Over the past few weeks our proprietary quantitative model has experienced a significant decline, falling from an almost unequivocally bullish reading of 7.45/10 to a lower neutral reading of 4.33/10. The deterioration in the overall score was caused by a broad-based decline in several important variables including, among others, the relative momentum in early cyclical, late cyclical, and defensive sectors, the steepening of the yield curve, the growth-sensitive Australian dollar to Canadian dollar exchange rate, and implied volatility.
In the meantime, the external models we follow are somewhat of a mixed bag, with NDR’s ‘Fab Five’ model almost freefalling from bullish to neutral and Leuthold’s ‘Major Trend Index’ getting back to bullish after an excursion into neutral territory. Typically, our internal model seems to move more or less in line with these renowned models, which we take to be a positive sign of the validity of our model. However, every once in a while we will observe some divergences, and this is where we get a chance to add value through our hands-on quantitative research.
The current level of 4.33/10 is still a neutral level and is not too concerning in itself. What is worrisome, however, is the downward trajectory that the model has followed over the past few weeks. Should this trajectory continue in the upcoming weeks, we will quickly find ourselves in mildly bearish territory, which has been historically associated with negative average returns, as well as a less attractive upside potential relative to downside risk over the following six-months. Falling into mildly bearish territory would be a clear message, at least from the quant department, that it’s time to start scaling down our exposure to equities.
As always, we will be watching closely.
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