We aim to consolidate our economic and financial market analysis into a single quantifiable bull/bear market indicator.
The above is a composite of five separate measures below.
Our first indicator is the only one that currently warns of an approaching bear market.
Yield curve/Continued Claims
The spread between the 10-year Treasury yield and the 3-month T-bill discount rate has been negative for 22 months. While that is a record time, it does not negate its reliability in predicting a recession within 12 months after the inversion ends.
Yield curve/S&P 500
The second yield curve indicator will only be triggered when the above yield-curve inversion ends.
Fed Funds Rate/Financial Conditions/Coincident/S&P 500
We modified our Fed Funds Rate/ISM Business Activity indicator to reduce whipsaws, replacing it with a composite indicator comprising:
- the Fed Funds Rate;
- the Chicago Fed National Financial Conditions Index;
- the Coincident Economic Activity Index from the Philadelphia Fed; and
- the S&P 500 with 30-week Twiggs Smoothed Momentum.
Three out of four components are required to confirm a bear market.
Last week, the Fed announced a 50 basis point rate cut, our first bear signal.
However, the Chicago Fed National Financial Conditions Index declined to a low –0.58 for the week ending September 20. Values above -0.4 warn of monetary tightening, while below -0.4 indicate easy monetary conditions.
The Coincident Economic Activity Index crossed below 2.5% annual growth for the 12 months to July (2.38%), warning that the economy is slowing. However, on September 25, the July figure was revised to 2.58%, with August rising to 2.72%.
30-Week Twiggs Smoothed Momentum also signals a healthy up-trend on the S&P 500 at 12.8%.
With only one bearish out of four, the composite indicator signals a bull market.
Cyclical Employment
Cyclical industries—manufacturing, construction, transport, and warehousing—account for most of the jobs lost during a typical recession. Cyclical employment grew by 17,900 in August, showing no sign of a recession on the horizon.
Heavy Truck Sales
Heavy truck sales are another reliable leading indicator of recessions. Seasonally adjusted sales of more than 42,000 units in August continue to signal a robust economy.
Conclusion
Four out of five risk indicators continue to signal a bull market.
Our strategy is to divide our investment portfolio into five equal-sized buckets of 20% each. For each indicator warning of a bear market, one bucket will be switched to alternative investments—such as A-grade bonds or gold.
At present, only the 10-year/3-month Treasury yield curve warns of a bear market, so we maintain 80% exposure to stocks.