Capital markets everywhere continue to struggle with growth-killing headwinds.
You know, the usual suspects — China, commodities, energy, junk bonds — all showing persistent weakness. Negative interest rates on government bonds in some countries. Gold is one of the few bright spots, but it can’t lift the global economy all by itself. Oil has rallied nicely as well, but remains in a bear market for now and may falter again. With a macro picture like the one we find ourselves in today, how do investors decide what to do?
While there is no universal answer 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 TV. 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.
This tool is a dashboard showing key indicators of market health in four 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. Technicals include price momentum, advance/decline trends, new highs minus new lows, and money flows.
Macroeconomic includes 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 four 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 February.
The first two indicators are flashing yellow. Both the fundamental and the technical measures of market health have been weak since last July.
The third indicator — macro — is flashing red. The message from this is that the risk of recession is higher than usual, but not a certainty. We would have to see three 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 green. This indicator has been flashing yellow since last August, but the recent rebound in the market has caused it to move well out of the danger zone for now.
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 four levels.