Monday, May 21, 2018

The struggling Canadian canary

Back in March, I wrote about the new Fragile Five, which were five highly leveraged developed market economies that were undergoing property booms. The five countries are Australia, Canada, New Zealand, Norway, and Sweden.

As a reminder of how insane property prices are in Vancouver, which is one of the epicenters of the real estate boom, I highlighted this little gem that was listed for about USD 1 million.


Here is the same beauty from the back.


For some perspective. This chart depicts the debt bubble in Canada and Australia. If you are worried about runaway debt in China, then you should be equally concerned about the property bubble in the other Fragile Five countries.



So far, this has been a "this will not end well" investment story with no obvious bearish trigger. Now, there seems to be signs of a turning point in the Canadian economy.

The full post can be found at our new site here.




We would further like to announce our Sale in May. The offer is available only to the first 100 to sign up. Please use this link to order.


Sunday, May 20, 2018

Deconstructing the institutional pain trade

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 Model is an asset allocation model which 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 the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bullish*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

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 the those email alerts is shown here.


Institutions and the pain trade
The BAML Fund Manager Survey (FMS) is one of the most interesting surveys around, as the frequency is regular (monthly), extensive, and it has a long history. For readers who are unfamiliar with the survey, it reflects mainly the views of fund managers with global investment mandates.

Reading between the lines of the latest FMS results, I found that institutional managers are positioned for a late cycle inflation surge, but they are starting to de-risk their portfolios in anticipation of weaker growth. To summarize, institutional managers believe that:
  • Growth momentum is slowing, but
  • Inflation expectations are rising, but
  • The day of reckoning, as defined by either a recession or even a yield curve inversion, is still a long way in the future.
Fund managers have positioned their portfolios:
  • In commodities, which I interpret as positioning for a late cycle inflation surge, but
  • They are de-risking by selling equities,
  • Selling their emerging market (EM) positions, and
  • Buying bonds, but
  • Portfolio risk appetite remains above average.
The highlights of the consensus portfolio bets amount to long energy, short USD, and short bonds. This analysis is highly speculative, but if I were the market gods and I wanted to inflict the maximum level of pain on market participants, here is what I would do.

The full post can be found at our new site here.





We would further like to announce our Sale in May. The offer is available only to the first 100 to sign up. Please use this link to order.


Wednesday, May 16, 2018

Market waves and ripples

Mid-week market update: Charles Dow once characterized the stock market`s price movement as being composed of tides, waves, and ripples. We can see a mini version of this thesis by the market's action in the past week. The major indices had staged an upside breakout through a downtrend and sentiment had turned bullish.


This week, the narrative became more cautious:
  • 10-year bond yields had spiked significantly above 3%.
  • The US-North Korea summit is at risk of going off the rails.
  • The anti-migrant Lega Nord and anti-establishment Five Star Movement are on the verge of forming the next Italian government.
  • The Sino-American trade talks are undergoing their own roller coaster. Trump's weekend "rescue ZTE" tweet was followed by a White House clarification that walked back some of rhetoric.


Which is the wave? Which is the ripple?

The full post can be found at our new site here.



We would further like to announce our Sale in May. The offer is available only to the first 100 to sign up. Please use this link to order.


Monday, May 14, 2018

Tame inflation? Don't get complacent!

The Treasury market rallied last week when the 10-year Treasury yield tested the 3% level and pulled back.



The decline in yields (and bond prices rally) was not a big surprise for a number of reasons:
  • 10-year yields (TNX) was exhibiting a negative RSI divergence
  • A tamer than expected Consumer Price Index
  • Hedge funds were in a crowded short in the 10-year T-Note and T-Bond futures
While the bond market rally is likely to have a bit more leg over the next few weeks, my inclination is to enjoy the party, but don't overstay the festivities.

The full post can be found at our new site here.




We would further like to announce our Sale in May. The offer is available only to the first 100 to sign up. Please use this link to order.


Sunday, May 13, 2018

How I learned to stop worrying and love rising rates

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 Model is an asset allocation model which 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 the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bullish*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

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 the those email alerts is shown here.


Yellow flags galore, but no red flags
In the wake of last week's publication (see Why I am not ready to call a market top), I had a number of discussions with investors that amounted to, "What about _________ (insert the worry of the day)".

The main themes discussed, in no particular order, were:
  • Rising rates and the flattening yield curve;
  • Trade war;
  • Oil price spike; and
  • Fed policy error as they tighten into a decelerating economy.
I conducted an (unscientific) Twitter poll, and respondents were mostly concerned about a Fed policy error, while the oil price spike was the least of their worries.


While I believe that all of these risks are legitimate, they can be characterized as yellow flags, but there are no red flags that signal an imminent recession or equity bear market.

The full post can be found at our new site here.



We would further like to announce our Sale in May. The offer is available only to the first 100 to sign up. Please use this link to order.


Wednesday, May 9, 2018

The bulls are back in town

Mid-week market update: In my last mid-week market update (see Still choppy, still consolidating), I highlighted the weekly (unscientific) sentiment survey conducted by Callum Thomas. The poll showed fundamentally oriented investors to be very bullish, while technical survey was bearish. I suggested at the time that one of the signs that the sideways consolidation may end was an agreement between the fundamental and technical survey, indicating either positive or negative momentum.

The latest survey shows that such an event has occurred as technicians have flipped from bearish to bullish.


While this is not an unqualified trading buy signal, there are plenty of indications that the bulls are back in town.

The full post can be found at our new site here.

Monday, May 7, 2018

Why you shouldn't get wedded to any market indicator

Over the years, I have had a number of discussions with traders who have religiously embraced specific trading systems and investment disciplines. This is a cautionary tale of how systems fail.

Charlie Bilello won the NAAIM Wagner Award for his work on the lumber/gold ratio:
Lumber’s sensitivity to housing, a key source of domestic economic growth in the U.S., makes it a unique commodity as it pertains to macro fundamentals and risk-seeking behavior. On the opposite end of the spectrum is Gold, which is distinctive in that it historically exhibits safe-haven properties during periods of heightened volatility and stock market stress.

When you look at a ratio of Lumber to Gold, it is telling you something about the risk appetite of investors and the relative strength or weakness in economic conditions. When Lumber is leading Gold, volatility in equities tends to fall going forward. When Gold is leading Lumber, the opposite is true, and equity volatility tends to rise.
History shows that the lumber/gold ratio has been an excellent indicator of risk appetite. The bottom panel of the accompanying chart shows the rolling correlation of the lumber/gold ratio (cyclical indicator) to the stock/bond ratio (risk appetite indicator). The lumber/gold ratio is rising, which is a buy signal for risky assets.


Does that mean that you should bullish on stocks? Maybe.

Consider the copper/gold ratio, which is another cyclical indicator based on a similar theme. The copper/gold ratio is telling a story of economic softness.



Should you be buying or selling? Which indicator should you believe?

The full post can be found at our new site here.

Sunday, May 6, 2018

Why I am not ready to call a market top

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 Model is an asset allocation model which 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 the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bullish*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

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 the those email alerts is shown here.


Market top is still ahead
As stock prices chopped around in an indecisive fashion in past few weeks, the traders in my social media feed have become increasingly nervous and bearish. The bull can point to the SPX repeatedly testing its 200 day moving average (dma), which has held as technical support. However, the market's inability to rally despite what has been good earnings news during a Q1 earnings season with solid results is worrisome.

My review of intermediate and long-term technical market conditions, as well as the macro backdrop reveals that no pre-conditions of a bear market are in sight. While there are concerns that the American economy is undergoing the late cycle phase of an expansion, which is typically followed by a bear phase. I am not ready to make the investment call that stock prices have topped out just yet.

Consider, as an example, the Relative Rotation Graph (RRG) as a way of analyzing changes in sector leadership. RRG charts are a way of depicting the changes in leadership in different groups, such as sectors, countries and regions, and market factors. The charts are organized into four quadrants. An idealized group rotation pattern occurs in a clockwise fashion. Leading groups (top right) deteriorate to weakening groups (bottom right), which then rotates to lagging groups (bottom left), which changes to improving groups (top left), and finally completes the cycle by improving to leading groups (top right) again.

The latest RRG chart depicts a stock market with the emerging leadership of late cycle inflation sectors (gold and oil), which is the result of late cycle inflationary pressures, along with interest sensitive sectors (REITs and utilities) as the result of a dovish Fed.


This combination suggests that the market is setting up for one last inflationary blow-off before the Fed steps on the monetary breaks to cool the economy into a bull market killing recession.

The full post can be found at our new site here.

Wednesday, May 2, 2018

Still choppy, still consolidating

Mid-week market update: Stock prices are still consolidating sideways. The technical pattern could either be described as range-bound, or as a triangle. The market tested the bottom of the triangle this week, but support held.



The market indecision could be traced to the continued disagreement between fundamental and technical investors. Several weeks ago, I highlighted a Callum Thomas weekly (unscientific) poll of market sentiment showing a record level of technical bears combined with a high level of fundamental bulls (see Technicians nervous, fundamentalists shrug). The latest reading shows a continued bifurcation of opinion, though the difference in opinion is not as extreme.



The market may continue to trade sideways until fundamental and technical opinions begin to agree again.

The full post can be found at our new site here.

Sunday, April 29, 2018

How much does 3% matter to stocks?

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 Model is an asset allocation model which 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 the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bullish*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

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 the those email alerts is shown here.


The 3% question
The US equity market took fright last week when the 10-year Treasury yield rose above 3%. Stock prices recovered when yields retreated. How much should equity investors worry about a 3% 10-year yield?


Rather than focus on any single level, investors would be advised to concentrate on the interaction between stocks and bonds. Consider the P/E ratio. The factors that drive equity prices are:
  • How fast is the E in the P/E ratio likely to grow?
  • What is the outlook for interest rates and how does it affect the E/P ratio?
The full post can be found at our new post here.

Wednesday, April 25, 2018

Is good news now good news, or bad news?

Mid-week market update: What should we make of the stock market now that the 10-year Treasury yield has breached the 3% level? Should we pay attention to the JPM Asset Management historical analysis which stated, "When yields are below 5%, rising rates have historically been associated with rising stock prices"?



Should we pay attention to the latest BAML Fund Manager Survey, which concluded that the median manager is not overly worried until the 10-year yield crosses 3.5%?


Up until now, good (economic) news has translated to good (stock market) news, and bad news has been bad news. At some point, market perception will shift to putting greater weight on the bearish factors behind higher growth because of the expectation of a more hawkish Fed response, over the bullish factors behind better earnings growth.

Is the market at that turning point when good news is bad news, and bad news is good news?

The Q1 GDP report this Friday provides an important litmus test of whether that inflection point has been reached. Supposing that GDP growth comes in at better than expectations. Will stocks rally because of higher growth expectations, or drop because higher growth will pressure the Fed to raise rates at a faster pace? Similarly, what if growth came in at below expectations?

The full post can be found at our new site here.

Monday, April 23, 2018

Don't miss the eurozone revival!

Remember my post, Opportunity from Brexit turmoil? I suggested on February 22, 2018 that we were seeing a setup for a long trade in UK equities. Brexit political chaos was reaching a crescendo, and there was a chance that we may see another referendum where the Remainers could prevail.

Since then, while there is no news of a second referendum, Business Insider reported that Theresa May may resign if she loses a vote on leaving the customs union after Brexit. The FTSE 100 (top panel) has steadied, and rallied through resistance and a downside gap from early February. In addition, UK equities have turned up relative to global equities (bottom panel) and begun to outperform.



We may be seeing a similar buying opportunity in the eurozone.

The full post can be found at our new site here.

Sunday, April 22, 2018

Trade war jitters fade, but for how long?

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 Model is an asset allocation model which 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 the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bullish*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

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 the those email alerts is shown here.


Falling trade tensions = Equity bullish
I have written in these pages before that, in the absence of trade war tensions, the path of least resistance for stock prices is up (see Watch the Fed, not the trade war noise).

From a technical perspective, stock market is well supported by positive divergence from breadth indicators. Both the SPX Advance-Decline Line and the NYSE common stock only A-D Line made all-time highs last week.




From a fundamental viewpoint, equity valuations are not especially demanding when compared to bonds. The market started to get concerned last week when the 10-year yield approached 3%, but some perspective is in order. As the following chart shows, FactSet reported that forward P/E ratio is in the middle of its 5-year range. By contrast, the 10-year yield is near the top of its 5-year range, indicating slightly equities are cheap relative to Treasuries. On a 10-year perspective, however, the forward P/E is above its historical range and so is the 10-year yield. Depending on your time horizon, valuations are either slightly cheap or slightly expensive, but levels are nothing to panic over.


In addition, earnings are continuing to rise. Results from Q1 earnings season have been solid, with above average EPS and sales beat rates. In addition, forward 12-month EPS are rising, indicating positive fundamental momentum.


The bullishness is not just attributable earnings results. Brian Gilmartin at Fundamentalis pointed out that revenue growth and beat statistics are highly encouraging.



What could possibly go wrong?

The full post can be found at our new site here.

Wednesday, April 18, 2018

The canary in the credit crunch coalmine

Historically, every recession has been accompanied by an equity bear market.


One characteristic of every recession has been a credit crunch. As the economy slows, banks react by tightening their lending criteria, which dries up the availability of credit, and eventually causes a credit crunch. There are a number of ways that investor can monitor the evolution of lending standards.

The most obvious way is to watch the Fed's lending officer survey. The latest data shows that readings remain benign for both corporate and individual borrowers. One disadvantage of the survey is the results only come out quarterly, which is not very timely and amounts to looking in the rear view mirror.


A more timely data series are the Chicago Fed`s Financial Conditions Index, and the St. Louis Fed`s Financial Stress Index. Current conditions show that Stress levels are starting to rise, though the absolute stress levels remain low. Both of these data series are released monthly, which is more timely than the lending officer surveys.


There may be a better real-time way of watching for a credit crunch.

The full post can be found at our new site here.

Tuesday, April 17, 2018

Time for a pause in the bulls' charge

Mid-week market update: Don't get me wrong, I am still bullish, but the stock market rally appear a little extended in the short run and due for a brief period of consolidation. The SPX broke out from its inverse head and shoulders (IHS) pattern this week, cleared its 50 day moving average (dma), and filled in the gap from March 22. The next upside objective is the IHS objective of 2790-2800, whic coincides with resistance defined by the highs set in late February and March.



In the short run, however, the market looks overbought and may be due for a pause.

The full post can be found at our new site here.

Sunday, April 15, 2018

Buy gold for the late cycle inflation surge?

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 Model is an asset allocation model which 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 the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bullish*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

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 the those email alerts is shown here.


Late cycle expansion = Inflationary revival
The missiles have flown, and the bombs dropped. Inflationary pressures are rising. Is this the time for gold to shine?

Notwithstanding the short-term effects of geopolitical tension, consider the longer term inflationary pressures, which are building not just in the US but globally. Ned Davis Research recently pointed out that roughly two-thirds of countries are growing above their long-term potential. Unless these countries can increase their potential through faster labor force or productivity growth, inflationary pressures begin to build, followed by central bank tightening. We could reach recessionary conditions in the next year or so.



This suggests that the economy is undergoing a late cycle expansion characterized by capacity constraints, which would lead to an inflationary revival. Gold prices are currently testing a key resistance level. Should it stage an upside breakout, who know how far they could go.



The macro bull case for gold is easy to make. Gold is an inflation hedge, and inflation momentum is rising.


J C Parets of All Star Charts highlighted a washout in the silver/gold ratio as an indicator of precious metal risk appetite. A rising silver/gold ratio would indicate that animal spirits have taken over the precious metal complex, which would be highly bullish.


Tiho Brkan pointed out that hedge funds are in a crowded short in silver futures, which is bullish for silver, and for gold by implication.


In short, sentiment models indicate that silver prices are poised for a powerful rally. The combination of rising geopolitical tensions, and possible strength in silver prices would  be highly bullish for gold and other inflation hedges.

Does that mean that investors and traders should pile into precious metals in anticipation of a late cycle inflation surge? Not so fast! There are two sides to every story, and the bull case for gold may be too facile to be true.

The full post can be found at our new site here.

Wednesday, April 11, 2018

A bottoming process

Mid-week market update: As the market bounces around in reaction to the headline of the day, it is important to maintain some perspective and see the underlying trend. Numerous sentiment and technical indicators are pointing towards a bottoming process and a bullish intermediate term outlook. Day-to-day price movements, on the other hand, are hard to predict.

Consider, for example, the positioning of large speculators (read: hedge funds) in the high beta NASDAQ 100 futures and options. Hedgopia reported that large speculators are in a crowded short in NDX.


By contrast, large speculators are in a crowded long in the VIX Index, which tends to move inversely with the stock market.


While Commitment of Traders data analysis tend to work well as a contrarian indicator on an intermediate term time frame, sentiment models can be inexact market timing indicators.

The full post can be found at our new site here.

Tuesday, April 10, 2018

China's cunning plan to defuse trade tensions and reduce financial tail-risk

About three years ago, I outlined China's plan to extend its infrastructure growth without creating more white elephant projects in China (see China's cunning plan to revive growth). Enter the One Belt, One Road (OBOR) initiative to create infrastructure projects in the region. OBOR projects were to financed by the Asia Infrastructure Investment Bank (AIIB), which many countries had been falling all over themselves to finance. The infrastructure projects were to be led by (surprise) Chinese companies, which would extend their flagging growth.

Fast forward to 2018, The Nikkei Asian Review and The Banker issued a report card of OBOR projects. Here are their main findings:
Project delays After initial fanfare, projects sometimes experience serious delays. In Indonesia, construction on a $6 billion rail line is behind schedule and costs are escalating. Similar problems have plagued projects in Kazakhstan and Bangladesh.

Ballooning deficits Besides Pakistan, concerns about owing unmanageable debts to Beijing have been raised in Sri Lanka, the Maldives and Laos.

Sovereignty concerns In Sri Lanka, China's takeover of a troubled port has raised questions about a loss of sovereignty. And neighboring India
openly rejects the BRI, saying China's projects with neighboring Pakistan infringe on its sovereignty.
None of these problems are big surprises. I had outlined in my 2015 post that Chinese led infrastructure projects tended to see inflated costs, and the geopolitical objective of OBOR was to extend China's influence in the region.

Today, China faces two separate problems. The most immediate issue are rising trade tensions with the United States. The second and more pervasive issue is the growing mountain of debt, which are backed by less productive assets, which elevates financial tail-risk. The China bears' favorite chart exemplifies that problem.


The latest developments indicate that Beijing has developed a cunning plan to defuse both trend tensions and reduce financial tail-risk.

The full post can be found at our new site here.

Monday, April 9, 2018

Evaluating Jim Paulsen's market warning

I have been a fan of Jim Paulsen for quite some time. The chart below depicts the track record of my major market calls. His work formed the basis for my timely post in May 2015 (see Why I am bearish (and what would change my mind)), which was received with great skepticism at the time.

The track record of my major market calls


This time, though, I believe that Jim Paulsen's warning for the equity market outlined in this Bloomberg article is off the mark. Paulsen's cautionary signal for the stock market is based on his Market Message Indicator, which has rolled over. The indicator is described in the following way:
The gauge takes five different data points into account: how the stock market is performing relative to the bond market, cyclical stocks relative to defensive stocks, corporate bond spreads, the copper-to-gold price ratio, and a U.S. dollar index. The goal is to devise a gauge that acts as a proxy for broad market stress.
I have annotated (in red) in the chart below the subsequent peak in the stock market after this indicator gave a sell signal. This indicator is far from infallible, but the market has weakened the last few times this indicator peaked and rolled over. During the study period that begins in 1980, some sell signals simply did not work, or there were long delays between the sell signal and the actual peak.


Here is what I think Paulsen is missing.

The full post can be found at our new site here.

Sunday, April 8, 2018

Watch the Fed, not the trade war noise

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 Model is an asset allocation model which 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 the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bullish*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

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 the those email alerts is shown here.


Fade the trade war jitters
"Fool me once, shame on you. Fool me twice, shame on me." We've seen this movie before on trade. The White House begins the process with tough and inflammatory rhetoric, only to see the threats walked back or watered down later.

Consider the case of the steel and aluminum tariffs, which were levied for national security reasons. The initial announcement shocked the market, but the Trump administration eventually walked back most of their effects by providing exemptions for Canada, Mexico, the EU, Australia, Argentina, Brazil, and South Korea. Um, those exemptions account for over half of American steel imports. What "national security" considerations are we referring to?

The KORUS deal is another example. The agreement was hailed as a great victory by the Trump administration, but the tweaks were only cosmetic in nature. The South Koreans agreed to two concessions. In return for an indefinite exemption from the steel and aluminum tariffs, Seoul agreed to a steel export quota to the US, but the quotas are toothless because they are contrary to WTO rules and could be challenged at anytime. In addition, South Korea doubled the ceiling on American cars that don't conform to Korean standards which could imported into that country. The ceiling increase was meaningless because US automakers were not selling enough cars under the old ceiling. In other words, the KORUS free trade deal was a smoke and mirrors exercise and a face saving out of a potential trade war.

The NAFTA negotiations followed a similar pattern of using bluffs as a tactic, and reacting afterwards. Trump began the process by declaring the free trade agreement "unfair" and "terrible". He then threatened to tear up the treaty. The latest news from Bloomberg indicates that American negotiators are pushing very hard to have an agreement in principle in place by the Peru Summit of the Americas that begin April 13 next week. How much leverage will the American side have if the other negotiators know that Trump wants a deal by next week? Much work needs to be done before an agreement in principle can be made, but watch for more climbdowns and a declaration of "victory" by the White House.

So why worry about a possible trade war with China? Investors worried about equity downside risk should instead focus on the likely direction of monetary policy. New Deal democrat recently outlined a simple recession model which states that whenever the YoY change in the Fed Funds rate rose above the annual change to employment, a recession has followed within a year.


As the Fed normalizes monetary policy, it is on the verge of making a policy error where it tightens into a weakening expansion and crashes the economy. Recessions have invariably translated into equity bear markets in the past. That's why investors should look past the trade war noise and focus on monetary policy.

The full post can be found at our new site here.