We aim to consolidate our economic and financial market analysis into a single quantifiable bull/bear market indicator.
We modified one of our five component market risk indicators to reduce whipsaws. Instead of the Fed Funds Rate confirmed by ISM Services Business Activity, we have created a composite indicator comprising:
- the Fed Funds Rate;
- the Coincident Economic Activity Index from the Philadelphia Fed;
- the Chicago Fed National Financial Conditions Index; and
- the S&P 500 with 30-week Twiggs Smoothed Momentum.
Three out of four components are required to confirm a bear market.
Our first signal was the Coincident Economic Activity Index which crossed below 2.5% annual growth for the 12 months to July, warning that the economy is slowing.
Last week, the Fed announced a 50 basis point rate cut, adding a second bear signal.
However, the Chicago Fed National Financial Conditions Index below zero signals easy monetary conditions at a low -0.56.
30-Week Twiggs Smoothed Momentum also signals a healthy up-trend on the S&P 500 at 12.8%.
The signal, therefore, remains Risk-On.
Of our four remaining risk indicators, only one signals Risk-Off.
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.
Our second risk signal would only be triggered when the yield curve inversion ends.
Employment in cyclical industries—manufacturing, construction, transport, and warehousing—accounts for most of the jobs lost during a typical recession. Cyclical employment grew by 17,900 in August, with no sign of a recession on the horizon.
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.