Cam Hui | Nov 23, 2014 11:41PM ET
Trend Model signal summary
Trend Model signal: Risk-on (upgrade)
Trading model: Positive
The Trend Model is an asset allocation model used by my inner investor. The trading component of the Trend Model keys on changes in direction in the Trend Model - and it is used by my inner trader. The actual historical (not back-tested) buy and sell signals of the trading component of the Trend Model are shown in the chart below:
Update schedule: I generally update Trend Model readings on my blog on weekends and tweet any changes during the week at @humblestudent. In addition, I have been trading an account based on the signals of the Trend Model. The last report card of that account can be found here.
h2 No one ever expects the Central Banker street party/h2In early November, when the BoJ unexpectedly announced another shock-and-awe QE program, I wrote (see Enjoy the party, but watch for the police raid):
While the BoJ party is just getting going, the partiers are spilling out onto the street and getting out of control. The neighbors are getting upset and they're about to call the cops. My inner trader remains wary of the time when the police show up and raid the party.
I identified two main risks to the "BoJ party". First, the latest round of Japanese QE will inevitably weaken the JPY against other major currencies and could invite a global currency war. In particular, it would make Japanese capital goods more competitive against eurozone (German) machinery exports and would weaken an already fragile European economy.
As well, I was concerned that China's economy was weakening rapidly and it was unclear how much more stress it could take. I asked:
How much stress can China take without taking action that reverberates around the world?
Up until recently, the PBOC`s modus operandi has been to launch either limited or covert stimulus if growth slowed too much for fear of sending the wrong message, that Beijing was backsliding on its financial reform initiatives (via The Economist ):
The central bank’s answer to this dilemma has been to loosen monetary policy, but in a covert fashion. It lent the state-owned China Development Bank one trillion yuan ($163 billion), according to rumours that dribbled into local media in June. Some likened it to Chinese-style quantitative easing (QE): the central bank had in effect printed cash to rev up growth. But whereas central banks in developed economies have explained every step of their QE schemes to markets, the PBOC did not even bother to announce its activity.Get The News You WantRead market moving news with a personalized feed of stocks you care about.Get The AppThen, in September and October, it launched a “medium-term lending facility”, injecting a further whack of cash—769.5 billion yuan, it turns out—into the economy via loans to commercial banks. Rumours spread for weeks before the central bank confirmed them on November 6th. As for the initial trillion-yuan loan, it eventually acknowledged the operation, though declined to say how much it had lent, at what rate or even to which bank.
Despite their size, these covert stimulus packages didn`t seem to be enough:
The combined amount of the infusions, if as big as reported, would be huge—equal to more than three months of America’s now-completed QE scheme when it was at its height, or to five months of Japan’s current programme. The impact of China’s easing, however, has been underwhelming. It has not reached the real economy. Short-term interest rates have fallen: a closely watched interbank rate is down by almost two percentage points this year, to 3.2%. But the rate at which banks lend to businesses, which matters more for growth, has remained stuck at about 7%.
The news about falling home prices in October may have been the last straw:
Finally, Beijing blinked and the PBOC unexpectedly announced an interest rate cut that is designed to effect a more broadly based stimulus program (via Marketwatch , emphasis added):
In a speech to a banking conference, Draghi said the ECB was prepared, if needed, to expand its purchases of assets, which raises the amount of money flowing in the economy. That heightened hopes in financial markets that the ECB may soon buy large amounts of government bonds of eurozone members, a path other big central banks have taken but the ECB has largely resisted.“We will continue to meet our responsibility — we will do what we must to raise inflation and inflation expectations as fast as possible, as our price stability mandate requires of us,” Draghi said.
“If on its current trajectory our policy is not effective enough to achieve this, or further risks to the inflation outlook materialize, we would step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our purchases,” Draghi added.
To emphasize its resolve, it tweeted that it had start to buy ABS as part of its effort to expand its balance sheet:
The BoJ party wasn`t enough. The PBOC party wasn`t enough. The ECB has decided that it wants in on the party action too. So we now have a Central Bankers street party.
h3 The music`s fine, drinks are free/h3In response to these announcements, commodity prices spiked in reaction to the Chinese stimulus news. In Europe, the STOXX 600 staged an upside breakout from a minor resistance level.
I also highlighted a number of positive European catalysts in my last post (Two contrarian plays that will make you queasy):
In addition, BCA Research also made its case that positive momentum will result in a turnaround in eurozone equities:
In the US, a San Francisco Fed paper indicating that inflation may not rise as much as expected could provide cover should the Yellen Fed decide to lean dovishly on the timing of raising interest rates (via tweeted that I was buying the breakout:
The market friendly news from the PBOC and ECB helped propel the SPX to further highs:
Currently, both the intermediate term fundamental and technical underpinnings of the stock market are supportive of further highs. The latest earnings analysis from Dana Lyons also observed that the SPX is well above its trend on an inflation-adjusted basis. The only other time it has been this far above trend was the March 1998 to July 2001 period, which was at the height of the Tech Bubble. I would note, however, that the last time these overbought conditions appeared, it took a full two years before the excesses began to correct themselves. Overbought markets can get more overbought:
As well, Byron Rich is projecting a SPX target of 2917 by the end of 2015 in a Forbes article:
If we applied the long-run annualized return for stocks (8%) to the pre-crisis highs of 1,576 on the SP 500, we get 2,917 by the end of next year, when the Fed is expected to start a slow process toward normalizing rates. That’s nearly 45% higher than current levels. Below you can see the table of the SP 500, projecting this “normal” growth rate to stocks.
Notwithstanding Rich`s *ahem* outlier forecast of a 45% SPX gain, consider this Twitter observation from Jesse Livermore, the blogger at Philosophical Economics, that puts some perspective on the current advance in US stocks from 2009:
I got to thinking. Eisenstadt is a well-respect market analyst who uses models that are tilted towards growth and momentum. Grantham is a well-respected value investor - and value investors tend to be conservative and early. If they are both thinking 2,225 to 2,250 on the SPX, might it overshoot to the 2,400 level, where the combination of over-valuation and some macro event, e.g. Fed tightening, cause the market to crash?
Let me make this very, very clear. I am not forecasting a market crash, but a scenario involving melt-up followed by a market crash is within the realm of possibility. These figures put forward by Eisenstadt, Grantham, Lyons and Livermore certainly puts some parameters of the upside potential in a bull run.
Under these circumstances, let`s enjoy the potential market melt-up first instead of worrying about a market meltdown, Party now, pay later.
In the short term, I am seeing signs of positive momentum everywhere. The latest BoAML Fund Manager Survey is seeing a renewal of optimism about global growth but the bullishness is not excessively high:
Fund managers have expressed a desire to pile into equities:
While their positions are above average, the BoAML comment is that readings are only 0.7 standard deviations above average and not stretched:
Technically, the SPX touched its weekly upper Bollinger® Band on Friday but did not close above it. Episodes where the market has closed above the upper weekly BB are rare and have tended to signal impending weakness. However, as the market did not punch above its upper weekly BB, it may be poised for a multi-week ride on the upper BB, where the index rises along with the upper band:
In addition, BoAML has pointed out that Thanksgiving Week has been historically seasonally positive for equity returns (via ZH ):
In the meantime, it`s a great party. Don`t be such a worrywart about what might happen next year. My inner trader tells me:
Don`t fight the tape (or central bankers, for that matter). It's a new era of financial hedonism.
Disclosure: Long SPXL
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