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A stealthy growth correction

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.

 
A stealthy growth correction

 
 

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities
  • Trend Model signal: Bullish
  • Trading model: Neutral

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.
 

Growth stocks stumble

Marketwatch reported last week that a meltdown of Cathie Wood’s ARK Innovation ETF (ARKK) may spark a S&P 500 pullback.
“Many of the ARK and similar funds that hold high growth stocks are now trading between one and two standard deviations below their 50[-day moving averages] where buyers usually enter,” said technical analyst Andrew Adams in a Wednesday note for Saut Strategy. “I don’t think the market needs to go down any more, so a bounce attempt should occur given all the nearby support levels.”
Since the publication of that article, ARKK and other growth stocks have weakened further relative to the S&P 500.
 
“If the high-growth areas start breaking support and taking the rest of the market down with them, then maybe the 3,980-4,000 zone in the S&P 500 will be retested after all,” Adams wrote. The S&P 500 finished at 4,167.59 on Wednesday, 1% off a record close of 4,211.47 set on April 29.
A test of support in the 3,980-4,000 area would mark a pullback of only 5% to 6%, but given the damage seen in other parts of the market could lead to “some huge losses” elsewhere, he said. “I’d rather avoid that, so for now I think we can use yesterday’s lows as a test to see if that represented a selling climax in much of the market.”

The growth-heavy NASDAQ 100 bounced off a test of its 50-day moving average (dma) after being rejected twice at resistance. More worrisome is the breach of the relative support zone of NDX compared to the S&P 500 and ARKK to the S&P 500. Market internals such as the percentage of NASDAQ 100 stocks above their 50 dma is not oversold enough to signal a durable bottom.
 

A stealthy growth correction

Resilient Value

On the other hand, value stocks have been resilient and holding up the market. The value to growth ratio is soaring, though a little overbought. The Russell 1000 Value index remains in a well-defined uptrend while the Russell 1000 Growth index is struggling with a key support line. 
 

A stealthy growth correction

A review of the relative strength of the top five sectors tells the story of a bifurcated market. In aggregate, these sectors account for roughly three-quarters of S&P 500 weight and it would be difficult for the index to rise or fall without the participation of a majority of these sectors. Growth sectors, such as technology, communication services, and float-weighted consumer discretionary stocks, which are dominated by heavyweights AMZN and TSLA, are underperforming the S&P 500. By contrast, value sectors such as financials and equal-weighted consumer discretionary stocks are strong.
 

A stealthy growth correction

The bears haven’t seized control yet

However, there are no signs of significant technical breakdowns just yet. The relative strength of defensive sectors is strong indicating that the bears haven’t seized control of the tape.
 

A stealthy growth correction

To be sure, there are some warning signs. Mark Hulbert pointed out that the Shiller Crash Confidence Index, which measures whether investors are worried about a stock market crash, has declined precipitously. Hulbert concluded that ” the outlook for the next six- and 12-month periods would appear to be quite modest”,
 

A stealthy growth correction

The bond market has caught a bid and it is attempting an upside breakout from a possible inverse head and shoulders formation.
 

A stealthy growth correction

Both gold and silver have staged upside breakouts. Precious metals tend to be viewed as defensive and negative beta plays.
 

A stealthy growth correction

Bloomberg also reported that “Sam Zell Buys Gold With Inflation ‘Reminiscent of the ‘70s’”.
 

Billionaire investor Sam Zell is seeing inflation everywhere, and has bought gold as a hedge — something he says he used to knock others for doing.
 

“Obviously one of the natural reactions is to buy gold,” he said in a Bloomberg Television interview. “It feels very funny because I’ve spent my career talking about why would you want to own gold? It has no income, it costs to store. And yet, when you see the debasement of the currency, you say, what am I going to hold on to?”
 

Zell, 79, said he’s concerned not only about the U.S. dollar but other countries printing money as well, and questioned whether inflation will be transitory, as Federal Reserve Chairman Jerome Powell indicated last week.

I conclude from this analysis that while there are downside risks to the S&P 500, the weakness is only confined to growth stocks. Value stocks are still strong and they are holding up the index. My base case scenario calls for a period of choppy sideways consolidation for the S&P 500. Until a bearish catalyst appears for value stocks, which have cyclical characteristics, the overall market should hold up well.
In the short-run, the S&P 500 is overbought and due for a pullback early in the week. I am watching to see how the market behaves after the overbought condition is resolved later in the week.
A stealthy growth correction
I will be especially monitoring the price action of the growth-cyclical bellwether Semiconductor Index (SOX). SOX rallied last week after testing a rising uptrend to regain the 50 dma. However, the 50 dma has stopped rising and it is on the verge of falling, indicating the possible start of a downtrend for the group. Moreover, SOX breached an important long-term relative uptrend against the S&P 500.
A stealthy growth correction
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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