A year ago, bear-market risk looked elevated for the US stock market, based on a Hidden Markov model (HMM). The warning, which was discussed on these pages at the time (see here, for instance), has had a mixed record. Although stocks swooned in late-2015 and early 2016, the growling was relatively muted in terms of the S&P 500’s drawdown. That’s easy to say now, of course, although the real-time outlook looked quite dark at times. In any case, we’ve come full circle in terms of the HMM signal, which turned bullish late last month for the first time since mid-August 2015. In the wake of what’s been a real-time test of the model, let’s review what we’ve learned about HMM for monitoring bear-market risk.
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