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
Cam Hui considers the following as important: Free Posts, sentiment analysis, Technical analysis, Trend Model, Ultimate Timing Model
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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.
The latest signals of each model are as follows:
- Ultimate market timing model: Sell equities
- Trend Model signal: Neutral
- Trading model: Bullish
Update schedule: I generally update model readings on my site on weekends 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.
Easy to be bearish
The sentiment backdrop is making it easy to be cautious about the stock market. Bloomberg reported that the bears are going extinct as the market rallied.
Skeptics are a dying breed in American equities. It’s another illustration of how risky it has become to doubt the resilience of the market’s $13 trillion surge since late March.
Going by the short positions of hedge funds, resistance to rising prices is the lowest in 16 years. Bears pulled out as buying surged among professional investors who were forced back into stocks despite a recession, stagnating profits and the prospect of a messy presidential election.
If that’s not enough, TMZ published an article with the headline “Day Trading on the Stock Market Is Easier Than You Think”.
Yet the stock market grinds higher. Even as bearish warnings of excessive bullish sentiment and deteriorating breadth, the bulls are holding steadfast, like the outnumbered Greeks at the Battle of Thermopylae.
A case of bad breadth
Even as the stock market rose and made new all-time highs, the advance is being made on deteriorating breadth. Breadth indicators, such as the A-D Line, 52-week highs-low, percentage bullish, percentage of stocks above their 50 and 200 dma, are all not confirming the new highs.
The NASDAQ 100 has led this market upwards, but even NASDAQ breadth is showing similar signs of negative breadth divergence.
When I see broad breadth divergences like this, I am reminded of Bob Farrell’s Rule #7, “Bull markets are strongest when they are broad and weakest when they narrow to a handful of blue chip names,”
Weakened risk appetite
Other risk appetite indicators are also not confirming the market advance. The ratio of high beta to low volatility stocks is an indicator of risk appetite, and it fell below a key relative support line even as the market made new highs. So did different version of the Advance-Decline Line.
Credit market risk appetite, as measured by the relative performance of high yield (junk) bonds and leverage loans, are also not buying into the new stock market highs.
What’s holding up the market?
In light of all these dire warnings, it’s natural to be cautious about the market outlook. But why is the market defying gravity?
The answer is easy when you look under the surface and analyze the relative performance of the top five index sectors. Big Tech sectors, namely technology, consumer discretionary (AMZN), and communication services make up nearly half of index weight, and Big Tech has been extremely strong on a relative basis. It is difficult to see how the stock market could decline without Big Tech weakness.
Some of the leadership can be explained by the dominance of the megacap growth stocks. Take Apple as an example. The market cap of Apple now matches the entire market cap of the Russell 2000 small cap index. The stock broke up through a rising channel last week, which could either be the sign of a blowoff top, or signs of further market strength. Until leading stocks like Apple weaken, the bulls will retain control of the tape.
Big Tech dominance can also be seen on an equal weighted basis, which minimizes the contribution of heavyweight FANG+ stocks. The equal-weighted analysis of the relative performance of the top five sectors also shows that the Big Tech sectors are in relative uptrends.
The analysis of the relative performance of large and small cap technology stocks does show some cracks in the phalanx of tech leadership. The relative performance of small cap technology (green line, top panel) peaked out in April and rolled over even as large cap tech roared upwards. In addition, the relative performance of small cap to large cap tech (green line, bottom panel) mirrors the relative performance of small cap to large cap stocks, indicating that the size effect is more important that the sector effect.
The bulls last stand?
In light of this analysis, it is no wonder why the bulls’ phalanx is holding ground, just like the Greeks at the Pass of Thermopylae. For readers who are unfamiliar with the Battle of Thermopylae, a small Greek force held off an enormous Persian army at the Pass of Thermopylae, which was a very narrow passage, for three days. For two days, Persians sent wave after wave of soldiers at the Greek defenders in the narrow passage, and the assaulting force all returned bloodied. On the third day, the Persians found a narrow path around the pass and encircled the Greeks.
Historical analogies only go so far. What will crack these stubborn bulls? Watch for the answer in the leadership of the NASDAQ 100, and semiconductor stocks. The bears are not going to take control of the tape as long as the relative performance of these stocks are holding up.
For a study in contrasts, here is the percentage of stocks in the S&P 500 above their 5 dma. This indicator has breached a short-term uptrend and should be a bearish warning for traders.
Here is the same indicator for the NASDAQ 100. The uptrend remains intact. Are these conditions short-term bullish or bearish in light of Big Tech market dominance?
In conclusion, investors with intermediate and long term time horizons should be cautious about the stock market outlook, but it is unclear what bearish catalyst will reverse the market advance. Short-term traders, on the other hand, can give the bull case the benefit of the doubt, as long as the NASDAQ and semiconductor bull trends are holding up.
Disclosure: Long TQQQ