A Simple Trend Model for Equities

As a multi-asset portfolio manager, I often get asked for my views on different asset classes.  I use a framework to evaluate the relative attractiveness of each asset class by scoring it across the following variables:

  • Valuation
  • Sentiment
  • Fundamentals
  • Economic Growth
  • Government and Central Bank Policy
  • Trend

The weight that I assign to each variable depends on the investment horizon. For example, the longer(shorter) the horizon, the more(less) weight given to valuation.

Changes happen gradually. In other words, I don’t use this framework to make 100% in or out market timing calls. Only crazy people and academics trying to prove that market timing doesn’t work do that.

My primary focus is on getting the relative ranking between asset classes correct, not trying to forecast the return of any asset class.

With that background in mind, I thought I’d share one of the simple tools that I use to keep tabs on the trend of an asset class. Its a simple trend model that uses the following variables:

  • Absolute return over 1, 3, 6 and 12 months
  • Slope of absolute return over 1, 3, 6 and 12 months
  • Current price 10-month moving average
  • Slope of 10-month moving average
  • 3-month vs 10-month moving average

Each signal is equally-weighted. Scores range between -11 and +11.

I use ETF closing price data to calculate the score. For example, here a trend score for the S&P 500 using the SPDRS S&P 500 ETF ($SPY).

US Long

Here’s how I interpret the model. I don’t worry too much about the current score. As you can see its rather noisy. That’s why I pay more attention to the level and the change in direction.

For example, I consider scores above +5 to indicate a positive trend and scores below -5 to indicated a negative trend. Scores between +5 and -5 are anyone’s guess.

A sharp fall in the score from above +5 is a danger sign that the trend might be changing. Conversely, a sharp rebound in the score from below -5 is a sign that the trend might be changing.

I also use other measures to confirm the trend such as market breadth and performance relative to other asset classes.

A few interesting things stand out in this chart. First of all, the Oct 2018 – Dec 2019 fall in the S&P 500 resulted in the worst model score since 2016. The model moved from +7 at the September 2018 peak to -8 at the December 2019 bottom. This was far worse than the sell-offs in February and April 2018 which failed to turn the model score negative.

Secondly, look at how strong the trend was during 2017. The model score spent nearly the entire year above +5.

Thirdly, the model score is currently negative; despite the sharp rebound in the S&P 500 since December 2018. You can see this more clearly in the chart below. This is due to several of the longer-term indicators still scoring negatively.

US

It’s a similar story for developed market equities. Notice that the deterioration in the developed market model led the deterioration in the US equity model by a few months.

World

Emerging markets had a disappointing 2018. The model score fell throughout the first half of the year. It then spent the second half bouncing along the bottom of the model’s range.

The emerging market model score is currently the best of the three markets. That said a score of zero is hardly a glowing endorsement.

EM

I’m interested to find out what readers think of this model and whether or not you’d be interested in seeing future updates. Please let me know what you think. 

 

 

 

 

Advertisements

One comment

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s