Market Diverges From Economic Data

Economic releases were mixed last week.  Building permits came in stronger than expected, but are still at anemic levels.  Leading indicators were up 0.3% last month, which was also stronger than expected.

Unfortunately, the ECRI weekly leading indicator (WLI) declined again last week and ECRI's WLI is a much more reliable indicator than the government's leading indicator series.  Initial unemployment claims were higher than expectations again and the previous week was also revised higher.  The Philadelphia Fed release was terrible.  It came in at -16.6, much worse than the expectation of -0.2 and well below last month's reading of -5.8.  Historically, readings below -15 were typically followed by recessions.

My summary market indicator score combines the bullish or bearish readings from 34 separate data series. The indicator score has three main components: technical, breadth and relative strength, and leading economic indicators.

Due to the recent rebound in equity prices, the summary indicator score rose to -0.2 last Friday.  However, all of that increase can be attributed to the technical, breadth and relative strength components. The average reading for the leading economic indicators was still very weak:  -23.0 on a scale of -100 to +100.

This is a classic divergence.  Market prices have been moving higher, while economic data has been deteriorating.  This is an unstable situation and something has to give.  If the equity market is right, then we are just experiencing a soft patch and the economic data will eventually improve.  In that scenario, market prices would continue to rise.

If the equity markets are wrong and the economic environment continues to deteriorate, then equity prices would move substantially lower. Any significant adverse event in Europe would eliminate any doubt about the direction of the global economy.  The economy is already weak and any external shock would be too much to overcome.

It should be interesting.

Current Conditions

Global equity markets are down overnight and the US dollar and Japanese Yen are both stronger.  Oil prices are lower and US Treasury prices rallied overnight.  As of now, money appears to be moving to safer assets.  Yields in Italy and Spain are currently 5.89% and 6.54%, respectively.  These yields have declined from their peak, but are still at dangerous levels.

We will gain additional insight into Europe later this week when the two-day EU summit convenes on Thursday


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Brian Johnson

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About Brian Johnson

I have been an investment professional for over 30 years. I worked as a fixed income portfolio manager, personally managing over $13 billion in assets for institutional clients. I was also the President of a financial consulting and software development firm, developing artificial intelligence based forecasting and risk management systems for institutional investment managers. I am now a full-time proprietary trader in options, futures, stocks, and ETFs using both algorithmic and discretionary trading strategies. In addition to my professional investment experience, I designed and taught courses in financial derivatives for both MBA and undergraduate business programs on a part-time basis for a number of years. I have also written four books on options and derivative strategies.
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