A Momentum Market: How Long Will It Last?

By Roman Chuyan, CFA, President, CIO, Model Capital Management LLC

• Our Equity Model’s forecast for the S&P 500 remains positive as investors redeploy cash balances.
• A shift from Economic to Market factors occurred; momentum now drives the rally.
• Our models continue to dictate bullish positioning, but sentiment moves toward exuberance.

In my early-November article ‘Like A Rocket Ship,’ I explained how our models turned positive in a synchronized fashion, after the earlier market pullback, dictating bullish positioning. Accordingly, we moved our strategies into the market immediately, on November 2^nd. Our models turned out to be right – the market took off like a rocket ship. The S&P 500 has rallied by 9.7% so far in November which took its year-to-date gain to 12.8%. This is an unusual immediate gratification – investors are typically rewarded for waiting.

US and Foreign Stocks, Year-To-Date

As is always our process, our November-2^nd move was purely model-driven, irrespective of election uncertainty. We saw that the previous market drop had factored in most of the uncertainty and thought that we might get a relief rally when it’s over. The possibility of a contested election is usually small, but that’s what happened. Even more unusual was the market reaction – a strong rally in the face of a contested election. The financial media was utterly confused, with headlines like “The Market Rallies as Investors Eye Ballot Count.” The media (and some strategists) always take what just happened as the reason for a market move, but it’s often what had happened in previous months that matters.

The 6-month return forecast for the S&P 500 by our fundamentals-based Equity model increased again, to 7.0% which continues to indicate “Positive Fundamentals” – see Market Outlook for details. While the market rose and became even more overvalued, other factors continue to offset it. We therefore keep our strategies in their maximum bullish allocations.

There’s a noteworthy change in the Equity model’s result: the positive contribution shifted from Economic to Market factors. Cash Balances became the largest positive factor in the model. Investors began to redeploy cash in October, but balances are still large and could continue to fuel the rally. Still, the shift from Economic to Market factors means that the rally became momentum driven, which suggests that it could be shorter. A momentum-driven rally ends when the cash on the sidelines is reinvested.

While the 33% annualized GDP growth testifies to the phenomenally strong economic rebound in the third quarter, some recent economic indicators weakened. Consumer Sentiment, which leads consumer spending, unexpectedly dropped in November to 77, and Consumer Expectations sub-index weakened to 71.3:

Our Short-Term Risk model will be critical in the coming weeks, in my view. The Investor Sentiment component of the model detects patterns of investors becoming exuberant. This typically means that they fully invested in the market and is often followed by a correction. This tool has been moving in the direction of exuberance as the market rallied. For example, the AAII Bears-to-Bills ratio, one of the seven indexes included in the Sentiment tool, dropped to as low as 45% last week (bullish investors outnumber bearish by more than 2-to-1) or to 76% on a moving-average basis:

It’s wonderful to take advantage of this rally for our clients, but there are plenty of potential triggers for a reversal. Daily US COVID cases rose to a record of 188,000 on Thursday. While better treatment keeps fatalities well below their April peak, daily deaths also began to rise. In addition, the presidential election is still contested. So, we’ll keep an eye on our Risk model and keep our options open.

About Model Capital Management LLC

Model Capital Management LLC (“MCM”) is an independent SEC-registered investment advisor, and is based in Wellesley, Massachusetts. Utilizing its fundamental, forward-looking approach to asset allocation, MCM provides asset management services that help other advisors implement its dynamic investment strategies designed to reduce significant downside risk. MCM is available to advisors on AssetMark, Envestnet, SMArtX, and other SMA/UMA platforms, but is not affiliated with those firms.

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