One group of indicators that we follow quite closely are yield spreads.  They work as great risk indicators as well as  economic indicators. In the case of junk spreads they tend to lead rather than coincide or lag the overall economy.  One area where they really shine is at the darker end of the economy.  As you can see in the chart below junk spreads tend to lead the initial unemployment claims by anywhere from two-five months.  For the past four months junk spreads have been inching higher and higher as the economy has noticeably weakened.  What does this mean?  Well if the correlation holds up then we would expect initial claims to move higher.  This would go along well with most of the indicators that we are seeing such as the various manufacturing indexes pointing lower, with the exception of the Chicago PMI, as most indicators whether economic or market are pointing to a weaker economy. (Click on chart to enlarge)

Junk Spreads and Initial Unemployment Claims

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long US Treasuries and Gold.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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Remember the anti-drug commercials with the frying pan and the egg?  As of late it would appear as though investors have forgotten that you are supposed to say NO to drugs, especially during market hours.  In the chart below we have a rolling 21-Day Standard Deviation for the SP500 as well as the 50-Day moving average of that number.  On a one month basis we are at the second highest reading in over 10 years, second only to the crash of 2008.  Looking at the smoothed 50-day moving average we are actually at a new high. The close to close movement is running at an average of 2.34%. (Click on chart to enlarge)

SP500 Rolling 21-Day Standard Deviation

How can you use this information?  There are a few trading strategies you can investigate from this such as selling options or putting on some arbitrage positions betting the spreads will come back in.  For most investors however the more important thing to see here is that risk management is not only paramount to your investing/trading but it is a moving target.  As a general rule when volatility is high, or extremely high as the case may be, you would want to look at using relatively loose stops, scaling down your position sizes, lowering your leverage, raising cash, etc.  While most, maybe all, long time traders already use good risk management we have found that far to many new traders don’t adjust their trading when the market gets stoned.   Consequently they lose far more money then they have too.  Following tools like this can help you to smooth out your returns and stay in the game.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We always use risk management and own the domain name riskfreak.com.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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We follow several different types of indicators to include economic, valuation, sentiment, technical, etc. but one of the most important and powerful family of indicators would be monetary indicators.  Monetary indicators allow us to measure liquidity which of course affects all markets.  Historically some of the best gauges of liquidity have been interest rate trends, interest rates, margin debt, public offerings, money supply, etc.  One of the most powerful indicators is Fed policy and the tools it uses to put their policy into effect.  We have all heard the saying “dont fight the Fed” and while many market sayings are cliche this one carries weight.

During this cycle the Fed, in addition to its zero interest rate policy ZIRP, has been using quantitative easing to inject money into the economy in an effort to “prime the pump” and get people spending.  Unfortunately there is little if any evidence that any of this money has been finding its way to main street. Instead it has been going into financial markets and in the process has helped fuel some bubbles.  While the term bubble has been overused as of late we are using it in the sense that without QE1 and QE2 most financial markets would be a lot lower then they are today or a few weeks ago.

All of this brings us to the current situation.  As you can see in the chart below whenever the Fed is actively buying or selling securities the market goes up or down.  From mid 2005-2007 the Fed was buying small quantities and the market, already in an uptrend, continued higher with muted volatility.  Later during the early stages of the crisis, and after the Bear Stearns breakdown, the Fed decided in all its wisdom to sell some of its securities taking liquidity out of the market at the exact time that they should have been adding it.  While not the cause of the crash it did further enable it.  In early 2009 the Fed began QE1 at the same time that the government passed TARP.  Between these two massive stimuli the market was able to shoot higher.  While the argument can be made that the pump was primed and brought investors back into the market it is hard not to notice what happened once the Fed stopped buying.  As you can see the correction in mid 2010 coincided with the end of QE1.  As this correction got going and with the backdrop of high unemployment and a still sluggish economy the Fed embarked on QE2.  As you can see the market once again started to move higher.  Well guess what?  Since the Fed stopped buying the market has consolidated and as you have likely noticed over the past few weeks has started to crash moving down 18% in just two weeks.  (Click on chart to enlarge)

POMO and SP500

While it is true that there are other factors at work it is obvious to everyone except maybe the Fed that they have been the buyer and until the economy really does improve the risk markets will fall anytime that they back away.  With the statement earlier this week that the Fed is going to maintain a ZIRP until at least 2013 we are also led to expect an eventual announcement of QE3.  While we don’t think that it will help the economy and might actually hurt it, we do think that in the framework of Helicopter Ben’s mind this is the only course of action.  If we break lower by 5-10% expect the Fed to come out and announce another round of purchasing.  Oh and one more thing, don’t fight the Fed.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long US Treasuries via TLT  and gold via GLD.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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Despite the countless hours spent by the media talking up the debt ceiling debates and its effects on financial markets the real concern amongst actual investors has been the prospects of actual economic growth.  As we have stated in the newsletter as well as in previous posts on the blog we do not think, and bond yields have agreed, that anyone is actually scared of a default.  So despite the misguided hand of the media bonds and other financial markets are moving based upon future growth potential or the lack thereof.

On Monday we got a PMI number that came in not just low but drastically lower than expected and very near the negative growth line.  The PMI index is a diffusion index meaning that if it is above 50 then the manufacturing sector is growing and if it is below 50 then the manufacturing sector is contracting.  So how bad was the number?  Well last month PMI came in at 55.3 and this month it came in at 50.9 which means that manufacturing is barely above the zero line.  You can see the drop more clearly by looking at the chart below. (Click on chart to enlarge)

ISM PMI

As you can see the drop from the February peak reading of 61.4 has been fairly steady and swift as the manufacturing sector has been slowing down despite many economists expecting strength in the economy and a continued recovery.  Of course as long time readers know we have been less than impressed with the economy ever since the bottom back in March 2009.  The market rebound was impressive but the real economy has been very mediocre.   All this has weighed heavily on the markets as of late and since February bonds have been moving higher.  At the same time and with the help of he sideshow in Washington the stock market has taken a hard and swift hit as of late and is starting to get more in line with the actual economy.

One chart that we like to follow is that of the SP500 year over year growth rate overlaid with the PMI data.  As you can see the PMI is a good rough business cycle indicator.  While not perfect by any means it does a great job of tracking what the market is expecting in the medium term.  As you can see right now the PMI is pointing lower and it seems as though stocks are following its lead. (Click on chart to enlarge)

PMI and SP500 YoY % Change

Right now many of our economic indicators are saying to lighten up if not exit equities all together.  While this has been the case for a while the market via trend, breadth, and sentiment is coming around to the same conclusion, and that is that the economy is weak and prospects are not good for a favorable risk to reward environment.  Do you really want to sit in a market hoping to eek out meager gains of maybe 5% over the next year but with potential and relatively likely downside of 15-20%?  We don’t and instead have been going into assets that do well in times of slow economic growth.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long US Treasuries via TLT and also hold some small long positions in US equities.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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