This is a long post so skip to the end for a summary...
There are three important indicators I've watched for a while now which generally perform well in predicting market movements. They are:
1. The LIBOR curve 2. The yield curve and 3. The Shiller PE ration (CAPE)
The LIBOR Curve
The LIBOR curve is one of the world's most widely used benchmark for short-term interest rates. It serves as a primary indicator for the average interest rate. The slope of the yield curve gives an idea of future interest rate changes and economic activity.
There are three main types of yield curve shapes:
normal (upward sloping curve): long-term yields are higher than short-term yields. This is considered to be the "normal" slope of the yield curve and signals that the economy is in an expansionary mode.
inverted (downward sloping curve), short-term yields are higher than long-term yields. Dubbed as an "inverted" yield curve and signifies that the economy is in, or about to enter, a recessive period.
and flat, very little variation between short- and long-term yields. Signals that the market is unsure about the future direction of the economy.
Currently, the graph is showing upward movement between now and 2024. Flat for a portion of 2024 and then inverted out to 2026. Meaning a lot on large banks are unsure about the future from 2024 onwards and actually predict a recession (of sort) from 2025 - 2026.
This yield curve is the spread between the 10 and 2 year treasury notes. In an expanding economy, the graph should not invert because the yield on a 10 year note should always be larger than that of a 2 year note. This is because one would expect a higher return for locking up one's capital for a longer period of time.
Why would the curve invert? Because investors believe that the short term interest rates are about to fall quickly. Why would they do that? To stimulate the economy for some reason - perhaps in a recession?
Below is the 10/2 yield curve going back to 1985 and you can see that when the curve inverts, a recession generally follows shortly after. The current curve is still positive, but trending sharply down. Forecasting this out, it could go negative in 2023/2024 - an a recession usually lags...say in 2025?
The CAPE ratio is a valuation measure that uses real earnings per share over a 10-year period to smooth out fluctuations in corporate profits that occur over different periods of a business cycle. The ratio is generally applied to broad equity indices to assess whether the market is undervalued or overvalued.
It's just a simple ration to show that the market is quite expensive right now with respect to historical valuations.
And finally, I made this graph myself overlapping the Fed cash rate (orange) and the Nasdaq (blue) as in March 2021.
It's easy to see that the Fed's cash rate easily leads the market crashes by a couple years. My main concern is that each time, a market crash has been achieved at a consistently lower interest rate. It was 6.5% in 2000 dot com crash 5.25% in 2008 and then barely made it to 2.5% in 2018.
What will it be this time? 2% or 1.5%? My main issue is that rising interest rates flush out all the bad debt that exists in the economy by making the repayments more expensive. So whilst the market rallied last night on JPowell confirming rate rises in March, I think there is just too much bad debt out there for it to last.
It could be in margin trading in crypto, more bad housing debt - anywhere. Who knows! We won't know until it happens (and they make a movie about it).
Summary
Really, I am bullish between now and March next year. I will continue to watch all these indicators very closely. I'm going to be paying very close attention to the 10/2 yield curve as this is an excellent indicator for impending recessions. I'm still 100% in the market and will most likely sell 30% in a new all time high around 17,000 on the Nasdaq 100 and then buy the dip on a Nasdaq pullback which frequently occur next year.
I think we can continue upward until the Interest Rates hit about 1.5% and then I will begin to unwind back to about 30% invested. Then, as above once I see the Nasdaq pull back to more than 30%, I will begin to buy again with my 70% cash position. If the indicators are true then this could be around 2024/2025.
So fully invested for 2022/2023. Unwind once IR > 1.5% and then hold until Nasdaq pulls back more than 30%.
(20min delay)