L.O.V.E. is in the Air

Valentine’s Day is by far my wife’s most favorite holiday. Why shouldn’t it be? It is the day where love fills the air and embodies awe-inspiring romantic gestures for every hopeless romantic. For individuals like me, the day is, of course, meant to show appreciation, but more so to express my gratitude for putting up with my difficult antics and late-night rants about monetary policy. Sometimes I wonder if my wife is more excited about the holiday because it’s filled with roses and chocolates, or because it’s the day that she doesn’t have to hear me discuss economic theory to anyone willing to listen. Nonetheless, while the day is filled with devouring chocolate covered strawberries while one recites “roses are red, violets are blue”, it is the day that I get to place all of my undivided attention on the woman I love most all in the aim to recertify my affection. But, of course, we are not here to have coffee and talk about the birds and the bees, we are here to talk about investments and financial markets, and a different type of LOVE filling the air!

During our coffee last week, we talked about how there are multiple ways to Slicin’ N’ Dicin’ investment management techniques which ultimately led to many great follow-up conversations. Over coffee today, I would like to add a bit more color to the use of leading economic data and how its current improvement differs in the wake of particular contracting data. So, grab your cup of coffee as we chat about the L.O.V.E. in the air from improving economic data.

For the high-speed espresso drinkers, here is a quick bullet point synopsis:

  • Leading Economic Indicators inflect before Coincident and Lagging
  • The S&P 500 (stocks) are a component within the Leading Economic Index
  • We’ve seen a trough and reflection in Leading Economic Data while Coincident and Lagging data decline
  • Liquidity drives economic Output which will drive Value and Earnings growth

One of the focal points we discussed last week was how DCA uses leading economic data to determine the growth rates of the business cycle. As we always say, our process is rooted in the belief that financial markets are acutely sensitive to changes in economic conditions but it is extremely important to discern which type of economic conditions affect financial market behavior as not all economic variables have equal bearing on the performance of financial assets. Last week, we introduced the Conference Board leading economic indicator subset to show our fellow coffee drinkers some of the data we use in our method of analysis. Today, I would like to introduce what is known as Coincident Economic Indicators and Lagging Economic Indicators as these economic reports garner a lot of attention in the financial media. As you may deduce, leading data is a set of measurements aimed to anticipate turns in economic growth whereas coincident data is showcasing what is current happening in the economy, and lagging data is what is reported after the fact. Below is a table showing the subset of data for each category.

At first glance, one would naturally think that the majority, if not all, of the economic data listed in the coincident and lagging columns, would be extremely important to make an investment decision. While each economic data point listed is highly valuable for any market participant, the coincident and lagging economic reports come AFTER the inflection (ie change in direction) of the growth rate for leading economic data. The two charts below depict how the leading economic index has troughed before coincident and lagging data after the Great Recession and peaked before coincident and lagging data during this latest economic deceleration that began in early 2018.

As you may have noticed, stock prices, namely the S&P 500, is a data component within the Leading Economic Index. What that means is that the stock prices themselves are a leading indicator of economic data. At DCA, our Spicy, Secret Sauce is to identify the direction of Leading Economic Data which helps determine the performance of financial assets such as stock prices. Our method of analysis with the use of our DCA PIIL model helps us probabilistically determine the anticipated moves. One, in particular, is the liquidity, ie the amount of money circulating in an economy, that has been injected within the economy via central bank policy.

Most viewers of financial media have bore witness to a plethora of articles discussing the material slowdown in GDP (Gross Domestic Product) and job openings. Both of which are coincident and lagging indicators. At DCA, we’ve become more constructive of the economic outlook for the next 16 months as we believe, based on our DCA PIIL anticipatory series, that the recent Liquidity injection will lead to strong Economic Output that will drive Value and Earnings growth.

I hope you all had a wonderful Valentine’s day!

Please feel free to reach out with any questions, topic suggestions, or if you want to chat!
Sincerely,

ANDREW H. SMITH
Chief Investment Strategist
andrew@delosca.com
asmith971@bloomberg.net