#74 S2N: Not another “ism”

Sorry for the late delivery.

S2N Spotlight

Yesterday saw the release of the ISM Purchasing Managers Index (PMI). This index has been compiled for many decades and is well regarded and widely quoted in the financial industry. Essentially, anything below 50 indicates the economy is contracting, and anything above 50 means it is expanding. I drew a solid black line through 50 to emphasise the point. It dropped below 50 to 48.7 yesterday.

When you look at the month-on-month change, almost all you see is noise, as far as I am concerned. I seldom look at month-on-month, except for the big spikes I regard as signals.

I tend to look at year-on-year changes more closely, and here we see it has turned a positive 4% on the month, so this reading is not all that bad. In fact, it was a little bit better than its mean monthly return of 1.96%.

With all the confusion from above, I decided to put the 50-level rule through my backtester to see if it, as an indicator to trade the SP500, has any signal value. According to the results below, the answer is no. I haven’t done anything sophisticated like lagging the returns to the indicator or any other such optimisation technique. My takeaway is: don’t get too excited about this indicator on its own.

S2N Observations

The FDIC has identified 63 banks that are on the brink of collapse. 2 months ago, the Fed’s emergency lending programme for banks expired. Many regional banks never truly recovered from the crisis. If you look at this regional bank index in the US, you can see that while the main indexes are making new highs, this index continues to make lower highs, which is bearish.

I was looking for clues to see if there are stresses being picked up by the broader market agencies and Federal Reserve divisions. I stumbled upon this index, which I am not familiar with. It, too, has a long history. The Chicago Fed Financial Conditions Index is telling us the economy is in good shape; there is no need to worry at the moment.

I took a look at the put/call ratio on the SP500, and it is also very complacent and bullish. Just as you would expect with markets making new highs. It is usually when markets are extremely complacent that market tops are made. For those of you who are not familiar with this ratio, the closer it gets to 0 means that more people are holding or buying open calls than put options.

On the weekend, I received a Bloomberg news alert that OPEC had agreed to cut production in an effort to prop up the oil price. In the old days, this was big news; it would spike the oil price. In today’s times, it doesn’t even cause a reaction. Anyway, many people are not aware that America is the largest oil producer in the world, so it is no longer as supply-sensitive to the Middle East as it used to be.

The chart below is the crude oil futures curve. I have readapted my code to read futures chains from a different data vendor and didn’t have enough time to make the dates on the x-axis look nice. I will sort it out another time. The interesting part is that oil is in contango, which means that the later dates are below the nearer dates, like a yield curve inversion.

James Bianco, one of my favourite market commentators and strategists, shared a version of this chart. He is suggesting that over the last few years, oil has led the way for the 10-year Treasury yield. The similarities are quite remarkable.

To avoid being told that I cherry-picked this time frame because it worked so well, I went back a little further (10 years). You can see that the relationship still looks pretty strong.

Performance Review

Chart Gallery

News Today

The post #74 S2N: Not another “ism” appeared first on Signal2Noise.