Happy Friday Everyone!
I hope you all had a great week. It's been a rather ominous one for investors, as many business cycle indicators continue to deteriorate. In last week’s blog I showed how our Checklist had recently turned down from a positive score to neutral, meaning that any further weakening would turn our model negative and provide a signal that the bull market may very soon be over.
The video I produced sparked some really thoughtful questions from our Trading Club members, as could be seen in Richard’s message to me below...
I answered his questions in greater detail in this week’s Trading Club video, but essentially, he is right to identify that markets may continue to hold (or even sustain a rally) for 6-18 months or so following an inversion of the yield curve.
So whilst it may be premature to expect a sell off in equities immediately, our model considers several factors including (but not limited to) the yield curve. And this is the main reason for concern. When the 'stars are aligned’ with the majority of indicators, on balance, turning negative, then historically it has been a great time to act, without hesitation. With the Checklist at neutral, and the momentum in several indicators including the ISM Manufacturing PMI (specifically) looking to take the individual score negative, this became my primary cause for concern ahead of the release this week...
My worst fears for the report were confirmed, with the data coming in well below estimates and the vital ’50’ threshold (below 50 signals contraction).
Here you can see the chart (normalised to 0, rather than 50, for expansion / contraction) with the China PMI overlaid in yellow, which has also weakened and was suggesting similar deterioration in the US survey.
Digging in to the report, the news got worse. Looking at the New Orders minus Inventories sub components (upper panel), the spread turned negative (which has historically preceded a recession). The lower panel also showed how the headline New Orders were below 50, which with a simultaneous negative New Orders - Inventories spread, is an even clearer signal of a slow down in the economy.
So with the ISM report set to turn the Business Cycle Checklist negative overall, is it time to get out of the market? Equities still trade above their 200 day / 10 month moving averages, so whilst this suggests resilience from a technical perspective, my inner short seller looks at this chart thinking how great it could look in a year or two if one sold against the consensus here...
In the near term though, the current technical picture is supported by our US Equities Checklist which flipped to a +2 this month, suggesting a tactical long opportunity in the next couple of weeks (its never easy in trading with conflicting signals, is it!).
So perhaps there may still be a little more upside to sell in to, if indeed our Business Cycle Checklist is to close and confirm a negative score at the end of this month. So for now, particularly if the talk of more QE returns, or US and the China make headway in their trade negotiations, there may well be relief for longs...
Time will tell how this all plays out, but rest assured, with our Checklist process you will be ahead of the game and better informed than many investors who do not employ the same tools that we do as professional fund managers (and honest educators!).
If you would like to learn more join us as a member of our Trading Club or learn from Lex with our Million Dollar Traders Online Course.
Have a great weekend,
James Helliwell | Chief Investment Strategist