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When new highs aren’t bullish

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 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

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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 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 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 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.

 
When new highs aren’t bullish
The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities
  • Trend Model signal: Bullish
  • 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 those email alerts is shown here.
 

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

An exception to the rule?

The S&P 500 rallied to a fresh all-time high last week. While it is said that there is nothing more bullish than a market making new highs, this may be an exception to that rule, especially when there were more declines than advances on the day of a new high.
The S&P 500 kissed the top of a rising channel while exhibiting a negative 5-day RSI divergence. In addition, the VIX Index, which tends to be inversely correlated to stock prices, is testing a key support level at 20-21. More worrisome is the behavior of financial stocks. Large-cap banks reported last week and most beat expectations, but the entire sector is lagging the market.
When new highs aren’t bullish

More signs of froth

Sentiment readings have been extended since last 2020. The latest data point from NAAIM, which measures RIA sentiment, reached a record high of 113. While sentiment models are less useful at tops than bottoms (shaded areas), the last time the NAAIM Exposure Index neared these levels was the melt-up of late 2017 and early 2018.
When new highs aren’t bullish
These sentiment readings are consistent with the BoA Fund Manager Survey, which showed risk appetite at record levels.
When new highs aren’t bullish
As well, the Globe and Mail reported that BoA strategist Savita Subramanian observed that their “Sell Side Indicator”, which measures the risk appetite of Street strategists, is nearing a sell signal.

Sentiment has been getting more euphoric, as our Sell Side Indicator – a contrarian sentiment model – is at the closest level to the “Sell” threshold since the financial crisis. 

The 10-day moving average of the equity-only put/call ratio is nearing its lows again, indicating excessively bullishness. At a minimum, recent low reading episodes have resolved themselves in pullbacks.
When new highs aren’t bullish

Earnings season

One of the bright spots for the market bulls could be Q4 earnings season. FactSet reported the good news: Both EPS and sales beats are strong and above historical norms. Company analysts are revising their EPS estimates upwards, which should be a sign of strong fundamental momentum and bullish.
When new highs aren’t bullish
However, the market isn’t responding to good news in the form of earnings beats. FactSet also reported that the market is punishing positive earnings reports, and rewarding negative ones. However, the conclusion of rewarding earnings misses is based on highly preliminary data, and a very small sample size (n=3). I interpret these conditions as the market not rewarding earnings beats, rather than punishing beats and rewarding misses.
When new highs aren’t bullish

Where is the leadership?

The analysis of market leadership is also flashing warning signs. To be sure, the S&P 500 has been led by large-cap growth stocks. The NASDAQ 100 has led the market upwards, though the NDX to SPX ratio violated a rising relative trend line in early November. The latest relative upswing only represents a sideways consolidation within a range. 
When new highs aren’t bullish
A more detailed look at the relative performance of the top five sectors is more worrisome. These sectors represent 75% of S&P 500 index weight, and it’s virtually impossible for the index to rise sustainably without the participation of a majority of these sectors. The only signs of relative strength come from float-weighted consumer discretionary (AMZN and TSLA) and communications services. None of the other sectors are exhibiting signs consistent strong relative strength. Put simply, the market is being led upwards by a handful of Big Tech stocks. 
When new highs aren’t bullish
The narrow leadership is also evident in the analysis of market breadth. Even as the S&P 500 reached fresh highs, indicators such as NYSE and NASDAQ new highs, the % of stocks with point and figure buys, and the percentage of stocks above their 50-day moving average are all making patterns of lower highs and lower lows. As we progress through earnings season, the narrowness of the leadership poses a grave stock specific risk to the major indices. Any disappointment has the potential to open the door to a sell-off.
When new highs aren’t bullish
In conclusion, the market is undergoing a melt-up and a setback can happen at any time. At worse, the market is vulnerable to a violent air pocket of unknown magnitude. Remember Bob Farrell`s Rule #7: “Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.”
Brace for volatility in the coming week from individual earning season results and the FOMC meeting.
When new highs aren’t bullish
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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