Will The Coming Week Bring Out The Wimpy Bulls Or Wimpy Bears?
Cam Hui | Apr 20, 2015 12:26AM ET
Trend Model signal summary
Trend Model signal: Neutral
Trading model: Bearish
The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. 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 model component of the Trend Model seeks to answer the question, "Is the trend getting better (bullish) or worse (bearish)?" The history of actual (not backtested) signals of the trading model are shown by the arrows in the chart below. In addition, I have a trading account which uses the signals of the Trend Model. The last report card of that account can be found here.
Update schedule: I generally update Trend Model readings on weekends and tweet any changes during the week at @humblestudent.
h3 The bulls had their chance.../h3
Last week, I wrote that I expected that the US equity market would have difficulty making gains because we have seen a pattern of choppiness for 2015 (see Calling an audible (for more choppiness)). On the surface, there were plenty of reasons to be bullish. The earnings outlook appeared positive as consensus estimates were rising again; overseas markets were strong, which indicated global reflation; and last week was option expiry week, which was a historically bullish period.
So what happened? The bulls turned out to be utter wimps. The SPX pushed up to a minor resistance level at 2112, only to see the gains evaporate and ended the week in the red.
Nevertheless, the preliminary conclusion of a quick tour around the world is supportive of further gains. Non-US markets are rising. In Asia, stock markets are all in up-trends. While the Chinese market (via the Shanghai Composite) is a casino and somewhat divorced from China's economic outlook, the bourses of China's major trading partners (via the Hong Kong's Hang Seng, the Taiwan Weighted Index, South Korea's Seoul KOSPI, and Australia's ALL ORDINARIES) are signaling reflation, or at least the expectation of reflation. (Note that these charts do not reflect the announcement to put limits on margin trading and short selling, which cratered the China H-Shares futures by about 5% after the close).
Commodity prices (via the CRB Index among others) appear to have stabilized, which is another indication that global deflationary fears (particularly in China) may be overblown.
Get The News You Want
European markets (via the Dow Jones Global Index, DJ Euro Stoxx 50, FTSE 100), though weighed down by the never-ending Greek drama and dinged by Friday's weakness, are trending up.
The relative weakness of US stocks among the major markets is standing out like a sore thumb in my global review. Despite all these bullish tailwinds the SPX appears to be carving a broad top and violated its 50 day moving average on Friday.
What`s going on?
The best explanation I can offer, from a technician`s viewpoint, is that we are seeing the early signs of disappointment of investor complacency spawned by the steadily rising stock prices experienced in the past few years. I had previously highlighted a Wells Capital Management study showing how trended stock prices have become and how the trend appears to be overdone. I further extended the results of that study by comparing the long-term (36-month) trend and the short-term (6 month) trend (for more details see How to make your first loss your best loss).
The top panel of the chart below shows the rolling 36-month R-squared of stock prices, which shows that the trend in stock prices has been very good - too good. The bottom panel shows the difference between the 36-month R-squared and the 6-month R-squared shows that while the long-term trend is positive, the short-term trend is choppy. These conditions have historically led to market reversals in the past and readings are at levels similar to the ones seen before the market crashes of 1929 and 1987 (though with the caveat that this model is more predictive of future direction, not the magnitude of the move).
h3 Catalysts for a correction/h3
With that technical backdrop in mind, I have been seeking the fundamental catalysts for a correction for the past few weeks. I have a few candidates in mind.
- Fed tightening creates havoc in the HY and EM bond markets
- The mini-mania in Chinese stocks comes to a grinding halt and the risk-off contagion spreads
- The combination of a strong USD and pause in US economic growth spooks the earnings outlook
Let's go through each of these scenarios, one by one. The IMF recently outlined its global economic outlook and the risks to financial stability in a CNN Money ).
You have to understand that the Chinese stock market is not a traditional equity market in the western sense. It`s a casino. There is a Chinese expression describing a stock speculator as someone who "stir fries stocks". Think of the imagery of what happens to the ingredients when you stir fry in a wok and apply it to stock trading. Players care about fundamentals as much as horse players care about the ponies they bet on.
Remember the stir fry. Easy come, easy go - and lots of turnover.
For now, the Chinese enthusiasm for equities seems to have spilled over from the Mainland to the Hong Kong market. I have been monitoring the charts of the other "Greater China" markets, namely Taiwan, South Korea, Hong Kong and Australia, for Mr. Market's views of the Chinese economy (see chart above). As well, re-established his short positions at the open on Friday. He has a stop loss at about Thursday`s close. Should the SPX fall to the 2035-2050 support zone, he will be watching for an expansion of bearish momentum as factors in his decision process on whether to cover and take profits.
Disclosure: Long SPXU, SQQQ
Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.
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