By James Helliwell, Chief Investment Strategist
Last week was certainly one to forget. With the threat of nuclear war escalating through the words of US President Donald Trump, markets became jittery and (eventually) saw a meaningful rise in the VIX (the so-called ‘fear index’). Whilst the Dow Jones Industrial Average responded with a decline of just -31 points initially (no, thats not a typo) stocks and other risk assets came under greater pressure as the week progressed amidst frenzied media coverage.
With many pundits bracing for armageddon, and hedge fund manager Ray Dalio coming out with a call to buy gold as a hedge (he mustn’t have seen our gold checklist last week), it is easy to get sucked in to the fear and trade on pure emotion (curiously, boffins reckon fear is a more powerful emotion than greed). However, even with the risk of war between the United States and North Korea, our Market Indicators checklist provides a reference for what we should be looking to do as investors - and is based on facts, not feelings.
Let’s take a look at this approach in detail, which is based on our experience as professional investors and updated in real-time each month. The checklist provides a systematic process that fellow hedge fund managers and traders employ to analyse markets, from which the biggest trading decisions are made. We have similar versions to analyse stocks, currencies and commodities including crude oil and gold, and score each factor +1, -1 or 0 depending on whether they are regarded as positive, negative or neutral for the coming month. A positive total score indicates a potential buying opportunity, and a negative score suggests that you should look to sell (closing long positions or going short). A neutral score of 0 suggests avoiding trades when there is no clear bias.
Monthly indicators. We look at these data very closely as they define the long term trend in the economy, and by virtue, the market cycle. We look at things like the PMI Manufacturing surveys, building permits, retail sales and even port activity to gauge the strength of the global economy. Even though many of these are US data points, you can see large export nations such as China and Germany in there too. Heading in to August, there was a mixed picture, although with 4 greens showing improvement, and 3 reds showing deterioration, on balance we see a score of +1 which is a positive on our market indicators checklist. (+1)
Short-term indicators. The short-term appear resoundingly positive, with 7 greens and 2 reds this month. Only consumer confidence and the number of carloads showed contraction on last month. It is worth noting that whilst many of these data are available daily, we look at the month-over-month change here (Trading Club members receive this in our weekly market report every Monday showing the week-to-week change). Hard to find reasons to be negative here. Clearly positive for risk markets. (+1)
Leading indicators. Similar to the short-term indicators, the leading indicators we track are updated on a daily basis as they are based on market prices. For example, the various sectors and sector ratios, emerging market equities, Spain Credit Default Swaps and commodity prices including crude oil, iron ore and copper. What is overwhelmingly apparent here is an entirely green scorecard showing month-over-month improvement in everything that we track! It is very unusual to see a ‘perfect scorecard’ like this, so when we do, we pay attention. It deserves nothing but a +1 on our checklist. (+1)
Sentiment indicators. We view sentiment as contrarians. Usually if the fundamental picture is improving, then investors will have begun to position accordingly. More often than not, this means that our sentiment scorecard will present a negative signal as the market has become more bullish - as is the case here. However, this is not always the case, and although infrequent, these are my favourite setups when conditions are improving but the market has yet to embrace that with new found optimism. As there are only a couple of greens on our scorecard, we’ll keep this brief and say that the increased optimism is a warning to us as contrarians. (-1)
Overall we saw a positive total of +2 on our market indicators checklist as we headed in to August. This suggests that risk assets should outperform 'safe havens’ for the foreseeable future, and supports trading equities and cyclical commodities like crude oil from the long side. Of course, you must then do your homework to discriminate between good and bad investments within risk markets, just as we do in our Trading Club and have featured in our recent blog posts. (+2)
Put simply, it tells you to avoid being defensive and provides a greater probability of success being aggressive in taking on risk at the right opportunity - which has perhaps never been more relevant than now. Regardless of what you are trading, all markets are influenced by the degree of fear and greed in the market, and risk assumed by investors. The factors captured by our market indicators checklist cut through the noise and provide an objective analysis of this to put you at an informational advantage over other people in the markets trading without this clear process. Join us at the Academy to ensure that you are on the right side of the market and apply this same process to stocks, currencies and commodities, along with these market indicators, with expert analysis from myself and Lex van Dam each month.
Don’t be a sheep (and have a much better week!),
Lex van Dam’s Trading Club provides access to our best trade ideas within FX, stocks and commodities each month and you will stay ahead of the action with our weekly market report. We hope you found this article interesting and insightful. For further discussion or to receive access to our monthly Trading Club meeting, join us at the Trading Club.
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