Strategy I: Vix on Valium. Joe and I long have characterized the current bull market as a series of panic attacks followed by relief rallies to new cyclical highs and then to new record highs since March 28, 2013.
We are adding the 1.8% drop in the S&P 500 last Wednesday to our list of panic attacks even though it only lasted one day (so far). It was triggered by a wave of hysteria about the possibility of President Trump getting impeached for obstructing justice in the matter of Michael Flynn. We’ve been keeping track of the anxiety attacks since the start of the bull market in our chart publication titled S&P 500 Panic Attacks Since 2009.
We now count 56 of them. Of this total, four were “official” corrections, with the S&P 500 down between 10% and 20%, and six were mini-corrections, registering declines of 5%-10% on the panic spectrum (Fig. 1). We haven’t attempted to predict when these bouts might occur, but we’ve viewed them all as buying opportunities. We remain on the lookout for a bear market, which most likely would be caused by a recession. However, we don’t see either calamity anytime soon, as confirmed by our analysis of the leading indicators below.
Another way to identify panic attacks is by tracking the S&P 500 VIX, which is widely known as the “fear index” (Fig. 2). On this basis, the Trump scare is minor, with the VIX rising to just 15.59 on Wednesday. It spiked to 22.51 just before last year’s election on concerns that the FBI was coming after Hillary Clinton again. Before that, it spiked to 25.76 in late June on Brexit, which was just a two-day selloff.
It was relatively easy to panic investors following the Trauma of 2008. It’s been almost nine years since then. Time heals all wounds, as long as they aren’t fatal ones. Following the fiscal-cliff nonevent at the start of 2013, I wrote that investors might be getting “anxiety fatigue.” They seem to be less panic-prone, as evidenced by the shortness of the most recent attacks.
I’m thinking of applying for a permit to practice psychiatry so I can prescribe Valium for our accounts if they get too jittery. Someone needs to get some pills for the President. He really needs to calm down and tone it down.
Strategy II: Looking Up. While the headlines continue to be all about the swamp people in Washington on a 24/7 basis, the Index of Leading Economic Indicators (LEI) continues to climb to new record highs, and so does the Index of Coincident Economic Indicators (CEI) (Fig. 3). That news came out last Thursday, but it certainly didn’t make the front pages. Debbie and I aren’t surprised by the news because our YRI Weekly Leading Indicator continued to soar into record-high territory through early May, as it has been doing since early last year (Fig. 4). The same can be said about the Weekly Leading Index compiled by the Economic Cycle Research Institute (Fig. 5).
Joe and I aren’t surprised because the weekly S&P 500 forward earnings is also highly correlated with the LEI (Fig. 6). The former has been climbing rapidly into record territory since March 10, once the energy-led earnings recession ended and stopped weighing on earnings. The weekly S&P 500 forward revenues series has also been climbing to new highs. Let’s take a dive into the wonderful world of the leading and coincident economic indicators:
(1) LEI/CEI. Debbie and I also track the ratio of the LEI to the CEI (Fig. 7). It’s actually a useful leading indicator that is mostly cyclical without the uptrend of the LEI. It rose to 1.102 during April, the highest since November 2007, but remains below all the previous cyclical peaks since 1959. This could be a harbinger of a longer-than-average economic expansion.
(2) CEI. Also auguring for a long economic expansion is our analysis of the past five cycles in the CEI (Fig. 8). We’ve previously noted that the expansion phases, following the recovery phases back to the previous peak, lasted 65 months on average. That would put this cycle’s peak in March 2019. This isn’t a model but rather a benchmark based on recent history. Given our view that inflation is likely to remain subdued with Fed policy raising interest rates very gradually, we remain in the lower-growth-for-longer camp.
(3) GDP. The CEI and LEI are designed to time the peak and troughs of the business cycle, not the growth rate of real GDP. However, we’ve found that the y/y percent change in the CEI tracks the comparable growth in real GDP quite closely (Fig. 9). The former was up 2.0% during April. It has been fluctuating around this level since mid-2010, which is the same story for real GDP.
The yearly growth rate in the LEI has a much greater cyclical amplitude than the growth in real GDP (Fig. 10). However, it can be used to gauge whether the underlying economic momentum is rising or falling. It has been improving in recent months.
(4) Resource utilization. The LEI/CEI ratio is a leading indicator of the Resource Utilization Rate (RUR) (Fig. 11). We construct RUR by averaging the capacity utilization rate and the employment rate, which is 100 minus the unemployment rate (Fig. 12). Both measures confirm that the expansion is maturing. However, both also remain below previous cyclical peaks.
(5) Profit margin. The recent upturns in the LEI/CEI and RUR are good signs for corporate profit margins (Fig. 13 and Fig. 14).
(6) Yield curve. There are three financial components among the 10 components of the LEI. The S&P 500 is one of them. The other two are the yield-curve spread between the US Treasury 10-year bond yield and the federal funds rate, and the Leading Credit Index, which the Conference Board compiles using six different financial indicators (Fig. 15 and Fig. 16). It tends to spike prior to and during recessions. It doesn’t do much in between the spikes. It actually seems to be more of a coincident indicator, in our opinion.
The yield-curve spread, on the other hand, has a long history of accurately predicting recessions when it turns negative. As long as it remains positive, all should be well. However, if it is falling toward zero, it certainly should get our attention. Currently, there isn’t much to worry about. However, there is some concern that after the spread’s Trump-bump widening from 136bps during October to a recent peak of 195bps during December, it was back down to 140bps during April.
Of course, while the LEI uses the monthly yield-curve spread, it is also available daily. It was 147bps on Election Day, rising to 213bps on December 14 and falling back down to 132bps on Friday.
(7) Regional surveys. Below, Debbie reviews the regional business surveys conducted by the NY and Philly Feds. She reports that the average of their composite indexes dipped from a recent high of 31.0 during February to 18.9 during May, though that was up from April’s 13.6. That’s still well above last October’s 2.8 average, before the November 8 election results boosted animal spirits.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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