#25 Signal 2 Noise

micksonmatch
March 20, 2024

In today’s issue:

Commercial Real Estate Loan worries
The power of a central bank
The Nasdaq-to-SP500 ratio signal

S2N Housekeeping Updates

There is nothing to share today.

New Signals

In the coming weeks, I will be focusing on bringing this section to life with at least one in-depth signal analysis each day. This section will be the money shot.

S2N Insights

I want to just place it on the record that I am seeing more and more worrying signs that commercial real estate loans are starting to become a worry. I want to do more research before I am able to share if there is a signal to do something.

I know that I raise lots of concerns in these letters, but that is my job. I try to cast a critical eye on things to test the strength of the prevailing thinking. For me, that increases robustness to the investment process, or, to use Taleb’s language – convexity.

The power of a central bank

With the Bank of Japan ending the negative interest rate era yesterday, I thought it would be appropriate to take a look at what they have achieved.

As you can imagine, there are not that many people who want to buy a bond that has a negative interest rate. Yes, that is correct. You pay the bank for the privilege of depositing money. The BOJ really pioneered the art of quantitative easing (QE). To fill the gap in demand and maintain such low interest rates, they bought government bonds. And boy did they buy bonds.

The blue line is the size of the BOJ balance sheet with all its assets (not all bonds; they were really pretty risqué adding stocks). We know that a typical economic consequence of printing money is the devaluation of the country’s currency. The Yen didn’t disappoint. The relationship may not be immediate, but in the end, devaluation inevitably comes. The green line is Yen reflected most commonly in reverse. That is USDJPY. The higher the Yen goes, the weaker it becomes. The numbers in Yen are crazy; the BOJ total assets are more than 700 trillion Yen, which is equal to more than $5 trillion.

If you are wondering what the point of all of this is, the answer is twofold. Japan was experiencing deflation, so they needed to stimulate the economy through excessive money printing. The other reason was that by deflating the currency, it made the export part of the economy extremely attractive. This gave Japan’s excellent manufacturing sector a big boost and kept people employed. We now need to see the effects as it all starts to unwind.

The Nasdaq-to-SP500 ratio sell signal

I have been seeing a lot of references in the financial media about the crazy tech-to-market ratio being at bubble levels. I thought I would explore it a little. To create a relative ratio, I divided the Nasdaq Composite Index by the SP500. As you can see, we are at very high levels, but we are not the highest we have been before. The standouts were the dotcom bubble in 2000, the Corona virus, the work-from-home, and the day trading meme stock bubble in the 2020–2022 period. We will need to see if the A.I. trend takes the ratio into bubble territory.

In the chart below, I apply a somewhat arbitrary > 3-ratio level to identify SP500 sell signals. As you can see, it caught the dotcom high in 2000 but has been a little erratic in the last few years. I plan to work with this ratio little more and see whether I can use it in some form as a more reliable signal generator.