Sunday, May 14, 2017

How this bull will die

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. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Risk-on*
  • Trading model: Bearish (downgrade)*
* 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 will also receive email notices of any changes in my trading portfolio.

A maturing bull
This bull market that began with the SPX low of 666 in March 2009 has lasted over eight years. While that may seem like a long time, bull markets don't just die of old age. Rather, they end as excesses build up and central bankers act to cool down the overheated economy.

Today, there are numerous signs that this bull market is in its late stages. Valuations are elevated by virtually all measures. The chart of forward P/E from FactSet shows that current forward 12-month P/E ratio is well above historical norms.

Sentiment is getting frothy. The TD-Ameritrade Investor Movement Index, or IMX, is designed to measure long-term retail investor sentiment. IMX hit an all-time high in March and pulled back in April. Readings are still very elevated by historical standards, indicating individual investor enthusiasm for stocks.

So when does the next shoe drop? The most likely catalyst for a market top is central bank action to cool down the economy. Will a 0.25% hike crash the market? How about 0.50% this year, or Fed action to reduce the size of its balance sheet?

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

Our Sale in May event
Announcing our "Sale in May" event! Get $1 off plus an extra month free off the first year of an annual subscription*. Use the coupon code May2017 at checkout.

* Offer is only available to the first 100 to sign up and expires May 31, 2017. Subscription date extension will be made after order processing.

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