Mid-week market update: If you hadn’t known that it was FOMC day, you would have looked at the closing market diary and shrugged. The S&P 500 closed only +0.3% on the day. Beneath the surface, however, a lot has been going on in the past few weeks. 

Analysts who try to call the direction of the US equity market are facing an especially difficult time as they are encountering a bewildering array of both bullish and bearish sentiment readings. That’s because the stock market has bifurcated into a growth stock market and a value stock market. There is no more single stock market anymore.

This chart of the Russell 1000 Value to Russell 1000 Growth ratio tells the story. After value stocks opened a “Vaccine Monday” runaway gap last November, value stocks have made their way higher

As the markets remain in risk-on mode, readers should be aware of several lurking risks that may appear from the FOMC meeting. Undoubtedly, Powell will repeat his dovish mantra that the Fed is a long way from neutral and policymakers are focused on the labor market. 

Nevertheless, here is what I am watching:

What will the “dot plot” convey about the path of interest rates and how does that differ from market expectations?
Will the Fed do anything about the soaring 10-year yield, which has risen above 1.6%, i.e. yield curve control (YCC)?
What will happen to the Supplementary Leverage Ratio (SLR), and will the banks get SLR relief after March 31?

Timing of rate hikes

On Wednesday, the FOMC will release its SEPP, or “dot plot”, of interest rate expectations by members. Fed

Preface: Explaining our market timing modelsWe 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 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 a trading model, which is a blend of price momentum

The fiscal and monetary authorities of the developed world are engaged in a great macroeconomic experiment. Governments are spending enormous sums to combat the recessionary effects of the pandemic and central banks are allowing monetary policy to stay loose in order to accommodate the fiscal stimulus. Eventually, inflation and inflation expectations are bound to rise.

Here is what that means for investor portfolios. I recently highlighted a relationship from a Credit Suisse chart indicating that 50/50 balanced fund drawdowns rise during periods when stock-bond correlations are high (see Are you positioned for the post Great Rotation era?). Stock-bond correlations tend to rise during periods of rising inflation expectations. Balanced funds composed of simple stock and bond allocations

Mid-week market update: The rebound in the NASDAQ and growth stocks was not a surprise. Value outperformed growth by the most on record last week – and that includes the dot-com crash that began in 2000. 

Make no mistake. Growth stocks are experiencing an unsustainable dead cat bounce. 

Growth is oversold
Here is another illustration of how much growth is oversold relative to value. No matter how you measure it, large and small-cap value had turned up decisively against growth. The uptrend appears extended, and a pullback was no surprise. Nevertheless, the intermediate-term trend favors value over growth. 

I had pointed out before that the NASDAQ McClellan Oscillator (NAMO) had become deeply oversold. As well, %Bullish on P&F had reached an oversold reading while the NASDAQ

In his latest letter to Berkshire Hathaway shareholders, Warren Buffett reported that even Berkshire’s largest publicly listed holding is asset-light Apple, and Berkshire is a very asset-heavy company. Its two major holdings are railroad BNSF and electric utility BNE, which has a large capital project to upgrade the electrical transmission grid in the western US, due to be complete in 2030.

Recently, I learned a fact about our company that I had never suspected: Berkshire owns American-based property, plant and equipment – the sort of assets that make up the “business infrastructure” of our country – with a GAAP valuation exceeding the amount owned by any other U.S. company. Berkshire’s depreciated cost of these domestic “fixed assets” is $154 billion. Next in line on this list is

Preface: Explaining our market timing modelsWe 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 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 a trading model, which is a blend of price momentum

Is the US stock market in a bubble? Yes and no, according to Ray Dalio of Bridgewater Associates. Using a proprietary technique to create a “bubble indicator”, Dalio concluded that “the aggregate bubble gauge is around the 77th percentile today”, compared to a 100th percentile reading in 1929 and 2000. 

Dalio qualified his analysis with some parts of the market are indeed very bubbly, but others are not.

There is a very big divergence in the readings across stocks. Some stocks are, by these measures, in extreme bubbles (particularly emerging technology companies), while some stocks are not in bubbles. 
Credit Suisse came to a similar conclusion with their US Exuberance Index. The number of companies with price-to-sales over 10 have surged, but readings are not at the levels seen

Mid-week market update: Is the bond market panic over yet? The 10-year Treasury yield touched a high of 1.6% last week. It fell when the Reserve Bank of Australia began to engage in yield curve control, but it is edging back towards 1.5% again. 

Based on this week’s market action, I conclude that stock prices have unfinished business, both on the upside and downside.

Short-term bullish

I pointed out last week how the NASDAQ 100 (NDX), which was the worst hit of the major indices, was oversold on the NASDAQ McClellan Oscillator (NAMO). The NDX staged a strong relief rally on Monday but retraced all of the gains. Is the recovery over? Probably not yet. The historical experience indicates that the relief rally window usually at least a week. The current pattern may be setting up

With 96% of S&P 500 companies having reported, Q4 earnings season is all but over. For the markets, the earnings reports contained both good news and bad news. 

There was plenty of good news. Both EPS and sales beat rates were well above their historical averages. In addition, consensus earnings estimates have been rising steadily, and forward 12-month EPS estimates have nearly recovered to pre-pandemic levels.

In fact, the pace of Q1 estimate revisions is the second highest in FactSet’s history, second only to Q1 2018.

The bottom-up assessment

The tone from earnings calls is nothing short of giddy, according to The Transcript, which monitors earnings calls.

Covid cases are dropping, vaccines are being administered and warmer weather is coming.  Fatigued consumers are

Preface: Explaining our market timing modelsWe 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 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 a trading model, which is a blend of price momentum

Jerome Powell’s Congressional testimony last week made the Fed’s position clear. Monetary policy will remain easy for the foreseeable future. Inflation dynamics change, but not on a dime. While Fed policy will leave short-term interest rates anchored near zero, the market’s inflation expectations have been rising. Last week, the 10-year Treasury yield briefly breached 1.6% and the 30-year Treasury yield rose as high as 2.4%. 

Will heightened inflation expectations and rising bond yields rattle the equity market?

Reflation, or inflation?

Inflation fears are overdone. Jim Bianco wrote an insightful Bloomberg OpEd advising investors to distinguish between reflation and inflation. Equity markets perform well in under reflation. They face more headwinds with inflation. 

If

Mid-week market update: About a month ago, I warned that the market was undergoing a regime shift from growth to value (see What would Bob Farrell say?) and compared today’s Big Tech momentum stocks, not to the dot-com mania, but the Nifty Fifty era. On the weekend, I rhetorically asked in a tweet that if Bloomberg TV has to explain r/WSB lingo to its audience, it’s probably a sign that speculative momentum was nearing the end of its run. 

It finally happened this week. The MoMo (momentum) crowd is losing its mojo. The price momentum factor, however it’s measured, is undergoing a sharp correction. 

Here is what that means for the stock market. 

A growth to value rotation
The S&P 500 tested its 50-day moving average (dma) yesterday and recovered. Beneath the surface, however,

Is it too late to buy into the commodity supercycle thesis? The latest BoA Global Fund Manager survey shows that respondents have moved to a crowded long position in commodities. Many analysts have also hopped on the commodity supercycle train, myself included (see How value investors can play the commodity supercycle). 

As a cautionary note, one reader alerted me to a well-reasoned objection on the commodity supercycle thesis.

Much depends on China demand

China watcher Michael Pettis raised his objections in a Twitter thread. Simply put, a secular commodity bull doesn’t make sense from the demand side. Much depends on Chinese growth remaining at the current unsustainable levels.

I wonder if they’ve thought through the systemic implications. Given China’s disproportionate

Preface: Explaining our market timing modelsWe 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 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 a trading model, which is a blend of price momentum

The nature of the market advance has been extraordinary and relentless. From a long-term perspective, the monthly MACD model flashed a buy signal last August for the broadly-based Wilshire 5000 and there are no signs of technical deterioration. This is a bull market, but sentiment has become sufficiently frothy that a reset is overdue. 

The latest BoA Global Fund Manager Survey concluded that “the only reason to be bearish…is there is no reason to be bearish”. As the economic outlook improved and the vaccine rollouts are on track to control the pandemic, the market’s mood has shifted from despondency to mania. An immense amount of speculative froth has appeared. The market has been overrun by small uninformed YOLO (You Only Live Once) investors trading penny stocks and call

Mid-week market update: Instead of repeating endlessly the mantra of how frothy this market has become, I thought it would be worthwhile to take a look at one of the market leaders. Small cap stocks have led the market up during this recovery. 

On the other hand, the latest BoA Global Fund Manager Survey shows that institutions are off-the-charts bullish on small cap stocks, which is contrarian bearish. 

What are the risks and opportunities in small-cap stocks? 

Party just getting started
Arguably, the small-cap bull is just getting started. Callum Thomas at Topdown Charts highlighted the weight of the small-cap S&P 600 in the S&P 1500. S&P 600 weight recently made a relative bottom, but it has a long way to go before it even normalizes. 

From a valuation perspective, the

Preface: Explaining our market timing modelsWe 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 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 a trading model, which is a blend of price momentum

The investment seasons are changing. Two major factors are emerging in altering the risk and return profiles of multi-asset portfolios in the coming years, rising commodity prices and value investing.

There is a strong case to be made that we are on the cusp of a new commodity supercycle. The last time the CRB to S&P 500 ratio turned up, commodity prices outperformed stocks for nearly a decade. The ratio is on the verge of an upside breakout from a falling trend line, supported by the stated desire of the Biden administration and the Federal Reserve to run expansive fiscal and monetary policies. 

In addition, value stocks are exhibiting the start of a multi-year turnaround against growth stocks. 

Here is how to combine value investing while participating in rising commodity

Mid-week market update: Despite my warnings about negative divergence, the S&P 500 continued to rise and it is now testing a key trend line resistance level at about 3920. Much of the negative breadth divergence have disappeared, though Helene Meisler observed that about 35% of the NASDAQ new highs are triple counted. 

Is this another instance of a “good overbought” sustained advance?

The bull case

There is nothing more bullish than a market making new highs, and FOMO (Fear of Missing Out) price momentum has been relentless. Rob Hanna at Quantifiable Edges found that persistent moves to new highs rarely end abruptly.

Moreover, the price momentum factor, which measures whether market leaders continue to lead the market upwards, is also strong.

Macro Charts observed

Q4 earnings season is in full swing, and results are strong. With 59% of the S&P 500 having reported, both the EPS and sales beat rates are well ahead of historical averages. Moreover, forward 12-month EPS estimates surged 3.5% in a single week.

As well, estimates are surging across all market cap bands.

But it’s not all good news for earnings and the stock market. 

A surge in estimates

First, the good news. If we drill down to the quarterly EPS level, estimates are rising strongly across the board. In particular, Q4 estimates are seeing a surge in estimate revision. Q4 estimates rose 3.81 to 41.08 last week, an astounding 10.8%. Moreover, FactSet reported that the Q1 positive guidance is 64%, which is well ahead of the 5-year historical average of 33%.

With the

Preface: Explaining our market timing modelsWe 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 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 a trading model, which is a blend of price momentum

After last week’s wild market swings, it’s time to have a sober discussion about risk control. I know that risk control isn’t a sexy topic, but better portfolio risk control can lead to better overall returns. 

The framework of analysis will not be the conventional description of risk as it is stylistically shown above. Instead, I offer some “outside the box” thinking and focus on the following:

Mis-specifying investment objectives and risk preferences
How to take advantage of volatility
Regime change risk in the form of:
Unexpected tail-risk
Changes in market environment (conventional regime change);
Slow changing regimes that investors may be unaware of;
Changes in modeling assumptions.

The discussion range from practical suggestions for individual investors to big picture

Mid-week market update: The fever on the r/WSB squeeze has broken. As well, the elevated nature of sentiment readings has begun to normalize. Does that mean the correction is over? 

In the past few days, I have had an unusual number of people ask me that question. My answer has been, “In the words of technical analyst Walter Deemer, when it comes time to buy, you won’t want to.”

Do you still want to buy?

Bullishness in retreat

To be sure, sentiment readings have come off the boil. Callum Thomas conducts a weekly (unscientific) poll on Twitter every weekend. His latest readings show that sentiment has swung net bearish after several weeks of elevated bullish readings. Similar past episodes of bearish sentiment after prolonged high bullishness have resolved either in either

Is this GameStop’s “shoeshine boy” moment? Tracy Alloway pointed out that GME had made it to dog Instagram.  

If dog Instagram wasn’t enough of a shoeshine boy moment, how about this Michael Bathnick observation?

Regardless, there are a number of other opportunities in the short squeeze space to consider (other than silver).

Most shorted ETFs

The short squeeze play is getting played out, especially when short interest is falling to historic lows indicating there is little short covering demand should the market weaken.

Instead of looking for short squeeze opportunities in individual stocks, have you considered a list of the most shorted ETFs? These represent possible contrarian plays in unloved industries that may be poised to move up. For the purposes of this analysis,

Preface: Explaining our market timing modelsWe 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 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 a trading model, which is a blend of price momentum

Now that virtually everybody has bought into the reflation and global cyclical recovery trade, and Reddit flash mobs are ganging up on short sellers to drive the most short-sold stocks into the stratosphere, what could go wrong with this bull? 

Notwithstanding the silliness of the WSB flash mobs, here are some key bearish risks to consider.

The rise of bond vigilantes
Continuation of the trade wars
Health policy stumbles

Partying with abandon

Most of the investor surveys have been off-the-charts bullish for weeks. From most indications, retail and fast-money hedge funds are all-in on equities. Today, data is emerging that the slow-moving institutions are also fast becoming long risk.

The BoA Fund Manager Survey shows global manager risk positioning is at a record high.

Mid-week market update: What are we make of this market? In the last four years, the weekly S&P 500 chart shows that we have seen six corrective episodes of differing magnitudes. Risk happens, and sometimes with little or no warning. 

About half of those instances saw negative 5-week RSI divergences, which we are seeing today. Since the start of 2019, when the ARK Innovation ETF (ARKK) started to get hot, the ARKK to SPY ratio roll over every time during those corrections. That ratio is turning down again.

The stock market is becoming a market of stocks, instead of a stock market. Individual issues are moving separately instead of together. In the past, low realized individual stock correlations have been warnings of market corrections.

Will this time be any different? The

Preface: Explaining our market timing modelsWe 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 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 a trading model, which is a blend of price momentum

What would the legendary market analyst Bob Farrell say about today’s markets? I was reviewing the patterns of factor returns recently, and I was reminded of three of Farrell’s 10 Rules of Investing (which are presented slightly out of order). 

Rule 3: There are no new eras – excesses are never permanent.
Rule 2: Excesses in one direction will lead to an opposite excess in the other direction.
Rule 4: Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.

Applying those principles to the return patterns to growth and value over the last 20 years, we can see that growth has peaked out relative to value in 2020 (Rules 2 and 3).

Does that mean that this is the end of an era for growth stocks? Large-cap growth