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Don't Get Bearish Just Yet (Because You Can't Hurry Market Tops)

Trend Model signal summary
Trend Model signal: Neutral
Trading model: Bullish

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 out-of-sample (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.

Trend Model signal history

SPX with Trend Signals

Update schedule: I generally update Trend Model readings on weekends and tweet any changes during the week at @humblestudent.

So easy to be bearish, but..

Last week, I outlined my views over different investment time frames (see Bullish and bearish over different time frames). I wrote that I believed that the stock market is in the process of forming an intermediate term top over the next several months, but it is likely to rally to test the old highs or make marginal new highs over the next few weeks before a correction begins.

I stand by those remarks.

From a chartist's viewpoint, it would be so easy to be bearish right now. Breadth deterioration in the US equity market has become very evident. The chart below, of several measures of market breadth show the leadership is narrowing almost every day, which is a clear warning to the bull camp.

SPX Daily vs FLoat Weighted SPX 2014-2015

Rather than just repeat myself week after week about how breadth is weak, I thought that I would show the narrowness of the advance differently, by analyzing the market using point and figure charts. For the sake of consistency, all charts have been standardized with a 0.5% and 3 box reversal. Here is SPX, which shows that it has broken down out of an uptrend and may be undergoing a sideways consolidation.

SPX Daily Point and Figure Chart

If the market had just been losing momentum by breaking down out of an uptrend, I would not be as worried. The bullish impulse can resolve itself by resting through a consolidation period before resuming its upswing.

Unfortunately, other major averages are telling a more bearish story. Consider the point and figure charts of the three Dow Jones averages, namely the DJIA, DJTA and DJUA. The chart below, of the DJ Industrials, shows that it is starting to roll over:

INDU Daily

The Transports, DJTA, look worse, as they are in an unambiguous downtrend:

Tran Daily

I will not even pretend that the Utilities, DJUA, are in anything but a bear phase, though they may be forming a bottom.

UTIL Daily

Here is the small cap Russell 2000. It`s the same story of a market rolling over into a bear phase. It`s the SPX that is the laggard.

RUT Daily

I am seeing something else of concern: the message from cross-asset, or inter-market, analysis. The HY, or junk bond, market (via iShares iBoxx $ High Yield Corporate Bond fund (ARCA:HYG)) is not behaving well, which is an indication that global risk appetite is receding. The relative performance of HY bonds compared to equivalent duration US Treasuries (via iShares 3-7 Year Treasury Bond ETF (NYSE:IEI)) topped out in April and began to roll over.

HYG:IEI Daily vs SPX 2014-2015

On a longer term basis, I found that the relative performance of HY bonds (black line, inverted scale) tends to lead US equities (purple line) by 4-5 months. Here is a longer term chart going back to 1996, with SPX performance lagged by 5 months. The fact that HY spreads are starting to blow out must be a little disconcerting to stock investors.

S&P 500 and HY Spreads 1996-2015

Arguably, the poor performance of the junk bond market could be attributed to the steep drop in oil prices, which have negatively affected the HY prices of energy related issuers. However, this analysis from Deutsche Bank (via Bloomberg) shows that the spreads on non-resource related issuers have been rising as well.

CCC Spreads 2003-2015

Too many bears

Based on the analysis presented so far, the natural inclination is to batten down the hatches and get bearish. But not yet.

Josh Brown had a great perspective on the kind of technical deterioration that we are seeing. Despite the fact that his...


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