By Confluence Asset Management
For equity investors, there is always a concern about the major market declines; being able to reduce market exposure prior to crashes like the ones in 2000 or 2008 is always desirable.
Although large declines have occurred outside of economic recessions, they have become increasingly rare.
The last major market pullback absent a recession was the 1987 crash. Thus, an indicator that can use high frequency economic data (data that is available on a weekly basis) and relate it to equities should have some value.
This chart shows one of our recent efforts. The upper line is the monthly average for the S&P 500; the lower line is an indicator built of three economic numbers—initial claims, the CRB commodity index and the Conference Board’s Consumer Confidence data.
We have standardized¹ the economic data and created an indicator, shown on the bottom of the graph. In general, a positive reading is generally bullish for equities. We have placed vertical lines on the chart to indicate when the indicator turned negative with persistence.
These are usually periods of falling equities. Although useful, it is clear that the indicator is somewhat “late” in that the equity decline is well underway by the time it becomes negative. That would suggest that a momentum number based off the economic indicator might be helpful.