FINANCIAL CRASH TRACKING: PROTECT YOUR WEALTH AND INVESTMENTS FROM SECULAR DOWNTURNS

For the most part, as long term investors, we are invested in globally diversified funds and riding the 'market drift' up over the long term. So for the most part the equities market trends up. But even in up-trending markets, every single year there will be what is known as 'expected volatility' in equities.

An average year for the SP500 sees: -

• More that 7 separate 3% dips

• More than 3 separate 5% corrections

• A 10% correction, once a year

• A bear market (> 20% correction) every 3.5 years

Regardless of this volatility, most people's standard pensions will be invested in global equities and over the longer term this asset class will yield about 7% to 9% per year.  

EXPECTED VOLATILITY

Elsewhere in this blog I have explained how, as investors, we should not be overly interested in 'expected volatility' in markets over the shorter term. So this is the handful of 2% to 6% pullbacks we will see every single year along with the one or two 8% to 15% every year to 2 years. And then we have the 'corrections' of about 20% say once every 2 or 3 years. You get the picture. These can be ignored without too much damage being done to long term portfolio's, but of course, the rubber hits the road when that nasty 20% correction keeps on going and morphs into the 40/50/60% correction (or worse!)

The chart below is the actual number of average declines on the SP500 from 1928 to 2023 per percentage pullback...

The only real concern we then have is protecting our portfolios against the the big downturns and market crashes like the dotcom crash in 2000 and the Great Financial Crisis (GFC) in 2008.

The Global Stock Market "Big Picture"

For a deep dive into the Big Picture (long term) Technical and Fundamental Analysis that we are looking out for to warn us that US and global stark markets, and therefore our retirement funds, might be heading into a period of stagnation or decline.... <<< CLICK HERE >>>

When Bear turns to Bull ...

Our "Financial Crash Tracking" page is an attempt to detect the signs of an upcoming downturn or secular (longer term) pullback in markets. But it's not just about looking for then if we are in a downturn, we are looking for when a potential bottom and upturn has been established. This helps to inform portfolio allocation to equities and bonds in a long term investment portfolio. For example in the GFC 2008, bonds, and in particular, government bonds were the only asset class that did not crash.

I send out a summary each month in the BBI newsletter for subscribers. subscribe on the homepage or on the bottom of this page if you are interested.

There are 3 'Cofactors' needed for a crash or downturn in the stock market. This is what we are assessing below to gauge the degree to which we are seeing a 'secular' bear market materialise: -

1. Technical Analysis which points to a change of trend from bull to bear, boom to bust (and then vice versa)

2. A systemic level crash narrative or trigger.

3. Major indicators that precede a crash

In theory, we can forego the tracking of Cofactor 2 and 3 as long as we deem Cofactor 1 not to be displaying big enough warning signs.

COFACTOR 1) Technical Analysis which points to a change of trend

There are a number of charts over the long, medium, and short term that will inform us if a meaningful change of trend is happening and this is the first level of analysis that we need to see to know if something is starting to head in the wrong direction in a meaningful way. 

• The 'secular' big picture: Monthly and/or quarterly charts.

• The big/medium picture: Weekly charts.

• The little picture: Daily charts.

In these charts I use the same moving averages and momentum indicators to tell me where price action is likely heading. In a sense the same concept that can be used in short term 'trading' (as opposed to our use case of long term investing) is used whereby we use the lower time frames (weekly and daily) as trend change signallers and confirmation to initiate mitigation at the high time frames... the big picture.

The daily chart is our initial warning sign which alerts us to the handful of 2% to 5% pullbacks and these often sort themselves out with buyers stepping in and then a resumption of the secular trend, so we ignore for the most part, but nonetheless, every crash will begin with one of these smaller pullbacks so we still want to know about it.

The weekly chart is our sweet spot that we can choose to begin mitigation of the larger pullbacks that lead to corrections and crashes. 

Risk On vs Risk Off is Portrayed Through "Leadership"

NASDAQ vs SP500: -

Risker asset classes/indexes such as the NASDAQ can be compared to the broad market SP500 to gauge is the riskier index is 'leading' the less risky index. If that is the case then a risk on environment for stocks should see them drift higher in that risk-on landscape. The AVWAP line tieds to significant highs and lows is in the chart below shows the risk on outperformance of the riskier NASDAQ compared to the SP500. When the comparison proce action trades above the AVWAP lines then risk off is prevailing and stocks are likely to do well. And, vide versa when prive is below the AVWAP...

High Yield Bonds vs SP500: -

High Yield Bonds are known to be a decent leading indicator for the general direction of stocks. Note, you could do the same as above an create a comparison chart but also you can just stack the charts one on top of the other and you can see the decline the HY bonds along with the decline in stocks...

HYG (The main high yield bonds ETF) can show divergences ahead of price trend changes in the SP500 as show by the blue lines on the chart below...

Stocks vs Bonds: -

This one's a pretty good indicator for turns in the markets seen at recessions and market crashes as can be seen  on the chart in the link below.  switch to the 50 year view and you will see the 1987, 2000, 2008 peaks in stocks leadership switching to bonds. When we see this happening om this secular long term time frame, then it's a decent trigger to start deallocating equities...

• STOCKS vs BONDS

(Stocks = S&P 500 : Bonds = Total Return Bond Index)

COFACTOR 2) A systemic level crash narrative or trigger

I have discussed elsewhere in this blog about the fallout from the GFC 2008 and how the consequent globally co-ordinated central banking ZIRP (Zero Interest Rate Policy) has blown up the Everything bubble in all (or most) asset classes. So, there is no doubt in my mind that as at the time or writing (NOV 2024), the market is setup for a fall at some stage in teh not too distant future. We are 'late cycle' in the current economic cycle.

The graph below shows the trigger/narrative for each of the last 3 big artificially created market crashes. The Covid crash was a very unusual natural disaster so we can put that to one side. The 3 artificial triggers leading to the last 3 major recessions were talked about long before the recession actually occurred.

The current trigger narrative is kind of an amalgamation of all 3 previous triggers. We have a frankly delusional AI tech bubble, we have yet another housing bubble that has been blown up by the aforementioned ZIRP, and we have the potential for major escalation of two global wars.

So, as far as the trigger narrative goes for the bursting of this current bubble, we must simply observe which of these start to gain momentum. We could have 2 or more gaining momentum at the same time and god forbid... all 3. Nobody wants to see that, but it's also not beyond the boundaries of possibility...

Cofactor 1A: Where are we in Stocks and Economic Cycle

There is an important side note to the first Cofactor (although its actually a lot more than a side note), and that is... knowing where we are in overall stock/economic cycle. The real situation we are attempting to mitigate here is the 1929/2008 (Great Depression/Great Financial Crisis) scenario. Along the way there is always volatility. A 1987 style rapid crash with a few weeks of breath-catching, and then a slow but steady resumption to the default upwards market drift isn't a big deal, in the grand scheme of things, even though it may seem like it at the time.

'Buy & Hold' investors (i.e. 99% of investors) can get away with the 1987's without lifting a finger, but another 1929, 2000 (Dot Com), or 2008 (GFC)  is a different matter. All we are interested in is the emergence of the next 1929, 2000, or 2008.

These larger crashes happen in boom-bust cycles. This cyclical pattern is shown below in it's recognised stages. So what we are concerned with here is identifying when we are in the "stage 3 topping pattern" seen before a larger bear market downturn (stage 4)...

The stock market cycle is 6 months to a year ahead of the economic cycle. So by the time the economic cycle peaks, the stock market will be 6 months to a year into a downturn. This isn't something to track too closely, it's just something to keep an eye on to gauge the signs that we are nearing a top/peak in markets... 

So for example, when you see the Energy and Precious Metals sectors doing better than other sector, it's a big clue that we are at or approaching the topping phase of the stock market (as shown above).

As we speak in 2024 we are seeing Energy and Precious Metals among the leading trending sectors. Healthcare has also been in favour. Another tick in the box. We have seen (or are still going through) the 'Greed', 'Delusional New Paradigm' stages.. "AI AI AI". 

DEMAND SIGNALS FOR RECESSION AHEAD

The US Manufacturing PMI is a very important metric to track. As see below the bear market in 2022 was predicted by the divergence and decline of the PMU about 6 to 9 months before the downturn… i.e. The stock market will start doing badly about 6 to 9 month lag after the economy (PMI) starts doing badly...
(but the 2nd chart below shows long term HODL is still valid)

COFACTOR 2. MARKET DRIVERS AND INDICATORS That Precede a Crash

In order of what drives global financial markets, and indicators/indexes that reveal market health and direction, the following are the mainstay. To tick cofactor 2 off to support cofactor 1 we would expect to see a deterioration in the main factors, indicators, and indexes that drive market direction. 

Central Bank Liquidity

As long as the central banks are injecting liquidity and money into the system, our global funds are likely to go up. In the chart below from MacroMicro it's the red line that is most sensitive to the inflows and outflows into the M2 Money Supply. 

Note... on a longer term view, you can see why we have seen the markets rise since 2008 with the huge increase in the nominal M2 supply- the light yellow shaded bars on the chart. Markets have been essentially artificially inflated since 2008.

To see the main Money Supply graph that drives the US stock market and hence our standard globally diversified stock funds this link shows the Federal Reserve M2 supply. If it is trending up then it's generally bullish for stocks and vice versa.

Cross reference the above with the Global Liquidity Index as provided in this Trading View community chart...

Money Printing

Central bank balance sheets show how much money they have printed whereas the velocity of money shows how fast money is being recycled through an economy which will slow in a recessionary environment

https://tradingeconomics.com/united-states/central-bank-balance-sheet

https://tradingeconomics.com/united-states/velocity-of-m2-ratio-q-sa-fed-data.html

https://fred.stlouisfed.org/series/M2V

https://tradingeconomics.com/united-kingdom/central-bank-balance-sheet

Have The Central Banks Got Their Foot on The Brakes or Accelerator?  

The globally co-ordinated, post-Covid, central bank money printing and liquidity flooding the financial markets is now being withdrawn. How big is the hangover going to be? Whilst the big tech utilities (the so called 'FANG' stocks or the "Magnificent 7") have risen to prominence in a post-Covid world as things have moved more and more online, to what extent has this has been artificially fuelled by central banks?

The Quantitative Easing (QE) and Quantitative Tightening (QT) graphs below show the historical relationship for stock and bonds when the Federal Reserve QE/QT regimes were in play. As you can see, stocks are boosted significantly by QE whilst bonds suffer under QE and then vice versa with QT...

Credit Crunch Risk - Tightening Credit Conditions?

BANK TIGHTENING

One of the warning signs of trouble ahead is when banks begin turning off their credit taps through fear of adding poorly performing loans to their loan book. They 'tightening financial conditions'.

As can be seen in the image below, there is a good correlation between tightening financial conditions and the grey shaded areas which are major recessions. Is the current level comparable to the 2000 DotCom crash or the 2008 GFC? ( Click the image below to see the latest version of this chart on the Federal Reserve website...)

The same chart on Trading Economics Net Percentage of Domestic Banks Tightening Standards for Commercial and Industrial Loans to Small Firms can be switched to the 25 year view to see the spikes coincide with the previous 2 crashes. Switch to the forecast tab to see the projected trend.

BANK TIGHTENING MEANS LESS BANK LOANS

When the banks tighten lending (blue line below spiking up), the number of loans (the redline below) starts to decline and this leads to recession (the grey shaded area below). As you can see, there is a strong correlation...

Another one from the brilliant Fed website below shows another strong correlation with the major 2000/2008 downturns. Demand for loans? ....

• Net Percentage of Domestic Banks Reporting Stronger Demand for Commercial and Industrial Loans from Large and Middle-Market Firms

Credit Crunch Risk & Credit Spreads

The Chicago Fed’s National Financial Conditions Index (NFCI) releases a weekly update on U.S. financial conditions in money markets, debt and equity markets and the traditional “shadow” banking systems. As you can see from the Great Financial Crisis of 2008 (and to a lesser extent the 2000 crash) there should be a clear rise into the positive side of the graph if we are to see something similar happening now or in the future. (The same Trading Economics chart is also given below as the Chicago Fed chart doesn't always display properly)

• CHICACO FED NFCI RELEASE

• Trading Economics NFCI

Our friends over at Isabelnet.com are still cranking out loads of up to date charts to help us visualise various financial conditions relative to the economy... 

• Financial Conditions

ARE HIGH YIELD CORPORATE DEBT SPREADS SIGNALLING PANIC?

If High Yield Corporate debt costs (spreads) spike, it is a sign of panic in the debt markets and potentially systemic default risk of some form. The two links below for the US and European debt markets show these spikes for the Dot Com crash at the start of the century and the Great Financial Crisis of 2008 when you switch to the 'Max' timeline view.

• US Debt Spread Chart

• European Debt Spread Chart

The Bank of America High Yield Spreads chart below highlights the rise from low levels that preceeded the start of the DotCom crash, the GFC 2007 crash, the equities downturns of 2015/16/18 and the 2022 inflation inspired downturn. A future downturn would see a similar pattern emerging from a low position to an elevated one... 

BONDS TO CASH SPREAD INDICATOR

Another indicator to add to our arsenal is the spread between BBB rated bonds and what is essentially cash. This is only the 6th time in stock market history this level has been reached. (See the lower red circles on the graph below). Like the recent yield curve inversion, this indicator has exceeded than what was seen in 2007 before the Great Financial Crisis...

BOND DEFAULT RATES - A RECESSION/BEAR MARKET INDICATOR

The New York fed recent launched the Corporate Bond Market Distress Index (CMDI) to provide a quantified measure of the health of the corporate bond market. This article provides a further explanation but you can switch the link below to the 'Overview' tab also to get an explanation.

• Corporate Bond Market Distress Index (CMDI)

Are Bankruptcies on The Rise?

Credit crunches lead to bankruptcies. US corporate bankruptcies are up 43% from 2019.

• UK BANKRUPTCIES

• US BANKRUPTCIES

As can be seen below, the delinquency rate rises (the red line) before the Dot-Com and GFC recessions (grey areas) are accompanied by tightening financial conditions (the blue line)... (Click on the image to see the latest delinquency chart)

In order to back up the chart rise in delinquencies (red line) leading to recessions, we are looking for a rise in unemployment claims leading into a recession... (Click on the image to see the latest chart)

Bankruptcy Filings in the US surged to extreme levels in 2023. These levels were similar to those seen at the GFC in 2008 and the 2020 Covid Pandemic...

YIELDS & Yield Curve Inversion

• Since 1950, all major US recessions (and there have been 9 of them) were preceded by an inversion of a specific segment of the ‘yield curve’. Click here to see the evidence for this in black and white.

• An inversion of the spread between 2 year and 10 year Treasury bonds happens when two year Treasury's yield more than their 10 year counterparts.

• It can take up to 34 months for the recession to hit after the inversion. (This Business Insider link (opens new tab) explains this in more detail.)

• See our dedicated Yield Curve Inversion page.

• VERDICT as of NOV 2024: BEARISH

Earnings Down? Recession Indicators Up?

A decline in company earnings is another closely monitored metric associated with downturns and crashes. If earnings start to disappoint across the board then we have a slowing economy and are likely to see job losses. It's those job losses that lead to recessions and declines in our global equity funds. Speaking of which, the Yardeni link below gives us a view of earning for global stocks so it better suited to you if you are invested in standard globally diversified stocks funds...

Factset US Earnings
Yardeni MSCI Global Earnings

Yardeni S&P 500 Earnings & Dividend Yields

Yardeni S&P 500 Earnings & The Economy

Yardeni S&P 500 Earnings Forecast/Outlook

SP500 Earnings Per Share: The US S&P500 is the largest stock market in the world and therefore takes up a significant proportion of most global funds. If earnings of these companies start to decline on a secular basis (see the chart/image below) it can spell bad news for the SP500 and therefore our global funds. So we need to keep an eye on 'trailing' and 'forward' Earnings Per Share for the SP500 and when earnings revisions go negative.

The US S&P500 earnings per share, forward and actual on the Yardeni chart below show the clear downturn in these metrics before the 2001 DotCom crash and 2008 GFC crash. The actual earnings are more sensitive to a downturn so that seems to be the one to watch. As of time of writing in 2024 both are on an upward trajectory.

CAN FORWARD EARNINGS GROWTH ESTIMATES BE TRUSTED?

A word of caution in SP500 forward estimates... they have a reputation of being overly optimistic: - 

• SP500 EPS Forward Estimate (Ycharts)

What can't be massaged to influence investors is ACTUAL SP500 earnings. The trend in earnings turning down is a warning sign that stocks could run into headwinds in the near to medium term. 

• SP500 EPS ACTUAL (Ycharts)

The medium trend will inform us where we may be heading over the next six months to a year. The longer term trend (quarterly) may give us a better idea if we are heading into a deeper drawdown. (See the DotCom bust earnings crash (2000) and GFC downturn (2008) below. 

• SP500 Earnings Growth Per Quarter (Multpl)

Are Corporate Earnings Heading Down?

In the previous 2 financial busts, corporate earnings started trending down way before the recessions were declared. At the time or writing in 2024 corporate earnings are heading up pointing away from recession you could argue. But. there is always a lag between changes in monetary policy and the economy. If those corporate earning start trending down it would be another tick for the case for the next crash...

The Conference Board Leading Indicators Index

The "Conference Board Leading Economic Index Annual Percentage Change" US chart below, pulls together a bunch of the best 'leading' indicators to give stronger overall leading indicator for the direction of the economy (and therefore the stock market).

• See our dedicated Leading Indicators page "Conference Board" section.

• VERDICT as of NOV 2024: SHORT TERM => BULLISH. MEDIUM/LONG TERM => BEARISH

Jobs & Unemployment  – A Recession/Bear Market Indicator

Below are recession indicators from the Federal Reserve in the US that incorporate measures of employment. These indicators have been very accurate in the past. (The grey areas on the graphs are recessions). The smoothed US recession probability indicator blends 4 datasets into one index: non-farm payroll employment, the index of industrial production, real personal income excluding transfer payments, and real manufacturing and trade sales.“

• REAL-TIME SAHM RULE RECESSION INDICATOR

• SMOOTHED U.S. RECESSION PROBABILITIES

• See our dedicated Unemployment page.

Other Recession & Leading Indicators 

Isabel.net makes some great analysis publicly available and is well worth checking out.

• LATEST ISABEL RECESSION INDICATOR NEWS

• ISABEL LEADING INDICATORS

The MacroMicro global macro dashboard uses it's own Global recession indicator. Check out the global recession indicator chart which has gotten its calls or recession correct in the past.

The GDP based recession indicator below from the good old Federal Reserve claims to be an improvement as compared to the NBER Index which it claims is based on subjective assessment of indicators and is heavily lagged. As opposed the this GDP based indictor (link below) which uses the previous GDP quarter and is not revised up or down. It looks to be a pretty accurate indicator so definitely one to keep an eye on...

• FED GDP RECESSION INICATOR

Global Recession Probability Indicator Marks Global Stock Market Lows 

As can be seen by the often quoted NDRG Recession Probability Indicator below, it peaks around 90% either at or near to market lows ...

• U.S. Heavy Trucks Sales and Recessions

Before previous recessions, heavy truck sales have peaked and then declined. Are we seeing that now?

Plunging heavy truck sales are another correlation with falling stocks. The Bureau of Economic Analysis released the data for heavyweight truck sales in 2022. It was not good and coincided with declining stock markets.

Heavyweight trucks move a large percentage of the dollar value of freight around. So, when a big-ticket expenditure that moves freight around the country contracts on a year-over-year basis, we should take note because it can foreshadow a slowdown in overall economic growth.

• Retail Trade Sales Demand & Consumer Confidence

• See our dedicated Retail Sales & Consumer Sentiment page.

VERDICT as of NOV 2024: SHORT TERM => BULLISH. MEDIUM/LONG TERM => BEARISH 

STOCK Market Breadth/VOLATILITY/FUND FLOWS

Stock Market Volatility (The US VIX)

When the VIX breaks north of 40 it's a sign that something is not right in the global financial system. The VIX usually oscillates between about 25 to 30 on the upper end and 10 to 15 at the lower end. These VIX lows often point to market pullbacks so we need to keep one eye on this chart.

If the VIX volatility index shoots up somewhere between 40 and 50 then see how on the longer timeframe chart below it marks major bottoms in the market. When the extreme high VIX reading starts to come back down is when the big opportunity of long term gains can be made by buying at extreme lows

The weekly VIX gives us a good indication of medium term market direction for the SP500. We track the trendlines on the VIX... VIX trending down = market trending up … and vice versa… 

Dow Theory – Recession/Bear Market Indicator

The Dow Jones Transportation Average (DJTA) is an average of the top 20 transportation stocks in the United States. The Dow Jones Transportation Average is closely watched to confirm the state of the U.S. economy. DJTA should confirm the trend of the Dow Jones Industrial Average (DJIA). If the DJIA is climbing while the DJTA is falling, it may mean economic weakness is ahead. (Goods are not being transported (DJTA) at the same rate at which they are being produced (DJIA), suggesting a decline in demand.) Analyst recommendations

Is DJT a sell (or neutral) whilst DJI is still a buy? 

High Yield Corporate Bonds - A Leading Indicator for The Stock Market

High Yield Corporate Bonds (aka 'Junk Bonds') tend to lead the wider stock markets... a decent leading indicator.

As can be seen in the image below, there is a perfect correlation between declines in High Yield bonds and declines in the stock market. The direction of travel of high yield bonds in a clue to the direction of travel for stocks.

'Bottom of The Market' Indicator - Long Term Market Breadth

Market Breadth is a measure of the percentage of stocks above their 50 day or 200 day moving average in any given index. The longer term view of this graph is a pretty decent indicator of bear market 'bottoms'.  The highs is market breadth are often achieved so this charts works better at predicting lows which are not so often seen

The red marks in the image below show longer term lows in market breadth. The red marks show a bounce off a low that has gone lower than about 20%, both during and after the Great Financial Crisis 2008. Each time this has happened the market rallied off those lows into secular bull markets...

The image above shows up to about the middle of 2022. The chart below is fully up to date and shows that in 2022 a similar bounce was observed. The 50 day chart is also confirming the longer 200 day trend at it currently stands (at the time of writing at 90 so the trend is currently up.

As our Global stocks funds/indexes/trackers are about 60% SP500 stocks. market breadth will match fairly closely with the SP500 breadth but it's still worth keeping an eye on something like the MSCI World Index 200 day breadth. At some point in there could be outperformance of the US or a reduction in the percentage of US stocks in the Index.

Isabelnet - Market Breadth

Percentage of Stocks above 50 DAY Average (Long Term Chart)

This weekly chart has shows major lows when the stock market has bottomed out. So I would be looking or a major dip as seen in the chart and then re-investing when the dip reverses...

The Bullish Percent Index

The Bullish Percent Index can provide short to medium term indication of price direction by measuring how many stocks in a market index are in bullish trends. BPSPX below shows this for the SP500.

NASDAQ 100 Bullish Percentage

The long term NASDAQ 100 BPI chart below highlights the green lows where sentiment changed from bearish to bullish at the low points of the 4 major downturns in the US stock market. The shift from extreme bearish at the low of a pullback or downturn is what we would be monitoring to call out a change of trend if we are at the bottom. 

The vertical lines on the long term chart below show The NASDAQ market breadth dropping below 20 and then heading back up to 30 as a good time to buy the NASDAQ at extreme lows in the bullish percent readings....

This can be married with looking for divergences in the RSI of the BP Index for the NASDAQ. Note: this can also be done for the BP chart of the SP500, but as the NASDAQ leads the SP500 when it come to risk on/off sentiment then the first port of call is the NASDAQ.

The blue diagonal lines pointing down on the RSI chart section below can be matched with blue diagonal lines pointing down on the $BPINFO chart section (the Tech sector BP Index) showing the potential incoming declines in tech (risk-on). The chart below is the daily chart and so will be susceptible to false divergences and so we would need to switch the chart to weekly to get our sweet spot to detect meaningful longer term trend changes to the downside or upside...

New Highs & Lows Index

As can be seen from the new highs/lows index chart for the SPX (NEWHISPX) below, the 2020 pandemic red bars can be clearly seen. Once we see a few red bars in a row growing in size its a pretty decent indication something is up and selling might be considered...

The 2 Best Market Breadth Momentum Indicators

The McClellan Volume Summation Index can also be used to measure Market Breadth momentum. This indicator is touted as suited to identifying major trend reversals due to the fact that the McClellan Volume Summation Index is the long-term version of the McClellan Volume Oscillator.

The Advance/Decline Indicator rises when advances exceed declines and falls when declines exceed advances. You need to compare the Advance/Decline Line wuth the performance of the actual index it is tracking. The Advance/Decline line should confirm an advance or a decline by heading up or down at the same time. So when it starts trending down is when we will be interested. 

Divergence in 'advance/decline line' (ADL) points to price action reversing in the direction of the ADL line.

The CNN Fear & Greed Index, the NASDAQ & CTA Machines - Short Term Outlook

CNN Money (the finance arm of CNN) developed a sentiment tool called the “fear and greed index” to gauge the situation in the stock market. The index uses a number of sub-indexes to indicate if market participants are fearful or greedy. The current value of the Fear/Greed indicator is if no interest to us in our quest to detect trend changes, so on the page CNN page below, switch it to the 'timeline' setting and see if there is fear based trend down in the chart. The medium term trend for the F&G index and how that relates to the SP500 over the past few years can be seen in the Macro Micro link...

• CNN: FEAR AND GREED Indicator

• Macro Micro: FEAR & GREED Indicator overlaid with S&P500 

The Bull to Bear ratio will decline when sentiment leaves the market and that is when selling in equity markets is seen...

• Bull to Bear ratio

• Bulls and Bears spread

CTA BUYING MACHINES

CTA buying machines are a current reality in todays equity markets. It's unclear it they are a real driver of price action or whether they are just really good at what they do... tracking the momentum to the upside and downside. I get the impression they really a big 'driver' of price.

The chart below (from Goldman Sachs) for global equities marks out the extreme positions coinciding with short/medium term market tops with good accuracy.

... and a more advanced chart marrying together CTA's with Risk Parity and Vol Control funds smooths out the signal giving a clearer picture (and correlation) with market tops and bottoms...

Global & US Stocks Fund Flows & Insider Selling

A leading indicator for stocks/equities prices is the flows into and out of equity funds. Global stocks saw record in-flows in 2021 in excess of $1 trillion… bigger than the total inflows of the last 20 years. Then in 2022 those funds exited equities in a huge sell-off.

It's not that easy to track equity flows. The links below are the best I have found so far. So, it's a trend in outflows that we are looking for here to detect downwards momentum in equities...

• ICI ETF fund flows
  (Click the 'Release' link on the page)

Isabelnet even have a graph to show us a summary of insider stocks selling, the peaks of which tend to coincide with smaller timeframe stock market sell offs....

• Isabelnet Insider Selling

The Chaikin Money Flow Index measures money flows into or out of a stock or index by calculating the difference between high, low, and closing prices over a given look-back period, typically about 20 days. This indicator acts as an oscillator as can be seen below... when the chart heads below zero, it has a remarkably high correlation with the short tern peaks which are followed by short term corrections.

In the chart below on the far right, we see the extreme divergence on the 2024 sentiment driven bull run fuelled by fundamentals such as the confirmation of expected Fed policy (interest rate cuts) and the subsequent FOMO. The Chaikin Money Flow Index was diverging and warning about declining money flows WEEKS before the April 2024 correction...

NASDAQ Risk-on Market Price Trends down After Rate Cuts?

Highlighted below are the two previous financial crashes 2001/2008 precipitated by Fed rate cuts. If we see the risk-on NASADQ market start to trend down as risk-on appetite starts to wane, it's a warning sign...

Global Contagion Risk?

The Great Financial Crisis of 2008 started in the US because of the contagion risk in mortgage backed securities sold into the global markets. One of the downsides of a more connected world is contagion risk. Where is the contagion risk today?

Real Estate (Commercial AND Residential)

The commercial real estate market globally is undergoing severe headwinds due to the post pandemic 'work from home' revolution. The Federal Reserve Bank in the US is paying down this risk but I suspect it is, or will be, worse than they are making it out to be. They are being hit  with a double whammy of lack of demand (work from home) and high interest rates.

High interest rates are also hitting the residential housing market. We are  only really just beginning this 'higher for longer' period of interest rates so it is logical to expect mortgage delinquencies to rise in the coming years. Since the GFC 2008 we have  had 15 years of zero interest rates which has inflated property prices. In 2022/23 we then saw the fastest rate hike in history to control inflation. Again, logically, assets priced at the historically low interest rates should re-price to the higher rates.

The above can be applied to most developed Western economies, but also to the biggest housing market of them all... China. The risk here is a potential Western and Eastern real estate contagion/sell off triggered by post pandemic inflation and interest rate changes.

Is China the New Global Contagion Risk?

The economic problems in China have been well documented over the past few years. Over the past year though they have been intensifying and appear to be building up to something bigger. Some analysts are pointing to a Chinese 'Lehman' moment where a systemically big enough company/bank/market will collapse and spark contagion in global markets and a sell off in the global equity funds that we are all invested in.

However, markets can remain irrational for long periods of time and herein lies the seeds of the possible opposite scenario to a global sell-off. China will probably not allow a total collapse of their economy and are likely to come to the rescue of their beleaguered property and local governments with almighty QE (money printing) programs. This is just kicking the can down the road, and China knows that, but it is still more likely to happen than not. 

If China does decide to kick the can down the road, the future debt problem will be worse, but it would provide a significant boost to global liquidity in the near term. That could provide the fuel for an additional leg higher for global stock markets. It could further inflate the frothy valuations currently evident among the mega-caps on Wall Street. 

So we are keeping a close eye on Chinese QE and will let you know if this starts to materialise.

There is also a chance the China actually chooses to go through the pain now and allow the collapse of the financially dysfunctional institutions in its midst and in so doing, steal a march on the US which will at some stage have to go through the same kind of pain.  

Finally... The Bad Times Never Last Forever

To end on a positive note, all of the market crashes since the Great Depression of 1929, in the biggest stock market in the world, the US 500 are listed below with their associated recession lengths. At some point within at most 3 years, they reach a bottom and investors start piling in again at bargain prices. So in a sense, stock market crashes are self correcting. The point is to try to maximise returns at the point of maximum pessimism as Warren Buffet would say, buy buying near the bottom for the longer term. That is when market crashes can become a very lucrative opportunity...