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The rise of the Fear Bubble

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 a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bearish*
  • 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 receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.

The Fear Bubble
Ever since the NASDAQ Bubble burst, investors have been looking for additional bubbles to be wary of. The subsequent housing boom created a subprime bubble, which was facilitated by cheap financing, and wild leverage in the financial system that eventually led to a crisis. Now everyone is a bubble hunter.

We now have a new bubble, a Fear Bubble. The Fear Bubble can be found across all asset classes, and it can be seen in the diving 10-year Treasury yield; the deeply negative 10-year Bund yield and the growing count of negative yielding European fixed income instruments; and even the forex market, as evidenced by the cratering NZDJPY cross, which is a bellwether of the carry trade. The big surprise is US equities have held up reasonably well in this fearful environment.

The Fear Bubble is creeping into the equity market. Yahoo Finance reported that Goldman analysis found that funds are now increasingly defensive.
The average large-cap mutual fund is Underweight on U.S. firms with the highest sales exposure to China and has been gradually cutting exposure to these stocks during the past 18 months, according to fresh data from Goldman Sachs. Being Underweight is another way of Wall Street saying it expects the U.S. trade war with China to overly hurt companies with outsized exposure to the country and likely, and its stock prices.

Goldman notes that mutual funds are also Underweight semiconductors housed in the S+P 500 , another sector being damaged by the escalating trade war with China and also Huawei.

Meanwhile, hedge funds have also tilted more defensive with their portfolios. Goldman’s research shows hedge funds are Underweight information technology (trade exposed, too) and financials (also trade exposed — worsening trade conditions are causing the Fed to consider lower interest rates, which hurt bank profitability).

Tech overall is the largest net Underweight among hedge funds, Goldman says.
What should investors do, and how should they position themselves in light of this latest bubble?

The full post can be found here.

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