Tuesday, July 25, 2017

Why the labor market is tighter than you think

As the FOMC meets this week, one key question for Fed policy makers is, "How tight is the labor market?" A related question is, "In the face of tame inflation statistics, when are we going to see evidence of rising wage growth?"

Both questions are important for monetary policy. The New York Times had an article that lamented the lack of inflation. The WSJ reported late last week that, in effect, the Fed has no idea of what is going on with inflation:
The Federal Reserve is likely to stand pat on policy when it concludes a two-day meeting next week, but it faces a debate about the future path of interest-rate increases because of a deepening puzzle over inflation.

Officials will likely leave short-term rates unchanged and wait until September before announcing plans to slowly shrink their $4.5 trillion portfolio of bonds and other assets.

They face a dilemma, however, because the two sets of economic indicators they most closely monitor are sending conflicting signals about the urgency of additional rate increases.

The unemployment rate, which hit a 16-year low in May, shows labor markets are tightening. That argues for the Fed to keep lifting interest rates to prevent the economy from overheating. But inflation is drifting away from the central bank’s 2% target, suggesting borrowing costs should stay low to strengthen price pressures.
I recently highlighted analysis from Adam Ozimek of Moody's Analytics showing that there is no wage growth mystery. Ozimek found that the Phillips Curve, which postulates a trade-off between unemployment and inflation, is alive and well once he substituted the prime age non-employment rate for the unemployment rate (also see my recent post In search of the elusive inflation surge).

Using this analytical framework, the Fed is on the right track in normalizing monetary policy. Additional data indicates that the labor market is tighter than the market consensus, and a rise in inflation is just around the corner.

The full post can be found at our new site here.

Sunday, July 23, 2017

What would a contrarian do?

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 Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.


The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Risk-on*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


What's the contrarian class?
Being a contrarian is a lonely life. You don't hang out with the popular kids. You are probably the nerd in the class. You get picked last in team sports. You don't get invited to any of the parties. And even if you do, everyone laughs at you.

Over at Macro Man, he put us in a contrarian state of mind by asking, "What's the unloved asset class?"

The question was not in the context of a trade, such as short FAANG, but an asset class that you buy and hold for the next few years. Going down the list, he rejected US equities for the reasons of high valuation.


He also rejected developed market fixed income, as well as all forms of credit. The cap rates on commercial real estate isn't offering great value either.


Private equity? Just look at the cash on the sidelines waiting for deals.


At the end, he concluded, "Hmm, cash and gold seem to check a lot of boxes." No wonder contrarians don't get invited to parties.

Cash? Gold? While I believe that it's still a little early to get overly bearish on equities, but here is how a scenario that favors cash, gold and other commodities may develop.

The full post can be found at our new site here.

Thursday, July 20, 2017

Things you don't see at market bottoms: Wild claims edition

It is said that while bottoms are events, but tops are processes. Translated, markets bottom out when panic sets in, and therefore they can be more easily identifiable. By contrast, market tops form when a series of conditions come together, but not necessarily all at the same time.

I have stated that while I don't believe that the stock market has made its final cyclical top, we are in the late stages of a bull market (see Risks are rising, but THE TOP is still ahead and Nearing the terminal phase of this equity bull). Nevertheless, psychology is getting a little frothy, which represent the pre-condition for a major top. This is just one post in a series of "thing you don't see at market bottoms". Past editions of this series include:
It is said that one of the signs of a market top is when participants (and scam artists) start making wild claims for the future. Here are some examples:
  • USA Today: Millennials fear of stocks could cost them $3.3 million
  • Chinese offshore property stampede: Start of a trend?
  • A sucker born every minute, or more signs of unbridled greed
The full post can be found at our new site here.

Wednesday, July 19, 2017

What's the upside target in this rally?

Mid-week market update: As the major US equity indices reach fresh all-time highs, it is time to ponder the question of how far the current upleg is likely to carry us. While technical analysts have several techniques available at their fingertips, I rely mostly on the venerable point and figure charting system (click link for primer), which was first used in the late 19th Century, to determine upside targets.

Using the point and figure charting tool at stockcharts, I get an upside target of 2549 for the SPX with a traditional box size and 3 point reversal.



If I vary the parameters to a 1% box size and a 3 point reversal, the upside target is 2524. The difference seems to be the width of the consolidation pattern and the site of the upside breakout.


Is the target 2524 or 2549? What gives?

The full post can be found at our new site here.

Monday, July 17, 2017

In search of the elusive inflation surge

US bond yields began to settle down last week when Fed Chair Janet Yellen stated in her Congressional testimony that the neutral rate for Fed Funds is roughly the inflation rate, which is much lower than market expectations. In addition, she allowed that the Fed is likely to re-evaluate its tightening path in light of tame inflation figures.

Even Fed Governor Lael Brainard, whose Fedspeak had recently taken on a more hawkish tone lately, sounded dovish in a speech last week:
Once that [normalization] process begins, I will want to assess the inflation process closely before making a determination on further adjustments to the federal funds rate in light of the recent softness in core PCE (personal consumption expenditures) inflation...I will want to monitor inflation developments carefully, and to move cautiously on further increases in the federal funds rate, so as to help guide inflation back up around our symmetric target.
The June CPI print came in below expectations, which reinforced the view that low inflation releases may prompt a shallower path for rate hikes in 2017 and 2018. Brainard stated on Thursday, before the CPI release, "I don’t think anybody can give a fully satisfactory answer to why we’re seeing the inflation trajectory that we see today."

In the past, we have seen inflationary surges whenever the unemployment rate falls substantially below 5%. The graph below depicts the unemployment rate (blue line, with the zero level set at 5%), with CPI (red line). The rise in inflation has been quite tame by historical standards, which is creating a dilemma for policy makers.


The Fed's underlying model of inflation is the Phillips Curve, which posits a trade-off between inflation and unemployment. As the chart from this Money and Banking primer shows, the inverse relationship between inflation and unemployment has been flattening since 2000. Falling unemployment should drive up wages, which is the price of labor, and put upward pressure on inflation. This time, the wage and inflation response has been muted.



Questions are being asked at the Fed. Is the Phillips Curve broken? Why aren't wages rising?

The full post can be found at our new site here.

Sunday, July 16, 2017

Looking for froth in the wrong places

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 Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.


The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Risk-on*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


Where's the Bubble?
Ben Carlson at A Wealth of Common Sense recently detailed the four criteria for a market bubble:
In a recent conversation with Meb Faber, William Bernstein discussed how his criteria for seeing a bubble has more to do with sociological factors than econometric indicators. Here are his four signs of a financial market bubble:

(1) Everyone around you is talking about stocks (or real estate or whatever the fad asset of the day is). And you should really start worrying when the people talking about getting rich in certain areas of the market don’t have a background in finance.

(2) When people begin quitting their jobs to day trade or become a mortgage broker.

(3) When someone exhibits skepticism about the prospects for stocks and people don’t just disagree with them, but they do so vehemently and tell them they’re an idiot for not understanding things.

(4) When you start to see extreme predictions. The example Bernstein gives is how the best-selling investment book in 1999 was Dow 36,000.

He said he’s not worried about a bubble at the moment but seeing 3 out of these 4 conditions being met would be a warning sign.
Despite my series on investor sentiment, Things you don't see at see at market bottoms (which had four editions that were published 13-Jul-2017, 7-Jul-2017, 29-Jun-2017, and 23-Jun-2017), market psychology has not reached the "OMG I have to quit my job/mortgage the house to buy/trade the hot asset of the day". While there are some excesses, such low levels of institutional cash (chart via Business Insider), the lack of over-the-top froth suggests that the next stock market downturn from a recession may be relatively mild in the manner of a 10-20% decline seen in the 1990 bear market.



While I am somewhat sympathetic to that view, investors who are looking for signs of froth are looking in the wrong places. One of the processes that occur in recessions the correction of excesses in the past expansion. Most of the real excesses are not to be found within US borders, but abroad.

The full post can be found at our new site here.

Thursday, July 13, 2017

Things you don't see at market bottoms, Retailphoria edition

It is said that while bottoms are events, but tops are processes. Translated, markets bottom out when panic sets in, and therefore they can be more easily identifiable. By contrast, market tops form when a series of conditions come together, but not necessarily all at the same time.

I have stated that while I don't believe that the stock market has made its final cyclical top, we are in the late stages of a bull market (see Risks are rising, but THE TOP is still ahead and Nearing the terminal phase of this equity bull). Nevertheless, psychology is getting a little frothy, which represent the pre-condition for a major top.

As a result, this is another post in an occasional series of lists of "things you don't see at market bottoms". This week, I focus on more signs of retail giddiness.

  • The TD-Ameritrade Investor Movement Index hits an all-time high
  • E-Trade parties like it`s 1999
  • If the market is chasing yield, corporations can get away with murder
The full post can be found at our new site here.

Wednesday, July 12, 2017

U-S-A! U-S-A!

Mid-week market update: Having reviewed sector rotation last week (see More evidence of an emerging reflationary rebound), it is time to apply the same analysis to countries and regions.

First, let's start with a primer of our analytic tool. Relative Rotation Graphs, or RRG charts, are 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 rotates to lagging groups (bottom left), which changes to improving groups (top left), and finally completes the cycle by improving to leading groups (top right) again.

Here is the RRG chart of the major countries and regions of the world. All ETFs are priced in USD and therefore all currency effects are already part of the returns. The rotation analysis was performed relative to MSCI All-Country World Index (ACWI).



My interpretation of the RRG chart indicates that US stocks are poised to take the leadership position again, after a brief hiatus. Emerging leadership can also be found in the resource producing countries of the world, such as Australia, Canada, Latin America, and Russia. European and Asian stocks, which had been the leaders, are starting to consolidate and they are likely to begin to weaken on a relative basis. These patterns are consistent with my thesis of a developing reflationary blow-off equity market top.

The full post can be found at our new site here.

Tuesday, July 11, 2017

Are stocks being stalked by a silent Zombie Apocalypse?

There was some minor buzz on the internet when Jonathan Tepper tweeted the following BIS chart and rhetorically asked if zombie firms was the cause of falling productivity during this expansion. BIS defines a "zombie" firm as a company that has been listed for 10 years or more and has an EBIT interest coverage of less than 1. As the charts show, the number of "zombie" companies have been rising steadily, while advanced economy (AE) productivity and CapEx has been muted during this expansion.


While the zombie hypothesis has much intuitive appeal, especially to the permabear and doomster set, a deeper examination reveals some unanswered questions that casts doubt about this explanation for the muted productivity gains of this cycle.

The full post can be found at our new site here.

Sunday, July 9, 2017

A mid-year review of 2018 recession risk

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 Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.



The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Risk-on*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


What is the risk of recession?
Over at A Dash of Insight, Jeff Miller criticized WSJ reporter Greg Ip for writing what Miller consider to be a doomster-like article about rising recession market risk. He went on to accuse Ip of cherry picking data to make his point about a heightened risk environment, and concluded:
The entire article reads like a laundry list of points that would make sense to investors with limited knowledge of economics. That is why I am disappointed. My hope is that top journalists would help explain reality rather than feed fears stoked by so many others. This article will frighten investors. Is that what the author intends?
The issue of recession risk is important to investors because every recession has been accompanied by an equity bear market. So let me put in my two cents worth in my own assessment of recession risk for the American economy.


Some time ago, I created a Recession Watch page on my website. The recession risk criteria on the page was based on the framework specified by New Deal democrat. NDD used the work of Geoffrey Moore, the founder of ECRI, to create seven long leading indicators designed to spot recessions a year in advance (click on links for the latest FRED charts):
  • Corporate bond yields (Corporate bond yields have always made their most recent low over 1 year before the onset of the next recession)
  • Housing starts (Housing starts peaked at least one year before the next recession)
  • Real private residential fixed investment (Aside from the 1981 "double-dip," and 1948, it has always peaked at least one year before the next recession)
  • Money supply (In addition to the 1981 "double dip," on only 2 other occasions have these failed to turn negative at least 1 year before a recession)
  • Corporate profits and Proprietors` income, which can be a more timely proxy for corporate profits (Corporate profits have peaked at least one year before the next recession 8 of the last 11 times, one of the misses being the 1981 "double-dip.")
  • Yield curve, which may not be relevant in the current interest rate environment (The yield curve inverted more than one year before the next recession about half the time)
  • Real retail sales (It has peaked 1 year or more before the next recession about half of the time)
A review of the seven indicators revealed both good news and bad news. Here are the details of each indicator, along with a discussion of the internals behind each indicator,

The full post can be found at our new site here.

Friday, July 7, 2017

The things you don`t see at market bottoms, bullish bandwagon edition

It is said that while bottoms are events, but tops are processes. Translated, markets bottom out when panic sets in, and therefore they can be more easily identifiable. By contrast, market tops form when a series of conditions come together, but not necessarily all at the same time.

I have stated that while I don't believe that the stock market has made its final cyclical top, we are in the late stages of a bull market (see Risks are rising, but THE TOP is still ahead and Nearing the terminal phase of this equity bull). Nevertheless, psychology is getting a little frothy, which represent the pre-condition for a major top.

As a result, this is another post in an occasional series of lists of "things you don't see at market bottoms". This week, I focus on the theme of further signs of the bullish bandwagon.

To summarize, Callum Thomas of Topdown Charts constructed a Euphoriameter, consisting of forward P/E, VIX (inverted), and bullish sentiment. Readings are highly elevated, though they have not reached the highs seen at the last cycle top.



The full post can be found at our new site here.

Wednesday, July 5, 2017

More evidence of an emerging reflationary rebound

Mid-week market update: Further to my last post (see Nearing the terminal phase of this equity bull), There are numerous signs that the market's animal spirits are getting set for a reflationary stock market rally. First of all, the BAML Fund Manager Survey shows that a predominant majority of institutional managers believe that we are in the late cycle phase of an expansion.



The full post can be found at our new site here.

Sunday, July 2, 2017

Nearing the terminal phase of this equity bull

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 Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.



The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Risk-on*
  • Trading model: Bearish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


Charting the pain trade
Even as the recent SPX stays in a narrow trading range, there was plenty of pain to go around beneath the surface. The drubbing taken by NASDAQ stocks were largely offset by rallies in Financials and Healthcare.

So what are the next pain trades, and what are the implications?

Hedgopia documented how large speculators (read: hedge funds) have moved from a crowded short in the 10-year Treasury Note to a crowded long.



Similarly, large speculators are also in a crowded long in the T-Bond futures.



Bond yields began to rise, and the yield curve steepened dramatically.


Those are the first major pain points for traders. These dramatic reversals have further implications for the equity market.

The full post can be found at our new site here.

Thursday, June 29, 2017

Things you don't see at market bottoms, 29-Jun-2017

It is said that while bottoms are events, but tops are processes. Translated, markets bottom out when panic sets in, and therefore they can be more easily identifiable. By contrast, market tops form when a series of conditions come together, but not necessarily all at the same time.

I have stated that while I don't believe that the stock market has made its final cyclical top, we are in the late stages of a bull market (see Risks are rising, but THE TOP is still ahead). Nevertheless, psychology is getting a little frothy, which represent the pre-condition for a major top.

As a result, this is another post in an occasional series of lists of "things you don't see at market bottoms". This week, I focus on the theme of "subprime is the new black":
  • How cov-lite loans have become the norm
  • The popularity of subprime auto loan ABS
  • A start-up for customers with no money but want to buy things

The full post can be found at our new site here.

Wednesday, June 28, 2017

All eyes on policy makers

Mid-week market update: As we wait to see if the stock market can break either up or down out of this narrow trading range, this week has been a light week for major market moving economic data, However, there are a number of political and non-economic developments to keep an eye on.



The full post can be found at our new site here.

Sunday, June 25, 2017

Long live the reflation trade!

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 Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.


The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Risk-on*
  • Trading model: Bearish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


The global bull keeps on charging
Despite my recent negativity (see Risks are rising, but THE TOP is still ahead and Things you don't see at market bottoms, 23-Jun-2017 edition), I am not ready to throw in the towel on this equity bull market.

From a long-term perspective, the reflation trade is still alive, and growth is global in scope. As the 20-year monthly chart below of the Dow Jones Global Index (DJW) shows, the last two tops were preceded by negative RSI divergences. So far, DJW is barely overbought and has not even had the opportunity to exhibit a negative RSI divergence. This suggests that global equities can continue to grind higher, and the ultimate top is, at a minimum, several months away.


The tactical outlooks suggests that there may be some near-term weakness ahead. Drilling down to the weekly chart, DJW has shown a pattern of flashing double RSI overbought sell signals. In the past, the index has achieved a first RSI peak overbought reading (dark vertical line) which was followed by a second RSI peak (red vertical line). DJW has recently shown the same double overbought peak pattern, and, if history is any guide, the market is likely to stage a minor pullback.


I interpret these technical conditions as being in favor of the global reflation trade, though some minor pause may be necessary. This scenario is consistent with current macro and fundamental readings that are supportive of a reflationary driven equity advance..

The full post can be found at our new site here.

Friday, June 23, 2017

Things you don't see at market bottoms, 23-Jun-2017 edition

It is said that while bottoms are events, but tops are processes. Translated, markets bottom out when panic sets in, and therefore they can be more easily identifiable. By contrast, market tops form when a series of conditions come together, but not necessarily all at the same time.

I have stated that while I don't believe that the stock market has made its final cyclical top, we are in the late stages of a bull market (see Risks are rising, but THE TOP is still ahead). Nevertheless, psychology is getting a little frothy, which represent the pre-condition for a major top.

As a result, I am starting a one in an occasional series of lists of "things you don't see at market bottoms":
  • Argentina's 100-year bond offering
  • Irrational Exuberance Indicator at fresh highs
  • The E*Trade Indicator flashes a warning
  • More signs of excesses from the Chinese debt time bomb
The full post can be found at our new site here.

Wednesday, June 21, 2017

A market breadth model that works

Mid-week market update: Technical analysts monitor market breadth, as the theory goes, to see the underlying tone of the market. If the major market averages are rising, but breadth indicators are not confirming the advance, this can be described as the generals leading the charge, but the troops are not following. Such negative divergences are signs of technical weakness that may be a precursor to future market weakness.

That’s the theory.

I have been highly skeptical of breadth indicators as a technical analysis tool because breadth divergences can take a long time for the market to resolve, if at all. The chart below shows the SPX, the “generals”, along with several indicators of how the “troops” are behaving, namely the mid-cap and small cap indices, as well as the the NYSE Advance-Decline Line.


The behaviour of these indicators during and after the Tech Bubble was problematical. During the advance from 1998 to 2000, the NYSE A-D Line fell and flashed a negative divergence sell signal. At the same time, both the mid- and small-cap indices continued to rise and confirmed the market advance. Which divergence should investors believe?

After the market peaked in 2000, the mid and small caps traded sideways, which represented a non-confirmation of the bear market. Investors who followed this buy signal would have seen significant drawdowns during this bear market.

To be sure, there were periods when breadth indicators worked. The NYSE A-D Line traded sideways during the market decline of 2011, which was a buy signal. As well, it correctly warned of market weakness in 2015.

Putting it all together, the report card for these indicators can best be described as inconsistent and the timing of the signal uncertain. At a minimum, no investor would use breadth indicators in a trading system.

I believe that I discovered a solution to the problems that technicians struggle with when they use breadth indicators.

The full post can be found at our new site here.

Monday, June 19, 2017

Goldman's "Death of Value" and what being contrarian means

Recently, Ben Snider at Goldman Sachs published a report entitled "The Death of Value", which suggested that the value style is likely to face further short-term headwinds. Specifically, Snider referred to the Fama-French value factor, which had seen an unbelievable run from 1940 to 2010 (charts via Value Walk).


Goldman Sachs went on to postulate that the value style is unlikely to perform well because of macro headwinds. This style has historically underperformed as economic growth decelerates. However, the investment implications are not quite as clear-cut as that, based on my analysis of how investors implement value investing.


The full post can be found at our new site here.

Sunday, June 18, 2017

Risks are rising, but THE TOP is still ahead

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 Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.



The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Risk-on*
  • Trading model: Bearish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


Four steps, where's the stumble?
Wall Street traders know about the "Three steps and a stumble" adage, which states that the stock market tends to suffer substantial setbacks once the Fed takes three tightening steps in a row. Now that the Fed has raised rates four consecutive times, where`s the stumble?

Despite my recent post which suggested that the odds of a hawkish rate hike was high (see A dovish or hawkish rate hike), my social media feed was full of misgivings that the Fed is in the process of making a serious policy error like the 1937 rate hike cycle, where the central bank tightened the economy into a recession.


Another policy error that occurred in recent memory is the Jean-Claude Trichet led European Central Bank's policy of tightening into the Great Financial Crisis.


Similar kinds of concerns are rising today. There are preliminary signs of a weakening economy, and the Fed's willingness to stay the course on its rate normalization policy in the face of soft inflation statistics is raising anxiety levels.

While I believe that recession risks in 2018 are rising, my base case scenario still calls for one last blow-off top in stock prices before the equity party comes to a close. Current concerns about the Fed tightening into a weakening economy can be summarized by this chart of the Citigroup US Economic Surprise Index (ESI), which measures whether macro releases are beating or missing expectations. As the chart shows, ESI has been weak, and the 10-year yield has declined in sympathy. But ESI is already at very low levels. How much worse can the macro picture get before it rebounds?


The full post can be found at our new site here.