Best of the Week
Most Popular
1. US Housing Market Real Estate Crash The Next Shoe To Drop – Part II - Chris_Vermeulen
2.The Coronavirus Greatest Economic Depression in History? - Nadeem_Walayat
3.US Real Estate Housing Market Crash Is The Next Shoe To Drop - Chris_Vermeulen
4.Coronavirus Stock Market Trend Implications and AI Mega-trend Stocks Buying Levels - Nadeem_Walayat
5. Are Coronavirus Death Statistics Exaggerated? Worse than Seasonal Flu or Not?- Nadeem_Walayat
6.Coronavirus Stock Market Trend Implications, Global Recession and AI Stocks Buying Levels - Nadeem_Walayat
7.US Fourth Turning Accelerating Towards Debt Climax - James_Quinn
8.Dow Stock Market Trend Analysis and Forecast - Nadeem_Walayat
9.Britain's FAKE Coronavirus Death Statistics Exposed - Nadeem_Walayat
10.Commodity Markets Crash Catastrophe Charts - Rambus_Chartology
Last 7 days
Silver Bull Market Update - 7th Aug 20
This Inflation-Adjusted Silver Chart Tells An Interesting Story - 7th Aug 20
The Great American Housing Boom Has Begun - 7th Aug 20
NATURAL GAS BEGINS UPSIDE BREAKOUT MOVE - 7th Aug 20
Know About Lotteries With The Best Odds Of Winning - 7th Aug 20
Could Gold Price Reach $7,000 by 2030? - 6th Aug 20
Bananas for All! Keep Dancing… FOMC - 6th Aug 20
How to Do Bets During This Time - 6th Aug 20
How to develop your stock trading strategy - 6th Aug 20
Stock Investors What to do if Trump Bans TikTok - 5th Aug 20
Gold Trifecta of Key Signals for Gold Mining Stocks - 5th Aug 20
ARE YOU LOVING YOUR SERVITUDE? - 5th Aug 20
Stock Market Uptrend Continues? - 4th Aug 20
The Dimensions of Covid-19: The Hong Kong Flu Redux - 4th Aug 20
High Yield Junk Bonds Are Hot Again -- Despite Warning Signs - 4th Aug 20
Gold Stocks Autumn Rally - 4th Aug 20
“Government Sachs” Is Worried About the Federal Reserve Note - 4th Aug 20
Gold Miners Still Pushing That Cart of Rocks Up Hill - 4th Aug 20
UK Government to Cancel Christmas - Crazy Covid Eid 2020! - 4th Aug 20
Covid-19 Exposes NHS Institutional Racism Against Black and Asian Staff and Patients - 4th Aug 20
How Sony Is Fueling the Computer Vision Boom - 3rd Aug 20
Computer Gaming System Rig Top Tips For 6 Years Future Proofing Build Spec - 3rd Aug 20
Cornwwall Bude Caravan Park Holidays 2020 - Look Inside Holiday Resort Caravan - 3rd Aug 20
UK Caravan Park Holidays 2020 Review - Hoseasons Cayton Bay North East England - 3rd Aug 20
Best Travel Bags for 2020 Summer Holidays , Back Sling packs, water proof, money belt and tactical - 3rd Aug 20
Precious Metals Warn Of Increased Volatility Ahead - 2nd Aug 20
The Key USDX Sign for Gold and Silver - 2nd Aug 20
Corona Crisis Will Have Lasting Impact on Gold Market - 2nd Aug 20
Gold & Silver: Two Pictures - 1st Aug 20
The Bullish Case for Stocks Isn't Over Yet - 1st Aug 20
Is Gold Price Action Warning Of Imminent Monetary Collapse - Part 2? - 1st Aug 20
Will America Accept the World's Worst Pandemic Response Government - 1st Aug 20
Stock Market Technical Patterns, Future Expectations and More – Part II - 1st Aug 20
Trump White House Accelerating Toward a US Dollar Crisis - 31st Jul 20
Why US Commercial Real Estate is Set to Get Slammed - 31st Jul 20
Gold Price Blows Through Upside Resistance - The Chase Is On - 31st Jul 20
Is Crude Oil Price Setting Up for a Waterfall Decline? - 31st Jul 20
Stock Market Technical Patterns, Future Expectations and More - 30th Jul 20
Why Big Money Is Already Pouring Into Edge Computing Tech Stocks - 30th Jul 20
Economic and Geopolitical Worries Fuel Gold’s Rally - 30th Jul 20
How to Finance an Investment Property - 30th Jul 20
I Hate Banks - Including Goldman Sachs - 29th Jul 20
NASDAQ Stock Market Double Top & Price Channels Suggest Pending Price Correction - 29th Jul 20
Silver Price Surge Leaves Naysayers in the Dust - 29th Jul 20
UK Supermarket Covid-19 Shop - Few Masks, Lack of Social Distancing (Tesco) - 29th Jul 20
Budgie Clipped Wings, How Long Before it Can Fly Again? - 29th Jul 20
How To Take Advantage Of Tesla's 400% Stock Surge - 29th Jul 20
Gold Makes Record High and Targets $6,000 in New Bull Cycle - 28th Jul 20
Gold Strong Signal For A Secular Bull Market - 28th Jul 20
Anatomy of a Gold and Silver Precious Metals Bull Market - 28th Jul 20
Shopify Is Seizing an $80 Billion Pot of Gold - 28th Jul 20
Stock Market Minor Correction Underway - 28th Jul 20
Why College Is Never Coming Back - 27th Jul 20
Stocks Disconnect from Economy, Gold Responds - 27th Jul 20
Silver Begins Big Upside Rally Attempt - 27th Jul 20
The Gold and Silver Markets Have Changed… What About You? - 27th Jul 20
Google, Apple And Amazon Are Leading A $30 Trillion Assault On Wall Street - 27th Jul 20
This Stock Market Indicator Reaches "Lowest Level in Nearly 20 Years" - 26th Jul 20
New Wave of Economic Stimulus Lifts Gold Price - 26th Jul 20
Stock Market Slow Grind Higher Above the Early June Stock Highs - 26th Jul 20
How High Will Silver Go? - 25th Jul 20
If You Own Gold, Look Out Below - 25th Jul 20
Crude Oil and Energy Sets Up Near Major Resistance – Breakdown Pending - 25th Jul 20
FREE Access to Premium Market Forecasts by Elliott Wave International - 25th Jul 20
The Promise of Silver as August Approaches: Accumulation and Conversation - 25th Jul 20
The Silver Bull Gateway is at Hand - 24th Jul 20
The Prospects of S&P 500 Above the Early June Highs - 24th Jul 20
How Silver Could Surpass Its All-Time High - 24th Jul 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Stock Risks to Watch: Choose Your Bear Market Dashboard

Stock-Markets / Stock Markets 2018 Jan 23, 2018 - 03:27 PM GMT

By: F_F_Wiley

Stock-Markets

“Ya gadda have a praaacess”– British portfolio managers mimicking their American colleagues

When long ago a former employer sent me to London to join the other Americans, or mostly Americans, building out its U.K. office, my job was to create a process. In institutional asset management, process was the American way. For sales presentations and especially dealing with investment consultants, you needed process charts that showed information flowing this way and that and, ultimately, morphing through its travels on the page into repeatable investment decisions. Those charts proved your legitimacy as an institutional manager—regardless of whether they described your actual decision making, they let the community know that you weren’t just a “bunch of gunslingers.” Essentially, you couldn’t build a business without your process charts.


But British consultants were different. They didn’t care so much about your process as they wanted you to knock them over with flair. They wanted imagination, story-telling, charisma. The process charts in your pitchbook didn’t matter as much as the command in your voice. In London, gunslinging was nothing to be ashamed of, as long as you slung with style.

So it all came down to process versusflair. Along with baseball caps and mismatched accents, the clash of cultures depended on which of the two qualities was deemed most important. And along with the accents, in particular, the contrasting approaches explained mimicry performed by amused Brits when the conference room door was comfortably shut or when the pub was crowded enough that voices didn’t carry. Ya gadda have a praaacess.

So today, I give you what else but a few pieces of process. Not a complete one, not even close, but I’ll share two dashboards that compare current stock market conditions to the conditions that shaped past market cycles. The dashboards can support your portfolio decisions, in my opinion, regardless of whether you’re a process Kool-Aid drinking septic or a flair fancying Anglophile. (For the same approach applied to the economy, see “Here’s a Strong Signal from the Economic Dashboard.”)

VCURVE, Redux

I’ll start with an indicator that combines monetary policy and inflation risks. By wrapping the two risks into a single indicator, I can approximate where the Fed stands versus the curve, as in whether policy is ahead of the curve, behind the curve, or somewhere in between. Here’s the calculation:

  1. From the current fed funds rate, subtract the lowest rate since the last market correction.
  2. Add the change in inflation over the past twelve months

The “VCURVE” indicator is highest when the Fed tightens aggressively but inflation is rising, suggesting policy makers are behind the curve. But the indicator can still flash a warning when just one of the two major risks—policy risk and inflation risk—is elevated. As discussed in my last article, VCURVE spiked upward before or during all S&P 500 (SPY) corrections over the last sixty-four years, although with a growing number of head fakes once Alan Greenspan introduced the Fed put. Here’s a chart I included in the earlier article, which shows all instances of the S&P 500 correcting by more than 10% and for longer than one month:

As you can see, VCURVE correlates strongly with stock price cycles from the mid-1950s to the 1987 market crash, and then less strongly but still significantly over the last three decades. This article covers the last three decades, when VCURVE began serving more head fakes. After Greenspan’s aggressive 1987 crash response and then reinforced by occasional plunge protection thereafter, stocks have often powered through policy and inflation risks, continuing upward despite rate hikes and CPI volatility. In fact, my dashboards will show that bull markets have persisted until something breaks, each dashboard showing a different type of breakage.

The Pre-Recession Plunge

We’ll look at the first “breakage” example in Dashboard 1, where I compare today’s fundamentals to the fundamentals that sunk stock prices during three episodes of credit market and real economy turmoil. The economy fell into recession in each episode, following a pattern that’s as old as bank loans. First, one or more economic sectors ran into difficulties that led to a jump in loan delinquencies or bond defaults or both. Those delinquencies and defaults may have seemed contained at first, but they soon impaired bank balance sheets and depressed credit conditions. Business earnings weakened alongside or shortly after the deterioration in credit conditions, and, if housing was among the leading sectors as it often is, real house prices fell.

We’ve seen three such “pre-recession plunges” during the last thirty years—namely, the corrections or bear markets of 1990, 2000–2 and 2007–9. Here’s the dashboard comparing the three plunges to present conditions:

While the data shown in Dashboard 1 is imperfect (for example, mortgage delinquency data doesn’t fully capture housing finance insolvencies in 2007, which were concentrated in the structured credit space), I’m comfortable with four observations:

  1. The latest VCURVE reading of 1.4% remains below the readings that tend to predict bear markets. (See here for historical thresholds.) So VCURVE isn’t predicting a market top just yet, but it does bear watching as the Fed continues to raise rates.
  2. Delinquency and default rates are nonthreatening in the sectors most likely to affect stock prices, notwithstanding a recent wave of energy company defaults, which is fading as oil prices rise.
  3. Credit conditions look nothing like they did in mid-1990, mid-2000 and late 2007. Spreads for BBB bonds are within twenty basis points of their lows for the millennium, and bank lending standards are mostly benign.
  4. Neither S&P 500 earnings nor house prices show signs of an imminent recession.

All things considered, a pre-recession plunge seems unlikely in early 2018, but stay tuned— the fundamentals depicted in Dashboard 1 will certainly change during the year.

The Credit-Contagion Contraction

Removing the three plunges from the six S&P 500 corrections of the last three decades, there are three corrections left. You might recall that the correction in summer 1998 followed Russia’s bond default and the hedge fund Long-Term Capital Management’s near-collapse and bailout. In that instance, the credit market clearly led the equity market, as in the three plunges discussed above.

The other corrections began in April 2010 and April 2011, respectively. In each case, stock prices dropped before anticipated pauses in the Fed’s QE programs, suggesting the bull market may not have been established enough to survive without central banker support. But the 2010 correction also included a flash crash, while the 2011 correction included Standard & Poor’s downgrade of U.S. federal government debt from AAA to AA+. And just as importantly, both corrections breached 10% thresholds near critical points in the Greek debt crisis—EU leaders approved the first Greek bailout in May 2010 and then agreed a second bailout, although subject to austerity measures, in June 2011.

So, with the 1998, 2010 and 2011 corrections overlapping breakage in the world’s debt markets, I’ll include them in a second dashboard that considers credit contagion:

Unfortunately, Dashboard 2’s predictive power is limited, for two reasons. First, credit events sometimes arise without much advance widening of the spreads depicted on the chart. Second, the chart only includes sources of contagion that were most obvious in 1998, 2010 and 2011. If the next market-rattling credit event occurs suddenly in, say, the U.S. municipal bond market, Dashboard 2 won’t be especially helpful.

All that said, it’s notable that spreads in many markets—Portugal, Greece, and many issuers in the emerging market debt indices—fell to post-2010 lows in recent weeks. Credit risks may be building as governments and businesses continue to add debt, but they appear less immediate than before any of the 1998, 2010 and 2011 credit-contagion contractions.

Conclusions

The above dashboards are useful, in my opinion, for checking current conditions against past markets. As of today, they help demonstrate a “virtuous” loop of mutually reinforcing strength in risky assets and the global economy. I recently predicted, looking as far ahead as I think is reasonable, that the loop will keep the economy humming until at least mid-year and will probably support the bull market in stocks through the first quarter.

But my outlook carries risks, as usual. Stocks are clearly overbought, and they might have priced in greater benefits from the GOP’s tax cuts than businesses will actually realize. (See, for example, this analysis by Morgan Stanley and ZeroHedge.) If present trends continue, the rise in government bond yields might also weigh on stock prices, as happened before the market tops in 1990, 2000, 2010 and 2011. And perhaps most importantly, we’ve yet to hear Jerome Powell field a question about stock prices as FOMC chairman. If investors detect any hint that there won’t be such a thing as a Powell put (see here for discussion), stocks would be more vulnerable than the above dashboards imply. In that scenario and certain others, we might learn in hindsight that you would have needed to use your imagination to predict the next bear market. After all, you can’t just rely on process—you might also like to show some flair.

(Thank you for reading. For more background on the economic thinking behind our research, see my book Economic for Independent Thinkers.)

F.F. Wiley

http://ffwiley.com

F.F. Wiley is a professional name for an experienced asset manager whose work has been included in the CFA program and featured in academic journals and other industry publications.  He has advised and managed money for large institutions, sovereigns, wealthy individuals and financial advisors.

© 2018 Copyright F.F. Wiley - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules