Investors are correctly worried about the sustainability of the current bull market, and want to know what to do about managing risk. Should they do nothing, and just ride the bull? Should they cut back a little on equity exposure? Should they press their bets by adding even more equity exposure? Our Key Market Indicators Tool offers some guidance as investors struggle with these questions.
What’s Next?
The U.S. stock markets finally broke out of a 13 month slump today and made fresh, new, historical highs. This ends the 12th longest stretch between all-time-highs since the 1950s. So the big question now is… what’s next?
Chartists will say that once the market makes a new all-time high, there are further gains ahead because all prior resistance has been eliminated. Contrarians will say that the market is overbought and due for a correction. Value players will say that the market is overpriced relative to earnings and dividend yields. And the ZeroHedge crowd will say that Armageddon is just around the corner because, well, just because.
While there is no universal answer to these questions that applies to investors of all stripes – young, old, risk-averse, growth-maximizers, etc. – there is one thing that everyone needs, and that’s information. Hard data, not the opinions of analysts, advisers, or CNBC talking heads. To that end, I developed a tool that helps me and my clients assess the current health of the market and get to a reasonable conclusion about what they should do with their portfolio.
Key Indicator Dashboard
This tool is a dashboard showing key indicators of market health in 4 broad categories: fundamental, technical, macroeconomic, and risk. Each of these categories is an amalgam of several sub-indicators. For example, the fundamental indicator combines earnings trends, relative valuations, and debt levels. Technical indicators include price momentum, advance-decline trends, new highs minus new lows, and money flows.
Macroeconomic indicators include things like the treasury yield curve, trends in employment and inflation, and industrial production among others. And risk is a combination of five metrics – volatility, moving averages, credit conditions, drawdowns, and on-balance-volume.
Each of the 4 main indicators is then evaluated and converted into one of three “states” – green (all clear), yellow (caution) or red (high risk). I use traffic lights to make the indicators easy to see without having to dig into the details. Here is a snapshot of the latest dashboard, which was updated through the end of June.
The first two indicators are flashing yellow. Both the fundamental and the technical measures of market health have been weak since August 2015.
The third indicator – macro – is flashing green. The message from this is that the risk of a new recession arriving in the next 9 months is remote, but not impossible. We would have to see 3 or more consecutive months with a red light in order for recession risk to become high enough to warrant aggressive defensive action.
The final indicator – risk – is the only one flashing red. This indicator has been flashing yellow since last August, and the new high in the stock market today, combined with poor earnings and earnings expectations going forward, have turned it decidedly red.
Conclusion
The takeaway from all of this is that each investor has to decide what actions to take, or not take, based on his or her specific situation. This dashboard is not a prediction tool, and it should not be used as such. But it’s loaded with data that is relevant to the current health of the economy and the capital markets. It’s the trend of the indicators that are the most useful, rather than the current state of each one.
It’s my hope that investors will use this tool as it was intended – as a quick, visual representation of market health on 4 levels.
If you would like to see more detail about how each of these indicators are calculated, email me at info@zeninvestor.org with the subject line “indicators”.