For my first P123 post I have a couple of macro questions for the community.
The recent V-shaped turnaround since December has convinced me once and for all that the post-2008 market has truly come to believe, rightly or wrongly, that the Fed will rescue it if/whenever intervention is needed because of deteriorating economic conditions. And it will always seek to position itself beforehand in anticipation of such intervention (i.e. bidding stocks up whenever there is bad news in anticipation of Fed monetary easing and so forth). As such, all older paradigms about using backtested economic fundamentals (unemployment, yield curve, CPI, PMI, credit spreads, etc.) to predict market behavior prior to and/or during recessions need to be thrown out. In such a scenario what the markets of 1973-4, 1980-82, 2000-2, and 2007-9 did in response to the deterioration of their economic fundamentals becomes of much less importance to us as contemporary investors, as interesting as it might be for historical purposes. This is because the policy decisions of Fed officials, whatever they happen to be, become the most important determiner of the overall trajectory of the market. And Fed officials are regularly subject to whimsical political pressures. Their decision-making is highly capricious.
So today other, different macro paradigms need to take the place of older, fundamentals-based paradigms. Because of the difficulty of predicting Fed policy pronouncements, the new paradigms need to give much greater importance to the standard market sentiment indicators – breadth, advancing/declining volume, Hindenburg, 200 day avgs, consecutive down days, etc. Fundamentals factors need to be dramatically reduced in their importance in the new paradigms, although they probably ought not to be eliminated entirely. Either, (1) their percentage in our overall measurement cocktails should be reduced, or (2) they ought not to be activated at all in the new models unless/until the sentiment indicators ‘switch on’ and flash ‘bearish,’ thus opening a trap door to the gapingly unsupportive fundamentals. There are precision costs, to be sure, in reducing our prediction arsenal from larger, more sophisticated models that include an abundance of fundamentals factors to blunter, less predictive sentiment indicators. In our brave new world our macro predictions, which were always murky enterprises, will become much murkier. But any 1-yr, 2-yr, 5-yr, etc. macro predictions based on recession indicators, valuations, share supply/demand, or similar such metrics, may now need to be thrown out – or at the very least their importance may now need to be dramatically reduced.
In conclusion, I have two questions for the P123 community.
- First, am I right in reaching this conclusion about the need now to greatly reduce the importance of backtested economic fundamentals in our macro models?
- Second, what are the sentiment indicators that have you found to work best? Are you aware of any useful non-standard sentiment indicators that might be especially useful? I am interested particularly in non-price-based sentiment indicators, although price-based ones of course are welcome as well.