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Internal rotation + Seasonality = More gains

Summary:
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

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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.

 
Internal rotation + Seasonality = More gains
The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities
  • Trend Model signal: Bullish
  • 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 those email alerts is shown here.
 

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

Positive April seasonality

I normally only give seasonality secondary consideration in my analysis. But April is the most bullish month of the year for S&P 500 in the last 20 years and positive 80% of the time. Combined with the recent healthy internal rotation in the market, and if seasonality continues to track, the stock market should grind higher for the remainder of the month.
Internal rotation + Seasonality = More gains
I conclude from this analysis that the market can continue to rise in April. A healthy internal rotations has occurred that has relieved the pressure of overbought excesses. Several potential opportunities have arisen as a result of the market rotation:
  • A opportunity to lighten up on growth stocks;
  • A opportunity to buy into value stocks; 
  • A bond market rally; and
  • A possible bullish setup for gold and gold stocks.

Opportunities from market rotation

The market has been undergoing a healthy internal rotation, which has created a number of opportunities that I would like to highlight.
First, value stocks have broken the long relative downtrend against growth stocks. In the last month, however, growth has made a relative recovery against value. The value/growth ratio has reversed and become oversold on the 5-day RSI. The absolute performance of the Russell 1000 Value and Growth indices are more revealing. While value stocks remain in an absolute uptrend and continues to make new highs, growth stocks have rebounded strongly and they are now testing a key resistance level. I interpret these conditions as a growth counter-trend rally, and an opportunity for investors to rotate out of growth back into value. The trend is your friend, and the trend favors value.
Internal rotation + Seasonality = More gains
Further evidence of market rotation can be found in the short-term bottom in bond prices. The 7-10 year Treasury ETF (IEF) recently made a double-bottom while exhibiting a positive RSI divergence. The bond market is poised for a short-term rally and rebound.
Internal rotation + Seasonality = More gains
Another opportunity can be seen in gold and gold stocks. Even as inflation expectations rose, gold prices have been pulling back since mid-2020 in a bull flag pattern. Gold recently bottomed while flashing a positive 5-week RSI divergence. This is a setup for higher prices.
Internal rotation + Seasonality = More gains
The technical pattern for gold stocks is even more bullish. GDX is testing the top of a bull flag after the percentage of bullish on P&F reached an oversold condition in early March. 
Internal rotation + Seasonality = More gains

Bullish despite frothy sentiment

Undoubtedly some readers will have noticed that a number of sentiment models have reached excessively bullish readings, and I want to address those concerns. A noticeable difference has recently appeared between sentiment surveys, which ask respondents about their views on the market, and positioning models, which measure how actual funds are deployed.
Sentiment surveys have, by and large, been very bullish. As an example, the AAII bull-bear spread is highly elevated. While this model has not shown itself to be an effective actionable trading sell signal (grey zones), its readings are concerning.
Internal rotation + Seasonality = More gains
Similarly, Investors Intelligence bulls have jumped and bears have retreated. The bull-bear spread is at or near a crowded long condition.
Internal rotation + Seasonality = More gains
On the other hand, the NAAIM Exposure Index, which measures RIA sentiment, flashed a capitulation buy signal in early March. The index rose to 89.95 from a fearful 52.02 the previous week. Readings are neutral and not excessive.
Internal rotation + Seasonality = More gains
As well, the equity put/call ratio has been slowly rising indicating a healthy sentiment normalization.
Internal rotation + Seasonality = More gains
Helene Meisler’s weekly (unscientific) but timely Twitter poll done yesterday (Saturdy) saw net bullishness retreat after a record high last week despite the market advance. This is another sign the sentiment has reset and stock prices have further room tot rise.
Internal rotation + Seasonality = More gains
Market internals indicate that the market can rise further. Neither the NYSE McClelland Oscillator (NYMO) nor the NASDAQ McClellan Oscillator (NAMO) are overbought after reaching oversold conditions in early March. 
Internal rotation + Seasonality = More gains
The market’s advance has been orderly so far and characterized by a healthy internal rotation. The key risk is the rally becomes disorderly and excesses appear. If the S&P 500 were to overrun its rising trend line at about 4150-4160, it would be the sign of a blow-off top which is usually followed by a correction. As well, I am monitoring the spike in the correlation between the S&P 500 and the VVIX (volatility of VIX), which has signaled short-term tops in the past. However, the rise in correlation may be a one-time event. Bloomberg reported that a large buyer entered into a VIX call option spread, which undoubtedly elevated VVIX and caused the S&P 500/VVIX correlation to rise.

Somebody shook up options screens Thursday morning with a wager that the VIX Index will rise toward 40 — and won’t be lower than 25 — in July, up from about the 17 level where the volatility gauge currently trades. The trader appears to have made several block trades, buying a total of about 200,000 call contracts. That’s almost as big as the total daily volume of VIX calls, based on the 20-day average, data compiled by Bloomberg show.

Internal rotation + Seasonality = More gains
I conclude from this analysis that the market can continue to rise in April. A healthy internal rotations has occurred that has relieved the pressure of overbought excesses. Several potential opportunities have arisen as a result of the market rotation:
  • A opportunity to lighten up on growth stocks;
  • A opportunity to buy into value stocks; 
  • A bond market rally; and
  • A possible bullish setup for gold and gold stocks.
Disclosure: Long IJS
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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