Inflation Pressures: All Clear
A composite indicator constructed from the trends in yields on the 10 year Treasury bond, gold and the CRB Index suggests that inflationary pressures should be a non-factor for the equity markets. The indicator is shown in figure 1, a weekly chart of the SP500. I last discussed this indicator and its significance in this recent article.
Figure 1 SP500/ weekly
This indicator is not meant to be an oscillator type of indicator that rises and falls with prices. However, since 2009 or rather in this era of central bank intervention, markets have been highly correlated leading to “risk on” and “risk off” periods. This indicator has done a good job of defining those “risk on” and “risk off” periods. With the indicator recently hitting extreme lows and having turned up, it appears that the markets have entered a “risk on” phase.
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A question that I am often asked is if I use these indicators in my own trading strategies. The answer for this inflation sensitive indicator is “absolutely yes”. The indicator finds its greatest utility when it is elevated to an extreme level. In other words, when inflation pressures are high, equity prices tend to under perform to a significant degree. The rest of the time finds that inflation pressures are not a headwind for equity prices.
Category: inflation
Great charts Guy. Now if I go back to the summer and fall of 2011, what is to suggest we won’t see a repeat (i.e., false positives when it comes to buying)? Prices really haven’t moved too much on the averages, and at that time, both sentiment and the inflation indicator gave a buy signal. What makes this past correction more like that of May 2012 and less like Sept/Oct 2011?
I find too strange the aggressive support behind SP500 today. It looks like it’s indeed not all about sentiment and there seems to be some players working to sustain the market. The outcome of all this: I have no idea.
Phil:
This is what I usually say about the use of historical backtesting and the use of trading models: “ARL Advisers, LLC methodology is a quantitative and data centric approach to its market analysis. While some may suggest that this is akin to driving while looking in the rear view mirror, we like to think that if you don’t learn from the past you cannot understand the present. Either way, we are fully aware of the pitfalls of trying to predict the market, but clearly there are best practices. Developing a quantitative strategy provides a framework and expectation on how to navigate a potentially hostile environment known as the markets. The use of quantitative models in our portfolios allows us to execute with discipline and conviction when others are lost in the noise of the market.”
On a side note, I read some research yesterday from Vanguard regarding the use of various tools to predict the markets 1 year and 10 years out. The study went back to 1926. They looked at earnings and the Fed model and other fundamental metrics. The best predictor was earnings and this could only explain movements 40% of the time; everything else failed miserably.
I emailed the individual who forwarded the article — another very noted “market timer” — and asked what do you think of their conclusions that nothing works and research like this puts TAA (tactical asset allocation) into question…his 5 word response: It is all market timing!
It’s interesting to note that the market found support at the 40 week moving average. It looks like we’ll indeed have a Christimas gift. I’m bullish.
Within the context of the sentiment picture, I would not disagree with a bullish approach….the only caveat is the lack of bears….the bearishness I see is not people being bearish but just moving out of the market…likely playable bounce
I agree: “playable” until the weekly gets rid of the oversold status, which is running out quickly.