Equity model update

Regular readers will doubtless the recall the equity model that Macro Man has run for the past eight-plus years.  As a reminder, this model uses a few fundamental inputs to generate 12 month return forecasts for the SPX.   While the absolute magnitude of the forecast is generally not to be taken literally, Macro Man has derived a great deal of utility (and profits) over the years by tracking the trajectory of the forecast in both an absolute sense and relative to the level of volatility.

He runs a similar model using a scorecard approach, where five fundamental factors are given grades of +1 or -1.  Research suggests that any market delivering fewer than four +1's isn't worth owning, and that market returns with five +1's are generally much higher than those with four.  This scorecard model saw one factor turn negative in January, and retains the same profile through May.

What's interesting is that the regression return model is also deteriorating...and for fairly predictable reasons.   It's not at the point where it recommends exodus from longs, but as Macro Man has elucidated previously there are reasons to expect this model to lag somewhat in the current cycle.   In any event, the current 12m forecast is the lowest of the past couple of years:


As mentioned above, the reasons for this are entirely predictable.   Macro Man likes to break down the forecast components into what he likes to call "economic" and "liquidity" factors.     The former have been sluggish for some time, while the latter have been at astronomical levels for the past several years.   Over the last few months, the liquidity support for stocks has begun to ebb (while remaining ample) even as the economic factors have remained weak.


Ultimately, the regression model still likes owning stocks, but the case is much less compelling than it was even a year ago.  Macro Man has found that as long as the forecast Sharpe ratio is above 1, the model generally profits from owning stocks.  The forecast Sharpe is currently 1.5, down from as high as 4 eighteen months ago.  It's now realistic to contemplate the model going flat for the first time in nearly five years.

Of course, models are not the be all and end all, particularly on time frames that they're not designed to capture.   It didn't take Nostradamus to predict that the the liquidity support for US stocks would begin to decline, and it seems likely that the trend will continue for a while longer.   With Spooz still knocking against old highs without breaking through, Macro Man is happy enough to retain his tactical short.   When the time comes to be more strategic, he'd like to think that the model will capture it.
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washedup
admin
June 2, 2016 at 12:32 PM ×

@MM - "It's not at the point where it recommends exodus from longs,"

Thanks for the model update - does this model exit length when forecasted returns are below zero, or is there some other criteria that also includes risk?

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Leftback
admin
June 2, 2016 at 3:19 PM ×

OPEC decides to do d*ck. There's a surprise. Now watch as leveraged oil longs eventually decide to take their ball and go home. $WTI is headed lower from here, with the XLE and the CAD going along for the ride. Spoos will find it difficult to withstand both a firmer dollar (and yen) along with lower oil.

Our long JPY punt made money, we took profits on that today. We added to our UUP positions this morning.

Expectations for tomorrow's NFP number, and by extension for Dame Janet showing her beak and claws next week in her speech in Philadelphia, have sunk considerably in the last few days, but we suspect that the report will be on trend at around 200k, especially when the Verizon strikers are taken into account, and that it is unlikely to stay the Fed's hand. We are on course for a hike, probably in July, which doesn't mean to say that June will be uneventful. Mr Market is counting on getting the usual blow job next Monday, so he might throw a tantrum.

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Anonymous
admin
June 2, 2016 at 3:48 PM ×

http://www.businessinsider.com/bill-gross-investment-outlook-june-2016-2016-6

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Anonymous
admin
June 2, 2016 at 5:44 PM ×

mm,

regarding the model's liquidity inputs, have you made use of/found any value in the new-fangled stuff like w-x shadow rates and divisia m4? rate's-of-change there seem to be trending non-zero which is more than you can say for the fed's balance sheet!

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abee crombie
admin
June 2, 2016 at 6:01 PM ×

EURJPY heading lower...EM FX same thing generally. Oil positioning looks stretched as well with net longs up big in the past few months, so I can envision an LB move, though frankly I am not really interested in playing the range here.

I'll be watching HY to see if its just HF equity monkeys sector rotating or real moves.

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Anonymous
admin
June 2, 2016 at 6:08 PM ×

big squeeze in iwm here - putting out a decent short at 116 here....buying some tom calls as stop

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Anonymous
admin
June 2, 2016 at 6:20 PM ×

Why would oil go lower when there is a supply problem? Oil is failing to sell off on bad news, and rallying on good. It's going higher, we need 65-75 to get capex back on, and that's barely incentive pricing.

Oil has had its bear market and is tight. The bear market low still to come is in base

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Anonymous
admin
June 2, 2016 at 7:31 PM ×

Bloomberg on wti today

- Analysts, traders bearish on WTI crude futures, wkly Bloomberg survey shows.
15 of 30, or 50%, bearish
2, or 7%, bullish
13 neutral

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Skr
admin
June 2, 2016 at 10:58 PM ×

Leftback,
Nice going on JPY and you're profits. As you said it is going from "bottom left to top right", and from what I can see (technically), it has alot more to go.
May I ask, What fundamentally could cause this to happen?

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