is being published just before November 11, Remembrance Day, the day commemorating the end of World War I. It was on the 11th hour of the 11th day of the 11th month the guns fell silent.

Lest we forget the sacrifices of many and the terrible carnage of both World Wars.

As a reminder, it was the American-led geopolitical architecture in the wake of World War II, backed by an American nuclear umbrella, which contained the Soviet Union and ensured no major wars erupted after 1945. Now Trump’s America First isolationist policies are dismantling U.S. security guarantees and the possible removal of the nuclear umbrella. How U.S. allies react from the viewpoint of foreign and economic policy will be of enormous consequence for the world for the next generation.

A major issue in the current geopolitical environment is the Russo-Ukraine War. As Trump has shown a high degree of antipathy to NATO, Europe is becoming increasingly alone. How the EU reacts to U.S. isolationism and Ukraine will be of utmost importance to the outlook for Europe.

Here are the bull and bear cases.

Growth in unexpected places

On the surface, the record of EU growth looks weak. Beneath the surface, however, growth is characterized by subpar growth in core Europe and surprising growth in the periphery.

As the accompanying chart shows, GDP per capita in Germany and France were flat since the COVID peak in 2019. However, there are some surprises. GDP in Greece has stabilized since its crisis and has exhibited strong growth since 2019. One standout is Poland, whose per-capita GDP is rapidly catching up to the rest of the EU. Other former East bloc economies such as Czechia (not shown), are also showing strong signs of growth.

Another EU growth star has been Spain, which is set to become one of the fastest-growing advanced economies.

By contrast, Germany has become the sick man of Europe. Its competitive advantages of using cheap Russian energy to export manufactured goods to the rest of the world broke with the onset of the Russo-Ukraine War. In addition, Chinese EVs have become a serious global threat to German and European auto production.

But there is hope. Germany ran out of money to support Ukraine, which created a clash between Chancellor Scholz and Finance Minister Lindner, an FDP partner who believes in the fiscal “debt brake” on fiscal spending. Scholz fired Lindner, which collapsed the government and sets up for probable elections in January.

Germany has the fiscal room to spend, stimulate its economy, fund its share of the Draghi plan for European competitiveness (see The Slow March to Fiscal Dominance), support Ukraine and the European security situation.

In the wake of Trump’s probable disengagement from Ukraine, there have been calls within the EU to assume greater responsibility for its security and 3% of GDP spending on the military, which is in excess of the 2% NATO guideline. The GDP of the EU dwarfs the GDP of Russia, whose economy is about the size of Italy. In theory, this could be a wake-up call for Europe, both from the framework of regional security and growth outlook.

The outlook for Ukraine isn’t totally bleak. Trump promised to end the war within 24 hours, which hasn’t happened yet. But several trial balloons have been floated to end the conflict. Vice President Elect J.D. Vance has proposed freezing the conflict along current lines, the establishment of a de-militarized zone and a promise for Ukraine not to join NATO for 20 years. In return, the U.S. would supply Ukraine with weapons to deter future conflict.

Another, advanced by former Trump Secretary of State Mike Pompeo, focuses on enhanced military and financial support. Another trial balloon floated among Europe’s support of Ukraine calls for the lend-lease of weapons to Ukraine. Kyiv would buy U.S. weaponry, financed by the interest from frozen Russian assets. Such an approach would appeal to the transactional Trump, who can walk away with a win-win, by touting that the U.S. is supporting American manufacturing by selling weapons to Ukraine at no cost to itself.

That’s the hopeful case for Europe.

Party now, pay later

On the other hand, Trump may try to exact too high a price for Europe for the avoidance of tariffs and support for Ukraine. At a minimum, Trump will demand defense spending at 2% of GDP, plus an alignment with the U.S. on its hardline policies against Beijing.

The easy commercial path would be to turn away from the U.S. and pivot toward a closer trading relationship with China. Part of the pivot would involve reaching an accommodation with Putin for an interim peace agreement. Despite all the rhetoric about Russian sanctions, Robin Brooks has demonstrated how German exports to Russia-adjacent countries skyrocketed after the onset of war for transhipment to Russia.

Brooks also reported the consensus from European-based attendees at the recent IMF and World Bank meetings in Washington, D.C. that an end to the Russo-Ukraine War, even if it involved forced Ukrainian capitulation, would represent an end to uncertainty, and therefore bullish for the EU.

The longer-term price is a Ukrainian refugee crisis in Europe, and a severe test of NATO and the sovereignty of the Baltic States of Estonia, Latvia and Lithuania, particularly in light of probable U.S. disengagement from NATO. Undoubtedly, China will be watching the situation carefully for clues of how the West may react to an invasion of Taiwan.

Party now, pay later.

Investment conclusions

Europe is one of the three major trade blocs of the global economy, along with the U.S. and China. The probable withdrawal of U.S. security guarantees will be a paradigm shift in the post-World War II geopolitical architecture of the world. How it aligns itself in the coming years would have a seismic effect on its foreign and trade policy that could last for generations.

While the European growth outlook may appear anemic, investors who seek European equity exposure should consider peripheral Europe as sources of growth.

In addition, investors may benefit from exposure to European financials, which are outperforming based on tailwinds from a trend of global central bank easing.

How to trade the post-election melt-up

Posted by Cam Hui - November 6, 2024

Mid-week market update: I pointed out on the weekend (see A final update on the Trump Trade: Tail-risk assessment) that the term structure of the VIX had inverted, indicating high levels of market anxiety. The market was hedging for a catastrophic outcome that turned out to be nothing. Today’s post-election rally is mainly attributable to a positioning unwind of an over-hedged position. “Bloomberg reported that “Wall Street Quants Set to Buy $50 Billion in Stocks as Volatility Falls”.

What’s next?

The good news

Here is the good news for equity investors. Jurrien Timmer at Fidelity studied the two and four year post-election returns of the S&P 500. If history is any guide, stock prices will experience one of the strongest returns if the Republicans sweep the White House, Senate, and House. While the final tally for the House is incomplete and won’t be known for some time, they appear to be well on the way to a sweep, according to the Cook Political Report.

Tactically, the post-election melt-up can be explained by the unwind of hedges. It’s difficult to tell how far it will run, but the market isn’t overbought yet. So enjoy the party.

Valuation pressures

More concerning is the bond market’s reaction. The S&P 500 trades at a forward P/E of about 22, which is well above its historical average.

The surge in the 10-year yield in reaction to Trump’s victory will undoubtedly add to valuation pressures. In the short-term, valuation doesn’t matter much, though it is an important determinant of long-term returns.

The key question is how does the Fed react to these market conditions? Not only has the 10-year yield risen by 15 bps, the 2-year yield, which reflects market expectations of the Fed Funds terminal rate, rose by 8 bps. The market expects the Fed to cut by a quarter-point tomorrow and another quarter-point at the December FOMC meeting. Will Powell offer any guidance to the Fed’s reaction function at tomorrow’s press conference?

Stay tactically bullish

For now, my inner trader is staying tactically bullish. The relative performance of junk bonds (dark solid line) is tracking the new all-time high of the S&P 500.

The positioning unwind will play itself out in the coming days and weeks. It’s too early to be taking profits. The usual disclaimers apply to my trading positions.

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

Disclosure: Long SPXL

Market cross-currents

A benign CPI report

Crypto leads the stampede

Bullish breadth

An extended advance

A case of narrow leadership

The story of American Exceptionalism

A different kind of cycle

A year of transition

The case for a pullback

Can small cap lead the way?

Clues from the bond market

A bond market turnaround?

Bessent’s 3-3-3 plan

Party now

“This will not end well” warnings

No sell signals in sight

Cautions, but not bearish

Global macro manager

The bulls seize control

Magnificent Seven leadership

No breadth divergences

A possible sentiment warning

TCJA extension = Inflation?

How inflationary are tariffs?

Immigration and deportation

Investment conclusions

Magnificent Seven

The NVIDIA elephant

Why gold will beat stocks

A detailed technical picture

The end of disinflation?

Waiting for the bottom

Equity trading outlook

European and Asian weakness

Can America stand alone?

Cautious, but not bearish

Bullish factors

A cloudy crystal ball

A factor leadership review

Momentum, momentum!

Awaiting clarity

Growth in unexpected places

Party now, pay later

Investment conclusions

The good news

Valuation pressures

Stay tactically bullish

A Trump Trade update

The bull case

EM crisis ahead?

On a collision course with bond vigilantes

On a collision course with demographics

The worst-case scenario

The week ahead

The Trump trade

A focus on trade policy

The bear case

The bull case

Investment conclusions

The week ahead

The stock market

A bond market tantrum

Staying bullish