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Can the bulls breach the island’s moat?

Summary:
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 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 a trading model, which is a blend of price momentum (is

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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 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 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 those email alerts are updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.
 

Can the bulls breach the island’s moat?

The latest signals of each model are as follows:

  • Ultimate market timing model: Sell equities
  • Trend Model signal: Neutral
  • Trading model: Bearish

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.

Subscribers can access the latest signal in real-time here.
 

The moat around the island

I have been highlighting in these pages the bearish island reversal which formed in mid-July. Although stock prices haven’t fallen significantly, the bulls have been unable to breach the gap that defines the island reversal. Conversely, past market advances since the downside break from the island has stalled at resistance at about 3150-3160.
 

Can the bulls breach the island’s moat?

Is there a moat around the island?
 

A NASDAQ stall?

The intermediate term internals continue to tilt bearishly. Let’s begin with the NASDAQ, which achieved all-time highs on Thursday. However, the fresh highs were accompanied by negative 5 and 14 day RSI divergences, as well as negative divergences from the percentage of NASDAQ 100 stocks above their 50 and 200 day moving averages. That said, these negative divergences are not necessarily actionable trading signals, as they can persist for some time before the market turns down. What they do show is that the intermediate term outlook is not favorable for the bulls.
 

Can the bulls breach the island’s moat?

Similarly, the relative performance of NDX to SPX is also exhibiting a negative RSI divergence.
 

Can the bulls breach the island’s moat?

Macro Charts voiced a similar warning on the NASDAQ. Stay cautious, but wait for the downside break before turning too bearish.
 

Can the bulls breach the island’s moat?

A long-term monthly chart of the NASDAQ 100 reveals that the index is testing a key rising trend line. The advance is likely to stall despite the bullish development of the latest new highs.
 

Can the bulls breach the island’s moat?

Trouble under the hood

If we were to move beyond the NASDAQ leaders, the chart patterns of mid and small cap stocks are cause for concern. The chart below shows the S&P 500, the equal-weighted S&P 500, the Midcap S&P 400, and the Small cap S&P 600. Three interesting patterns emerge from this analysis.

  • All indices, except for the equal-weighted S&P 500, show a bearish island reversal.
  • All of other indices show a pattern of lower highs even as the large cap S&P 500 rallied up to test resistance at 3150-3160.
  • All of the other indices are below their 200 dma, while the large cap S&P 500 is holding above its 200 dma.
Can the bulls breach the island’s moat?

The pattern of lower lows and lower highs in the percentage of stocks above their 50 dma is another worrisome sign.
 

Can the bulls breach the island’s moat?

These are all signs of trouble under the hood, but they are only warning signs that will stay “under the hood” until the bears can muster a downside break in the major market indices.
 

Top of the range

Short term breadth is overbought and the market is due for a pullback. The confluence of bearish intermediate term internals and overbought readings argue for a range-bound market, where we are at the top of the range.
 

Can the bulls breach the island’s moat?

The stock exchange was closed on Friday July 3, but the futures market was open. Equity futures closed Friday in the red. While the after-hour futures is thin, Friday’s market action is nevertheless an indication that the bulls failed yet once again at a key resistance level.
 

Can the bulls breach the island’s moat?

My inner investor remains neutrally positioned at the asset allocation targets specified by investment policy. While he is cautious for fundamental and valuation reasons, he is mindful of the possibility that we are witnessing the start of a market bubble that could take stock prices to heights that he hasn’t imagined.

My inner trader is bearishly positioned. His base case scenario is the market will stay between 3010-3020 on the downside and 3150-3160 on the upside. Until the market breaks out from that range, he will endeavor to buy the dips and sell the rips.

Disclosure: Long SPXU

About Cam Hui
Cam Hui
Cam Hui has been professionally involved in the financial markets since 1985 in a variety of roles, both as an equity portfolio manager and as a sell-side analyst. He graduated with a degree in Computer Science from the University of British Columbia in 1980 and obtained his CFA Charter in 1989. He is left & right brained modeler of quantitative investment systems. Blogs at Humble Student of the Markets.

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