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A consolation prize for the bulls

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. 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

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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. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.
A consolation prize for the bulls
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.
A consolation prize for the bulls
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.
 

Cautiously bullish

Last week, I alerted readers to a possible rare Zweig Breadth Thrust buy signal (see The Zweig Breadth Thrust Watch). Unfortunately for the bulls, the ZBT failed to materialize, but the S&P 500 remains on an upper Bollinger Band ride while flashing a series of “good overbought” readings on the 5-day RSI. Historically, such advances have not stalled until the 14-day RSI becomes overbought.
A consolation prize for the bulls
You can tell a lot about the tone of the market by the way it reacts to news. The bears had a golden opportunity to seize control of the tape when presented with a huge Non-Farm Payroll miss on Friday. Instead, the S&P 500 closed roughly flat on the day.

A possible inflection point

Here are some important charts that give some clues on future market leadership. First, what’s the direction of the 10-year Treasury yield? The 10-year Treasury Note has been testing a falling trend line and it is correlated to the value/growth cycle. A rising yield would be the market’s signal that it expects stronger economic growth. Already, the yield curve is bottoming and starting to steepen, which is another indicator of better growth expectations.
A consolation prize for the bulls
Recent estimates of hedge fund positioning show that the fast money crowd has unwound its value tilt from last year. The value and reflation trade is no longer a crowded trade and readings are now neutral. 
A consolation prize for the bulls
In addition, a sustained market advance may need small-cap stocks to lead the next leg upwards. The relative performance of small stocks is improving and breadth internals (bottom panel) is constructive. However, the Russell 2000 and the S&P 600 remain range-bound.
A consolation prize for the bulls
Small-caps are poised for an explosive rally. Callum Thomas at Topdown Charts pointed out that small-cap fund flows indicate investor capitulation. 
A consolation prize for the bulls
The stage is set. What will light the fuse?

More upside potential

Tactically, the current advance can go a little further. While the NYSE and NASDAQ McClellan Oscillators are better at timing bottoms than tops, neither are overbought yet.
A consolation prize for the bulls
Sentiment models such as the Fear & Greed Index are nowhere near euphoric territory. 
A consolation prize for the bulls
Similarly, the AAII Bull-Bear spread is showing a neutral reading.
A consolation prize for the bulls
As well, Helene Meisler’s (unscientific) weekly Twitter poll shows that net bullishness in retreat despite the market’s slow grind-up last week. This looks like a classic case of the market climbing the proverbial “Wall of Worry”.
A consolation prize for the bulls
In conclusion, the stock market is undergoing a “good overbought” momentum-driven advance. Readings are not overbought yet indicating further upside potential. In addition, cross-asset internals are suggestive of a possible value and growth inflection point ahead in favor of value and cyclical stocks.
Disclosure: Long SPXL
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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