There have been reasons to be optimistic this week as equities held reasonably firm despite escalating tensions between the US and Iran following explosions on two oil tankers in the Strait of Hormuz, arguably the world’s most strategically important shipping lane linking the Gulf of Oman and the Persian Gulf. For me, the more significant news was that the US reached an agreement with Mexico on trade, avoiding US President Trump’s threat of imposing tariffs on goods from their Southern neighbour. Whilst negotiations with China are ongoing, it offered investors some hope that they may also be able to find compromise and agree a deal later this month (though I’m far from convinced of this). Amidst the noise, we turned instead to our Checklist process to generate ideas, and focused in on our Business Cycle Checklist that we explored in detail in last week’s blog. Here’s a sample of what our students learned in this week’s Trading Club video...
As you may recall, our Business Cycle Checklist observes 7 data points in order to help us assess economic conditions in the US. Each factor is scored either +1, -1 or 0 depending on whether we perceive the current position to be positive, negative or neutral (half marks are also awarded for ’marginal’ grading). The total is the sum of each score, and represents a quantifiable bias for us to approach our trading during the month ahead.
I use the word ‘quantifiable’ with good reason, as everything that Lex and I teach here at the Academy is based on hard fact and the reality of successfully navigating markets as professional money managers. We don’t indulge in lazy assumptions and anecdotes often espoused by lesser educators and “traders", as these are not only unhelpful, but also potentially harmful to your development. So putting our money where our mouth is, I wanted to show you the backtested performance of our Business Cycle Checklist in correctly assessing the state of the US economy, and providing a timely and reliable leading indicator of recessions.
Here you can see the Business Cycle Checklist score in red (RHS), against the S&P 500 in blue (LHS). As the Checklist score (red line) crosses 0, the business cycle has peaked and equity markets are at risk of double-digit declines.
This worked almost ‘perfectly’ ahead of the Great Financial Crisis (better than any other indicator I have seen published), and also nailed the top (with ~3 months) of the market in 2000/01. Whilst the economic variables that were most relevant in the past 20 years probably weren’t as relevant in the decades preceeding them, our extended backtest to the Summer of '69 (Bryan Adams will be pleased!) nontheless shows impressive results in anticipating major turning points in the business cycle, and correlated asset markets.
Of course, there’s a lot more to trading than backtested examples in excel. In reality, there can be a lot of emotion and psychology involved in managing trades, as well as your own mindset. Our students also know that we distance ourselves from automated ‘systems’ that also make trading appear easy where a computer can do it all for you, 24 hours a day, whilst you're asleep or partying with Instagram models on your private jet (join us for our professional trading education with our Million Dollar Traders Course and Trading Club memberships*).
A bit like the old Carlsberg advert (as the new one is a bit rubbish), “we don’t do trading systems, but if we did, they would probably be the best in the world.”
Have a great weekend!
*Instagram models not included.
James Helliwell | Chief Investment Strategist
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