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Is the Bull Market Back? Probably No

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The market rallied very strongly in Q1 2019. S&P 500 is up about 13% for the quarter and this is one of the best quarters since 1998. Although it seems like the resumption of the bull-market, we believe that the fundamentals and valuations do not support it and the risk is too high to be fully exposed to equities. We are net-long as the companies that we have in our portfolio have strong fundamentals and reasonable valuations but we are short index as we believe that the index as a whole is overvalued. Weakening fundamentals and overvaluation are recipe for a disaster and we are getting prepared for the disaster that is likely coming soon.

Our macro model has been highly predictive of future revenues/earnings and future stock prices. Some of those variables that are used in the model are Eurodollar futures, 10-year note, emerging market equities and debt, corporate bonds, US financial index ETF, South Korean export figures, lumber futures and VIX among few more.

In the last 20 years the model has given 11 signals where 7 were true, 3 were false and 1 is still open. The average gain on true signal is 31% and the average loss on a false signal is 7%. The model turned negative in early 2018 and has not given us a buy signal yet. The important thing to remember here is that the model provides us a macro view but does not tell us the exact time the market will go up or down.

When the model first gave us the “sell” signal in January 2018 SPY was at $275, then the following month it went as low as $247, then it rallied and went to $290 in September 2018, then it fell to $232 in December 2018 and has now rallied to $283. When we look at the first time, we got a “sell” signal we have seen significant declines and rallies but when we look at the overall picture, we are within few percentages from the first sell signal.

Devkota Macro Model Chart

What makes us think the time is right for another sell-off now?

We admit that we are not good enough to pick the top or the bottom but we also believe that one can identify times when it is prudent to take more or less risk. There are few indicators that have worked fairly well in the past that tell us when it is better to be fully invested or partially invested.

1. Inter-market analysis: We are big believers in inter-market analysis and believe that there are certain relationships that hold true. When these relationships start diverging from the historical relationship, we start to look for ways to protect our gains. The relationships that we are looking for is the price-action between small caps (IWM) and semiconductors (SMH) to S&P 500 (SPY).

In the charts below you will see that IWM and SMH are unable to make new highs as SPY is making a new high. I have circled those areas and I have circled what happened in the past when similar thing happened. These divergences do not always work but when the macro model is down these works more than 90% of the time.

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