Thursday, February 23, 2017

Solving the data puzzle at the center of monetary policy

There has been much hand wringing by economists over the falling labor force participation rate (LFPR). As the chart below shows, the prime age LFPR, which is not affected by the age demographic effect of retiring Baby Boomers, have not recovered to levels before the Great Recession.



The lack of recovery in LFPR has caused great consternation over at the Federal Reserve. These readings suggest that there is still considerable slack in the labor market, despite the sub 5% unemployment rate.

A number of explanations have been advanced for this phenomena, such as jobless Millennials spending all their time playing video games in their parents' basement instead of looking for a job (via Nicholas Eberstadt of the American Enterprise Institute).



Another possible explanation is the growth of disability as a shield against unemployment payments run out. As the Great Recession hit, disabled workers became discouraged and chose to rely on their disability payments instead of trying to find another job.


There may be another very simple alternative explanation for the collapse in LFPR. The answer is so simple, it's criminal that anyone missed it.

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

Wednesday, February 22, 2017

Stay cautious, but wait for the break

Mid-week market update: Markets behave different at tops and bottoms. Bottoms are often V-shaped and reflect panic. Tops are usually slower to develop. Hence the trader's adage, "Take the stairs up, and escalator down."

I have been writing that the US equity market appears to be extended short-term and ripe for a pullback, but that was last week and about 1% lower (see Why the SP 500 won't get to 2400 (in this rally)). I stand by those remarks.

I could say that the Fear and Greed Index appears to be extended and historically stock prices have had difficulty advancing further with readings at these levels.



I could also say that Ned Davis Research Crowd Sentiment Poll is also extended. Historically, stock prices have exhibited a negative bias at these levels (via Tiho Brkan).


None of this matters much to short-term traders. That's because sentiment and overbought/oversold indicators are less useful at tops than bottoms. While it may be timely for traders to tilt to the long side when panic starts to appear, market euphoria are not good trading signals of market tops. Savvy traders know to wait for a bearish break when the market gets overbought and giddy.

I am seeing some limited signs of a bearish break, but the trading sell signal is incomplete.

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

Monday, February 20, 2017

Negative real yields = Equity sell signal?

An reader asked me my opinion about this tweet by Nautilus Research. According to this study, equities have performed poorly once the inflation-adjusted 10-year Treasury yield turns negative. With real yields barely positive today, Nautilus went on to ask rhetorically if the Fed is behind the inflation fighting curve.



Since the publication of that study, The January YoY CPI came in at 2.5%, which was surprisingly high. The higher than expected inflation rate pushed the 10-year real yield into negative territory. So is this a sell signal for equities?


Well, it depends. The interpretation of investment models often depends a great deal on their inputs. In this case, the questions is how does we adjust for inflation? Do we use the headline Consumer Price Index (CPI), core CPI, which is CPI excluding volatile food and energy prices, or some other measure?

As I go on to show, how we adjust for inflation dramatically alters the investment conclusion for a variety of asset classes, like equities, gold, and the USD.

As is the case in the application any quantitative model, the devil is in the details.

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


Sunday, February 19, 2017

Watch what they do, not just what they say

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*
* 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.



Great expectations
Bloomberg recently highlighted the huge gap between expectations and reality. As the chart below shows, soft (expectations) data has been surging, but hard (actual) data has risen, but it has not caught up with expectations.


The markets are pricing for perfection, which sets up a situation where minor disappointments could spark a market sell-off. BCA Research found that such divergences between "soft" expectations data and "hard" economic data has seen equity corrections in the past.


This week, I examine the details of how expectations have diverged from actual data on a number of dimensions.
  • Small business confidence
  • Corporate confidence
  • Consumer confidence
  • Federal reserve expectations
  • Wall Street's tax reform expectations
The full post can be found at our new site here.

Wednesday, February 15, 2017

Why the S&P 500 won't get to 2400 (in this rally)

Mid-week market update: As the major market averages make new all-time highs, I conducted an informal and unscientific Twitter poll. I was surprised to see how bullish respondents were.




Let's just cut to the chase - forget it. Neither the fundamental nor the technical backdrop is ready for an advance of that magnitude. Even though the earnings and sales beat rates for Q4 earnings season is roughly in line with historical averages, Factset reports that the 12-month forward EPS growth is stalling. Past episodes has seen stock price struggle to make significant advances under such conditions.


In addition, the technical condition of the market shows that it is vulnerable to a pullback.

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

Tuesday, February 14, 2017

Cry Havoc, and slip loose the dogs of (trade) war!

The WSJ reported that the Trump administration is considering a new tactic in managing its trade relationship with China. Here is the Bloomberg recap for those without a WSJ subscription:
Under the plan, the commerce secretary would designate the practice of currency manipulation as an unfair subsidy when employed by any country, instead of singling out China, the newspaper reported. American companies could then bring anti-subsidy actions to the U.S. Commerce Department against China or other countries, it said.

The discussions are part of a strategy being pursued by the White House’s new National Trade Council to balance the goals of challenging China on certain policies while keeping broader relations on an even keel, the paper said. The Trump administration would avoid, at least for now, making claims about whether China is manipulating its currency, it said.
While such an approach may seem clever, it has the risk of sideswiping American relations with a whole host of other countries other than China. As well, the imposition of countervailing duties is subject to a challenge under WTO rules.

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

Monday, February 13, 2017

Why this uncanny recession indicator may not work this time

The chart below depicts the yield curve, as measured by spread between the 10-year and 2-year Treasury yields, (blue line) and equity returns (grey line). The yield curve has been an uncanny recession forecaster. It has inverted ahead of every single recession, and ahead of major equity bear markets.


Unfortunately, this indicator may not work this time.

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

Sunday, February 12, 2017

A blow-off top, or a wimpy 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. 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: 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 will also receive email notices of any changes in my trading portfolio.


So many questions, so few answers
Regular readers know that I have been calling for a cyclical market top in 2017 (see The roadmap to a 2017 market top). Outside of the risk of permanent loss from war or insurrection, severe bear markets have been mainly associated with economic recessions. My analysis has been based on the likely path of the US economy, and the timing of the next recession.


My base case, call it the "blow-off top" scenario, goes something like this:
  • The economy, which is in the late stages of an expansion, starts to overheat.
  • Investors and traders get enthusiastic about growth and bid stock prices up to unrealistic levels (hence the "blow-off")
  • The Fed responds by raising rates to cool off the economy, but find it's behind the curve...
  • Which results in a recession and bear market.
The blow-off top scenario would see the SPX reach the 2500-2600 level this year as it tops out.


I have been considering an alternative, call it the "wimpy top" scenario, where the market may have topped out already.
  • The economy, which is in the late stages of an expansion, starts to overheat.
  • Investors and traders get enthusiastic about the prospects for cuts cuts and deregulation under the Trump tax reform plan, which is what has happened so far.
  • Tax reform gets tied up in Congress and gets delayed until 2018.
  • Trump appoints hawks to the Federal Reserve board (now there are three vacancies with the resignation of Daniel Tarullo).
  • The new Trump appointed Fed governors, composed of hard-money advocates, becomes more aggressive, tightens monetary policy, and pushes the economy into recession.
  • An equity bear market is the result.
The wimpy top scenario is based on a double whammy of fiscal policy disappointment and a pivot to a more hawkish Fed policy. In that case, Current stock index price levels are roughly as good as they get.

The key differences between the two scenarios are the likely path of fiscal and monetary policy. Those are the big questions to which we have no answers. This week, I explain the risks and offer some suggestions of how to watch which scenario is the more likely one to unfold.

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

Wednesday, February 8, 2017

What's wrong with the VIX?

Mid-week market update: Increasingly, I have seen cases being made for an equity market correction. This Bloomberg article, "Five charts that say not all is well in the markets" summarizes the bear case well.
  • Uncertainty is at a record high: The number of news stories using the word "uncertainty" is surging.
  • Wall Street vs. Washington: While the Global Economic Uncertainty Index is elevated, the VIX Index remains low by historical standards.
  • The price of hedging tail-risk is rising: Even as the VIX remains low, the CBOE SKEW Index, which measures the price of hedging extreme events, is high. Which is right?

  • Gold is rising: Gold is often thought of as a safe haven in times of stress and the gold price has recently been inversely correlated with equity prices.

  • Watch for gold and bond yields to rising together: "Gold may prove the “tell,” according to Chris Flanagan, also at Bank of America. He advises investors to watch “for the combo of rising yields and rising gold prices to signal impending market volatility.” Three consecutive quarters of rising benchmark bond yields and gold prices preceded previous market falls including the 1973-1974 bond market crash and Black Monday in 1987, he says. The yield on the benchmark 10-year U.S. Treasury has risen to 2.44 percent from 1.77 percent since Trump’s election win. Gold has moved sideways."


Much of the anxiety can be summarized as, "What's wrong with the low level of the VIX Index? Isn't the VIX supposed to be a fear gauge?"

Why are't stock prices falling if actual fear is so high?

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

Monday, February 6, 2017

Peak populism?

Technical analysts often use the magazine cover indicator as a contrarian indicator. When an idea has become so commonplace that it becomes the cover of a major magazine, the public is all-in and it's time to sell.

The Economist reported on an ad hoc study by Greg Marks and Brent Donnelly at Citigroup using covers from The Economist and did find contrarianism works, even though The Economist is not really a popular mainstream magazine:
Interestingly, their analysis finds that after 180 days only about 53.3% of Economist covers are contrarian; little better than tossing a coin. After 360 days, the signal is a lot more reliable—68.2% are contrarian. Buying the asset if the cover is very bearish results in an 18% return over the following year; shorting the asset when the cover is bullish generates a return of 7.5%.
Now consider the following Time magazine cover and accompanying story on Steve Bannon, who is said to be the man behind the Donald Trump presidential throne.



There is also this cover from The Economist within the same week.



Still not convinced? How about this cover from Der Spiegel. You don't even have to read German to understand the idea.


It isn't just me, Helene Meisler raised the same question about magazine covers, which was answered by Liz Ann Sonders at Schwab.


Here at Humble Student of the Markets, our mission to focus on investing and try to remain apolitical. Like most on Wall Street, we don't protest political developments, we trade them.

Rather than interpreting these magazine covers as just peak Trump, as he will be POTUS for the next four years, the contrarian message may be "peak populism". Nate Silver recently wrote an article called "14 versions of Trump's presidency, from #MAGA to impeachment", where he laid out a variety of scenarios of how Trump's presidency might proceed.

I would like to offer some details of how the reversal of peak populism might work. As well, there is a possible trade for contrarian investors who are willing to bet on the "peak populism" theme.

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

Sunday, February 5, 2017

Still bullish after my chartist's round-the-world trip

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 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: Bullish (upgrade)*
* 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.


Confusing macro cross-currents
Last week, I wrote that investors should tune out the political noise and focus on the fundamentals of growth (see A focus on growth). Still, the markets appear to be confused.

On one hand, Friday's positive surprise from the January Jobs Report told the story of an American economy that is on a solid non-inflationary growth path. Indeed, the latest update from ECRI shows their Weekly Leading Indicator has surged to an all-time-high.



Urban Carmel pointed out that the macro outlook is strong in virtually all respects, and I agree. Moreover, the upturn is global in scope, which suggests that this recovery has staying power because of the breadth and scope of the advance.


On the other hand, the new Trump administration is starting to give Wall Street the jitters. Josh Brown summarized the anxiety well this way:
All the investment guys want the tax cuts and repatriation to happen. They want the 4% GDP growth. They want the infrastructure push to actually work. But, they’re definitely afraid. They don’t like the tweets, the executive orders, the daily mass protests or the shady people who seem to be accumulating power and influence.
I know of no conventional way to resolve the interplay between the bullish macro backdrop and bearishness from policy uncertainty. One approach to cut through the noise is to just ignore it. Instead, use technical analysis to understand what the markets are discounting.

This week, I will dispense with my usual macro and fundamental analysis and take a chartist's tour around the world. Let's see what the markets are telling us.

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

Thursday, February 2, 2017

An "island reversal" sell signal?

In response to my last post (see Watching the USD for clues to equity market direction), an alert reader pointed that the SPX had formed a bearish island reversal.


Wikipedia explained the island reversal formation this way:
In stock trading and technical analysis, an island reversal is a candlestick pattern with compact trading activity within a range of prices, separated from the move preceding it. This separation is said to be caused by an exhaustion gap and the subsequent move in the opposite direction occurs as a result of a breakaway gap.
I had grown up with trading aphorisms and folklore like this, so I decided to test out whether the island reversal formation had any trading information. The results were surprising, and it was another lesson in how asymmetric signals were at tops and bottoms (see The ways your trading model could be leading you astray).

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

Wednesday, February 1, 2017

Watching the USD for clues to equity market direction

Mid-week market update: With stock prices pulling back to test its technical breakout to record highs, it is perhaps appropriate to watch other asset classes for clues to equity market direction, especially on a day when the FOMC made its monetary policy announcement.

From a cross-asset perspective, there is much riding on the direction of the USD. As the chart below shows, the USD Index has weakened after making a high in December. It is now testing a key support zone, as well as a Fibonacci retracement level. Despite the pullback, the uptrend remains intact.


The other panels of the chart shows the UST 2-year yield and its rolling 52-week correlation with the USD. As well, I show the price of gold and its rolling correlation to the USD. The correlation charts show that the relationship between the USD and these two assets have been remarkably stable. The USD has been positively correlated to interest rates, as measured by the 2-year UST yield, and inversely correlated to gold prices.

As well, please be reminded that gold and equity prices have recently shown a negative correlation. In the past few months, stock prices have risen when gold fell, and vice versa.

With these cross-asset, or inter-market, relationships in mind, what happened to the USD in the wake of the Fed announcement?

Nothing. Sure, the greenback weakened a bit in response to the FOMC decision, but soon bounced back. The same could be said of interest rates, and stock prices.

That leaves investors and traders waiting for a decisive break for clues to stock market direction. Equities are mildly oversold, but my metrics of risk appetite remains in an uptrend. I am inclined to give the bull case the benefit of the doubt, but with reservations.

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

Tuesday, January 31, 2017

How much business risk is hiding in your portfolio?

This is the second in an occasional series of posts on how to build a robust investment process. Part 1 was addressed to the individual investor and trader (see The ways your trading system could lead you astray). This posts explores the issues that face the professional and institutional investor.

I had illustrated in the past why managers closet index. That`s because even a single misstep in an individual position could sink portfolio performance (see How Valeant revealed the dirty little secret of fund management). In this post, I would like to focus on how style and factor exposures affect business risk.

I recently came upon a study by Research Associates, which showed the tradeoffs between investment returns and business risk. The authors modeled a series of hypothetical portfolios with different styles, namely value, growth, momentum, quality, and random selection, which they called the "4 Orlandos", for the period 1967-2016. As it turns out, the styles that showed the best performance also had the highest chance of getting a manager fired.



The termination criteria for a manager (which they called an "agent") is detailed below and roughly reflects the patience level of institutional sponsors:
We select two highly stylized rules for a hypothetical investment board to use in evaluating the agent’s performance: 
1) Fire the agent if more than 50% of funds selected by the agent underperform the benchmark in a given period.
2) Fire the agent if the equally weighted portfolio aggregated from the selected funds underperforms the benchmark by more than 1%.
In the light of these results, the big question for institutional investors is, "We all want good performance, but how far do you want to stick your neck out?"

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

FOMC preview: Hints of a dovish tilt?

I had been meaning to write about a preview of the upcoming FOMC meeting. Here are the elements of the Yellen Labor Market Dashboard, courtesy of Bloomberg.





As you can see, many of the components have either fully or nearly recovered from the depths of the GFC, with the glaring exception of a subpar labor force participation rate. These factors put pressure on the Fed to start normalizing rates.

However, there is one important exception that may cause the Fed to have a slightly more dovish tilt than the market expects.

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

Monday, January 30, 2017

Forget politics! Here are the 5 key macro indicators of Trump's political fortunes

Wow, Trump's political honeymoon didn't last very long! In the past few days, there have been numerous objections of Trump's Executive Orders. I'll spare you the details of the protests and demonstrations, particularly from the Left. What stood out were the objections from the Right and within the GOP. As an example, Eliot Cohen, who served under Condeleeza Rice, fretted about the threats that Trump posed to the American Republic:
I am not surprised by President Donald Trump’s antics this week. Not by the big splashy pronouncements such as announcing a wall that he would force Mexico to pay for, even as the Mexican foreign minister held talks with American officials in Washington. Not by the quiet, but no less dangerous bureaucratic orders, such as kicking the chairman of the Joint Chiefs of Staff out of meetings of the Principals’ Committee, the senior foreign-policy decision-making group below the president, while inserting his chief ideologist, Steve Bannon, into them. Many conservative foreign-policy and national-security experts saw the dangers last spring and summer, which is why we signed letters denouncing not Trump’s policies but his temperament; not his program but his character.

Precisely because the problem is one of temperament and character, it will not get better. It will get worse, as power intoxicates Trump and those around him. It will probably end in calamity—substantial domestic protest and violence, a breakdown of international economic relationships, the collapse of major alliances, or perhaps one or more new wars (even with China) on top of the ones we already have. It will not be surprising in the slightest if his term ends not in four or in eight years, but sooner, with impeachment or removal under the 25th Amendment. The sooner Americans get used to these likelihoods, the better.
Cass Sunstein objected to Trump's economic approach by invoking Fredrich Hayek:
If American conservatives have an intellectual hero, it might well be Friedrich Hayek -- and rightly so. More clearly than anyone else, Hayek elaborated the case against government planning and collectivism, and mounted a vigorous argument for free markets. As it turns out, Hayek simultaneously identified a serious problem with the political creed of President-elect Donald Trump.
Sunstein worried aloud about Trump's conservative credentials and autocratic tendencies:
In "The Road to Serfdom" and (at greater length) in "The Constitution of Liberty," Hayek distinguished between formal rules, which are indispensable, and mere “commands,” which create a world of trouble, because they are a recipe for arbitrariness. When formal rules are in place, “the coercive power of the state can be used only for cases defined in advance by law and in such a way that it can be foreseen how it will be used.”

Like the rules of the road, formal rules do not name names. They are useful to people who are not and cannot be known by the rule-makers -- and they apply in situations that public officials cannot foresee.

Commands are altogether different. They target particular people and tell them what to do. (Think Hitler’s Germany, Stalin’s Soviet Union, Mao’s China, Castro’s Cuba.) They require the exercise of discretion on the spot. As examples, Hayek pointed to official decisions about “how many buses are to be run, which coal mines are to operate, or at what prices shoes are to be sold.”
Forgive me for being cynical, but blah blah blah...None of this matters very much.

The main objective of these pages is to make money for my readers. I try very hard to divorce my investment views from my political views. As the chart below shows, the stock market can prosper under both Democratic and Republican presidents.



With that preface in mind, here are some key metrics to watch that Donald Trump needs to achieve in order to politically prosper in his first term.

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

Sunday, January 29, 2017

A focus on growth

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 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*
* 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.


It's not all about Trump
In the past few weeks, market analysis in these pages have been all Trump, all the time. As America`s 45th president assumed his first full week in office, his administration made a number of rookie mistakes that gave the impression of a government in disarray.

Politico reported that many of presidential executive orders were drafted by Trump aides Stephen Miller and Steve Bannon without consultation with the relevant departments or Congress. These actions made the implementation of some aspects of the executive orders difficult, impractical, or possibly illegal. CNBC reported that the Trump aides were leaking stories as a sign of infighting between different factions. Not only that, the Washington Post reported that most of the senior bureaucrats at the State Department, most of whom had served both Democrat and Republican administrations, had resigned en masse, which deprived the department of years of experience in the nuts-and-bolts of foreign policy.


So how did the stock market react to these events? The Dow proceeded to rally above 20,000 to make an all-time high, as did the SPX. This kind of market reaction in the face of negative political news is bullish. Moreover, it showed that investors and traders had turned their focus to the most important metric of equity performance, namely the growth outlook.

Indeed, analysis from Deutsche Bank showed that macro growth surprises have been the biggest driver of equity prices for the last 15 months (via Bloomberg).




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

Thursday, January 26, 2017

The ways your trading model could leading you astray

I have had a number of discussions with subscribers asking for more "how to" posts (see Teaching my readers how to fish). This will be one of a series of occasional posts on how to build a robust investment process.

For traders and investors, one of the challenges is how to build a robust discipline that works well through different market regimes. As a case study, consider this study from Simple Stock Model that generates signals based on the cash flows in and out of the SPY ETF as a sentiment signal. The trading rule is: "If the 4-week average of the 3-month change in SPY's percentage of shares outstanding is greater than +5%, be out of the market."

The chart below shows the equity curve from this trading system (white line = buy and hold, blue line = trading system). The results look pretty good, especially for a relatively low turnover model. (Incidentally, it's on a sell signal right now).

SPY shares outstanding trading system

Not so fast! Don't jump to conclusions before digging into the data and reading the fine print.

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

Wednesday, January 25, 2017

Global market rally = Dow 20K

Mid-week market update: Since the time I issued a correction warning in late December (see A correction on the horizon?), the US equity market has traded sideways in a narrow range. Moreover, the SPX has alternated between a seesaw up-and-down pattern since early January - until today.

As the SPX breaks upwards to a new all-time high, and the DJIA breaches the psychologically important 20,000 mark, it's hard to argue with price and momentum.



Overbought and vulnerable markets can correct in two ways. It can correct through price, with lower prices, or through time, with a sideways consolidation. The latter scenario is often accompanied by an internal rolling correction characterized by weakness in market leaders and nascent strength from laggards, which seems to be what has happened (see The contrarian message from rotation analysis).

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

Tuesday, January 24, 2017

The battle for the hearts and minds of the Fed

Now that the Trump team has moved into the West Wing of the White House, investors still one big Trump policy question mark that overhang the market. Who will Trump appoint to the two vacant governor seats at the Federal Reserve?

CNBC reported that David Nason is a leading contender for a board seat, but he is rumored to be considered for a regulatory role. Such an appointment gives us no hints about the likely future direction of monetary policy and who might replace Janet Yellen, should Trump choose not to re-appoint her as Fed chair in 2018.

Bloomberg reported that the latest rumor mill has the leading candidates for Fed chair, namely Glenn Hubbard, John Taylor, and Kevin Warsh, advocating a tighter monetary policy than the current Fed:
Potential candidates to head the Federal Reserve in 2018 suggested that monetary policy would be tighter if they were in charge.

Speaking at the annual American Economic Association meeting that ended Sunday, Glenn Hubbard of Columbia University, along with Stanford University’s John Taylor and Kevin Warsh, criticized the central bank for trying to do too much to help an economy struggling with problems that monetary policy can’t solve.

“The Federal Reserve is a little behind the curve” in raising interest rates, Taylor, a Treasury undersecretary for international affairs under the last Republican president, said Saturday during a panel discussion in Chicago.

Hubbard, who headed the Council of Economic Advisers under Bush, said he agreed with what he perceives as Trump’s stance that the U.S. has depended too much on the Fed to support the economy in recent years.
Is that what Trump really wants? There is a battle going on for the hearts and minds of the Federal Reserve. The outcome will have profound implications for the direction of monetary policy, the likely trajectory of economic growth for President Trump's next four years, and the stock market.

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