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. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here
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 is 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: 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.
A possible ZBT buy signal
The Zweig Breadth Thrust buy signal is a rare momentum buy signal that only occurs once every few years. Steven Achelis at Metastock explains the indicator this way (emphasis added):
A “Breadth Thrust” occurs when, during a 10-day period, the Breadth Thrust indicator rises from below 40% to above 61.5%. A “Thrust” indicates that the stock market has rapidly changed from an oversold condition to one of strength, but has not yet become overbought.
According to Dr. Zweig, there have only been [sixteen] Breadth Thrusts since 1945. The average gain following these fourteen Thrusts was 24.6% in an average time-frame of eleven months. Dr. Zweig also points out that most bull markets begin with a Breadth Thrust.
The ZBT window began on Friday August 20, 2021. It has 10 trading days, or until September 2, 2021 to flash a ZBT buy signal.
Besides a possible ZBT buy signal as an indicator of powerful price momentum, here is what else I am watching.
Risk appetite indicators
In particular, I am monitoring for signs of risk appetite. As an example, the high-beta small cap indices remain range-bound, but their relative performance is improving. As well, internal breadth (bottom panel) is showing a turnaround. I interpret these as constructive signs for the bull case.
The relative performance of small cap stocks is an important beacon of the cycle in light of the vast gulf in relative valuation.
Credit market risk appetite, as measured by the relative price performance of junk bonds against their duration-equivalent Treasury counterparts, is also turning up.
The 10-year Treasury yield is testing its falling trend line, which is bullish for the cyclical and reflation case. However, the USD Index is testing resistance and an upside breakout would be bearish for cyclicals. Which way will the market turn?
If the USD were to strengthen further, the first to feel the effects would be the fragile EM countries with large current account deficits. How would their stock markets behave?
Even if the market fails to flash a ZBT buy signal, these cross-asset indicators serve as possible confirmations of a bullish tone to the market.
Value and growth
Another important indicator of market direction is the relative performance of value stocks, which are more cyclically sensitive, to growth stocks. Value has been trying to bottom out against growth in the past few weeks, but relative internals (bottom two panels) remain weak. Better relative performance of value would be an important indicator that the reflation bulls have seized control of the tape.
There are hopeful signs. Patrick Zweifel
of Pictet Asset Management pointed out that global trade is turning up, largely owing to resilient trade data from South Korea and Taiwan.
As well, COVID-19 hospital admissions appear to be peaking, especially in problematical jurisdictions like Florida, Texas, and Arkansas. These are also bullish signs for a cyclical rebound.
In addition, this Bloomberg Businessweek cover is a classic contrarian magazine cover indicator that is bullish for the cyclical and reflation trade.
The cyclical and reflation trade may start to enjoy a period of positive seasonality. Let me explain what may be a complicated but important cross-asset relationship.
Much of the value and growth relationship depend on bond yields. The relative performance of the growth-heavy NASDAQ 100 has been correlated to the 10-year Treasury yield.
The 10-year Treasury yield is correlated to the Economic Surprise Index (ESI).
However, the ESI Index has shown a high degree of seasonality and it is poised to turn up.
In addition, the S&P 500 is poised for a period of positive seasonality after some volatility in September.
In conclusion, the market may be on the verge of an important Zweig Breadth Thrust buy signal, which would be a powerful and bullish indicator of price momentum. Even if the ZBT buy signal were to fail, other indicators makes me constructive on the outlook for US equities.
Disclosure: Long SPXL