Market Fundamentals: Only the Brain Damaged Survive

• Posted by DynamicHedge
• on September 7th, 2012

How did we get here?  More importantly how could anyone stay bullish amid the bearish hype permeating through various media outlets?  I’ve argued for a long time that we’re in a choppy bull market and the upside must be respected.  Back in June, I wrote a post about top-down macro fundamentals.  I advised readers as to the correct manner to read government agency or academic data: squint to the point where only vague shapes and colors are recognizable.  Sophisticated investors call this “trend analysis”.  Amateur traders second guess every data point and chop their way to ruin.

I joke about making the process easy enough for someone with “brain damage” to follow, but the point is to keep it SIMPLE.  I want to empower people who are intimidated by this stuff to get over it.  Macro trends mostly move  at a glacial pace and often the the only answerable question is “are getting better or worse as a whole.”  It might be hard to believe but only 1 in 1000 traders and investors will follow these indicators faithfully, so if you do, you’re setting yourself up to be better than average.  Adding a solid technical interpretation of the market will put you at an even bigger advantage to your competition.

Guess what?  The economy isn’t great, but things are improving if you look at the data objectively .  Let’s see how the analysis of the market worked.

Employment Situation

The Employment Situation report, or Nonfarm Payrolls as it’s more commonly known, is the single most important economic report — bar none.  It’s ability to move markets is undisputed…You also have my full permission to look at only the headline number and the year-over-year change.

I can make out a bit of a trend.  Forget the report that just came out, this post is about how we got to these highs.

How about the secondary measure of Jobless Claims (below)?

Noisy data?  Squint.  Trend is from the lower left to the upper right.  Note: chart has been inverted for clarity i.e. upward slope means employment is improving.

Building Permits

Construction is a big part of the US economy and it’s also very capital intensive.  How people feel about the future can be expressed in how many of them are willing to go out there and take a risk with capital.  Home prices and construction affects the consumer sectors of the economy in a major way.

I see a trend here as well.  Lower left to upper right.  Forget the numbers, the trend is moving in the right direction.

Consumer Sentiment

Low readings are thought to mean contraction and deflation.  Bullish readings indicate that people might be getting a little too hopped up and we’re in for some inflation.  I look at this indicator as a long-term contrary indicator on sentiment towards the stock market.  Low readings indicate the wall of worry is in tact.  High readings mean that the public is all in and drinking the kool-aid.  This means that if the market is rallying from a point of depressed sentiment, it probably has a long way to go before it stops.

Bottom line is that we were rallying off a point of depressed sentiment.  There was nowhere to go but up if the market decided to move.  For reference, I consider 90 to be a higher reading, 70 to be lower, 100 is roaring, 60 is full depression.

Leading Indicators

You don’t need to know much about it or how it works except that it has a very good track record.  There have been only a couple notable false positives on recession calls since inception.  One of them occurred very recently and subjected the ECRI to some unwarranted criticism.  One thing that can be said is that the leading indicator data is much more noisy today than in the past.  Previously, anytime growth dipped to the -5% level it was cause for alarm.

The WLEI stayed above the sacred -5% level for nearly all of 2012 and the trend has been up.  Don’t make it any more complicated than that.

Wild Card

Call this the indicator du jour.  Cost of energy becoming a big deal?  Pull up petroleum inventories and oil prices.  Fed targeting GDP?  Watch GDP.  Fed hawks worried about inflation?  Get glued to the CPI report.  Fed doves looking for a reason to pull the trigger?  Deflating CPI is a good excuse.

I was watching Italian yields.  Italy was the richest country in the Euro zone with funding concerns.  Spain has additional structural problems, so I keyed in on Italy.  This is not as easy to interpret but yields were on the whole, moving lower (even before the Draghi announcement).  Lower yields mean demand for debt which is the primary funding mechanism of the government.

 

Final Tally

I count that 4 out of 5 indicators were moving obviously and deliberately in the correct direction.  Yields were a mixed bag, but you may not have chosen yields as your wildcard so I will omit it.  Anywhere on earth 4 out of 5 ain’t bad.  Certainly good enough to keep me bullish.

See the original post for detailed description and links to source material:

Fundamental Top-Down Macro for the Brain Damaged

 

 

 

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