Tag Archives: investing

Using Economic Indicators To Time The Market

If you pay attention to the financial market news, you may have noticed a lot of attention being focused on the slowing US/Global economy and the implications it has for financial markets. Just do a search on ‘slowing global PMI’ and watch the hours waste away. Basically, the US/Global economy is slowing which means recession is right around the corner, which means financial markets will tank. That seems to be the predominant bear case now, or one of the many. There is some merit to this argument. The worst market downturns occur during recessions. The trick is that you need to know that before the recessions actually happen. In this post, I’ll point you to some research in this area, then focus on just one indicator that does a decent job of forecasting recessions and how it can potentially be used as a market timing indicator on its own. To try and predict recessions, there are all kinds of metric and techniques used (ECRI, Conference board indicators, etc.). You can spend many many hours looking at all of these and their histories. Believe me. Me and an investor friend have spent tons of hours looking at and studying these. And the history of indicators predicting recessions is mixed to say the least. But I won’t bore you with that here. Instead, if you’re interested, you should read this by Philosophical Economics (which I’ll call PhiloEcon) and some of the linked posts in that piece. There is some incredible work and insight in the post (pretty much anything he/she writes is worth your time). Turns out that historically, the change in the trend in unemployment rate has been a pretty good indicator of recessions. It has also been decent at signaling when the economy has come out of a recession. Below is the key chart. Not bad. When the unemployment rate crosses above the 12-month moving average to the upside, a recession is likely coming, when it crosses below the 12-month moving average, the economy is out of the recession. Can this be used to time the stock market? And does it work better than other market timing indicator such as the popular 200-day simple moving average of prices? Basically, yes. You can read through the post and see how using the unemployment rate improves returns and risk over buy and hold and a trend following system. As usual, I wanted to run some numbers myself. Let’s take a look at that. I first wanted to see how the unemployment rate indicator (UI from now on) performed on its own versus buy and hold and other trend indicators, specifically the 200-day SMA and 12-month absolute returns. I also wanted to use real investable products, including fees. I looked at returns going back to the beginning of 1999 through April 26, 2016, for the S&P 500 ETF (NYSEARCA: SPY ), which fortunately started in 1993. This time period encompasses two of the biggest market downturns in history. I compared buy and holding the SPY versus using the 200-day SMA, 12-month total return, and the UI to exit and enter the market. When the timing systems are out of the market they are not invested, i.e. 0% cash return. Below are the results. Very impressive. This simple indicator delivered returns 3.4% per year greater than buy and hold and more than doubled risk-adjusted returns. It also beat both other timing systems by a long shot. In addition, the simple UI system produced fewer false positives and traded a lot less. Definitely worthy of consideration. You can probably see where I’ll be going next with this. In some following posts, I’ll look at adding a risk-free asset to the mix during times of risk-off, combining the UI with other indicators (which is what PhiloEcon has done in the GTT system), and adding some global risk assets to the mix. To give you a preview, they are all better than what I’ve shown here. Finally, before I end this post, what is the unemployment indicator saying right now. Does it support the bear case I noted in the opening paragraph. No, it doesn’t. The current unemployment rate is 5.0% where the 12-month moving average stands at 5.2%. If the unemployment rate increases by 0.1% each of the next two months (April and May – remember the reported unemployment rate is for the previous month), then the rate would cross above the 12-month moving average. We won’t find out until the May unemployment rate is reported at the beginning of June. And we’ll know this week what the April rate is. This seems unlikely but you never know. The FOMC’s own projections don’t support a change but they are notoriously poor forecasters. Others think that more realistically the end of the year would be the time frame we could possibly see a trigger. But there is no need to forecast to use the UI system. For now, if you were using this system it would be risk on still. In summary, historically, the change of trend in the unemployment rate has been a good signal to time the market. Better than the two most popular trend indicators around.

Shiller Was Warned Not To Tell The Truth About The Stock Market – And We All Heard The Message

By Rob Bennett Robert Shiller says in his book Irrational Exuberance that: “On several occasions I have discovered firsthand the pressure on public prognosticators to deliver positive statements about the market. Once, just before going on national television, the anchor looked me squarely in the eye and told me that what I said could conceivably have an impact on the market, and that people can get upset if they perceive prognosticators as disrupting the market.” I’d like to know what Buy-and-Holders think of that statement. Buy-and-Hold is rooted in the belief that it is economic developments, not investor emotion, that determine stock prices. If that were so, nothing that Shiller said could affect the market. Do Buy-and-Holders think that the television anchor’s worries were foolish ones? I don’t think they were foolish so much as dangerous. What Shiller or anyone else says certainly can affect market prices. Buy-and-Holders agree even though they follow a strategy rooted in a belief that only economic developments matter. I know because it is Buy-and-Holders who have insisted that I be banned at the 20 investing sites at which I have gotten the boot. If what I said didn’t matter, why would the Buy-and-Holders want to see me banned? The Buy-and-Holders haven’t convinced even themselves that only economic developments matter. We all filter out information that disturbs us because it threatens our confidence in our world view. Conservatives filter out information advanced by liberals and liberals filter out information advanced by conservatives and it has ever been so. It’s a universal phenomenon. What possible reason could there be for believing that it doesn’t work that way with stocks? A man hears what he wants to hear and disregards the rest. I filter out information casting doubt on the merit of the Valuation-Informed Indexing strategy. I am not aware of doing so, and I understand that it’s a bad idea to do so. I need to know the drawbacks more than anyone else does. It is foolish for me to tune out the words of my critics. But it’s hard to imagine that I do not often do so. Humans always tune out stuff they don’t want to hear. Is that not so? And it always hurts us. That’s also so. That’s why I see such a huge opportunity in Shiller’s research. If we were to begin taking Shiller’s research seriously, we could overcome the force that has made stock investing risky since the beginning of time. That force is self-deception. Do away with self-deception and you change the game in a fundamental way. Many people think it can’t be done. Since we always have engaged in self-deception re stocks, they think we always will. I am more hopeful because Shiller’s P/E10 metric quantifies the effect of self-deception. Now that we can tell people the dollar-and-cents price of following Buy-and-Hold strategies, we can persuade them to ditch the self-deception. People like to make money. We now have the tool we need to motivate investors to demand that Shiller and lots of others tell them the straight story. Even Shiller does not tell the straight story today. It is not my intent to be critical with that statement but to point out how deep the problem goes. Shiller’s next words in the passage that I quoted above are: “He was right, of course, to give me such advice, and I shudder to think that I (or anyone else) could ever help cause a market event that would cost some people their fortunes.” Huh? The television anchor invited an expert onto his television show and then discouraged that expert from sharing his true beliefs with his listeners. How could that possibly be the right thing to do? The television anchor should be ashamed of himself. Shiller should be proud of himself for sharing this revealing anecdote and also a little ashamed as well for soft-peddling the danger of the practice (which is widespread) described. Everyone does what the television anchor did. The newspapers celebrate price jumps even though all they do is raise the price of stocks, a good that all of us who hope to be able to retire someday must buy. Investment advisors brag about the good advice they gave when prices rise even though all price increases greater than those justified by the economic realities (that is, all price increases greater than the 6.5 percent real price increase that has been the price increase that has applied in the U.S. market for as far back as we have records) are temporary cotton-candy gains fated to be blown away in the wind as time passes. Retirement calculators assume 6.5 percent gains on a going-forward basis even when prices are insanely inflated and it is obviously unrealistic to expect such gains. Everyone lies in the stock investing field. Because everyone demands lies. Those who don’t lie are silenced. Those who don’t lie make the ones who do lie look bad. A bull market cannot survive truth-telling. And we all like those pretend cotton-candy gains. For obvious reasons. Two paragraphs down from the passage cited above, Shiller tells a different anecdote: “One investment manager for a pension plan spoke to me about how difficult it was for him to suggest in his public statements that people should perhaps be concerned about overpricing of the stock market. Despite his considerable reputation and apparent sympathy with the views expressed in my book, he seemed to be saying that it was not within his authority to make bold and unprovable statements contrary to conventional wisdom. He seemed to view his charge as interpreting received doctrine and that it would be considered a dereliction of duty to voice contrary opinions that came only from his own judgment.” We expect doctors to express their own judgment. That’s why they get paid the big bucks. It’s the same with baseball umpires. And with accountants. And with lawyers. And with engineers. And with every other kind of professional. The person giving investing advice is the only exception to the otherwise universal rule. Because of what the television anchor said to Shiller. Question Pretend Gains and they might disappear. No one wants that. And so the Pretend Gains grow bigger and bigger and bigger until the cost associated with their disappearance (which is ultimately inevitable) becomes so large that it causes an economic crisis. It’s a problem. Disclosure : None