I hope that you’re all well and have managed to enjoy some of the sunny weather this week! Although some people in the UK have been able to return to work, or continue working, there are many who have been either furloughed or made redundant in the past month. I appreciate that it is a challenging time for us all, and that some of us have been more fortunate than others in terms of health and wealth.
I am increasingly humbled by the privilege I have to continue doing what I love, whilst having my health. However, for some of those close to me it hasn’t been so easy. Thankfully, none of my family have contracted the virus, but some of them have seen their work and incomes change dramatically. Nonetheless, this is indicative of the times we are in, as is apparent from the cautious guidance by our governments and the ever-growing number of people filing for unemployment benefits.
Here you can see the Initial Jobless Claims data released yesterday which saw more than 2.4 million Americans file for unemployment benefits:
Sharing this on a sunny Friday morning ahead of a long (UK bank holiday) weekend doesn’t feel quite right, but if you look beyond the headline you may find hope in the fact that the rate of change is slowing, and therefore showing improvement. Whilst this may sound a little crazy, markets are said to trade ‘at the margin’, meaning that the rate of change is often more relevant than the absolute level when it comes to adjusting your outlook and determining forward looking trading decisions.
At present, our Business Cycle Checklist shows a negative position. However, the day to day gyrations in markets are the result of different groups of investors looking at the various data in numerous ways. The shorter-term speculators and hedge funds often favour the rate of change to time their tactical trades (not always a winning strategy, as their performance will attest!). Longer-term investors can be more patient and wait for the absolute levels in each of their preferred indicators to shift and confirm the trend in the business cycle. Our checklist combines both, so we feel it is just as relevant to be aware of the rate of change in many of these indicators as it is to read the absolute level.
Although not represented in our US-focused Checklist, the Eurozone Manufacturing PMI showed a similar improvement in the rate of change, even though the absolute level (beneath 50; normalised to zero on this chart) remained negative. The reason we wouldn’t trade on the rate of change alone is that you would likely find yourself whipsawed by many ‘false dawns’ in a bear market, before eventually finding the cycle low. Nonetheless, it is still important to observe and will be more relevant to some people than others depending on their risk appetite and psychology.
Yet the longer-term picture and ‘absolute’ level in indicators we do track, such as the LEI Index below, are very clearly negative and continue to deteriorate at a concerning pace. The red highlights on the chart below indicate NBER defined recessions, and the relationship between the LEI and the business cycle highlights the peak in activity in late 2018.
As I have emphasised in recent weeks, the Central Banks have moved early to attempt to control the depths of this recession with massive quantities of stimulus. Here you can see the US balance sheet approaching $7 trillion, which we are on track to exceed next week (we were around $6.5tn at just the turn of the month!).
This has no doubt supported equities, with the S&P 500 recovering just over half of its losses from the 3400 high to the 2200 low. According to my very rough maths, and assuming the contraction in Q2 GDP is at least in-line with expectations, then the amount of stimulus as a percentage of GDP added by the Central Banks makes the current level seem fair value. You can see in the chart below that the S&P has been in a holding pattern (rectangle) between 2800 - 3000 all month waiting to see whether GDP is likely to come in better or worse than expected (i.e. what is ‘known’ is already ‘priced in’).
It again highlights the importance of tracking the rate of change in data, not just the absolute level, as I introduced at the beginning of today’s post. In an epic tug-of-war between fundamentals and stimulus only time will tell how it all plays out, but what is clear is that it has never been more important to have a proven trading process at your disposal.
If you would like to join us for our full analysis including new insights each week, and learn from the ground up with online tuition from Lex in our MDT online course, then head to milliondollartraders.com and take your financial knowledge to the next level right away!
Have a safe and pleasant weekend,
James
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