One Trader's Antidote To 'Billionaire Bear' Dalio's Fearmongering

Authored by Kevin Muir via The Macro Tourist blog,

Yesterday, yet another Billionaire Bear issued a stark warning. This time it was Bridgewater Chief Investment Officer Ray Dalio who penned a piece comparing the current environment to 1937.

This was after an earlier in the month letter where Bridgewater warned that risks were rising, and that clients should have 5% to 10% of their portfolio in gold:

“Most immediately, during the calm of the August vacation season, we are seeing 1) two confrontational, nationalistic and militaristic leaders playing chicken with each other, while the world is watching to see which one will be caught bluffing, or if there will be a hellacious war, and 2) the odds of Congress failing to raise the debt ceiling (leading to a technical default, a temporary government shutdown, and increased loss of faith in the effectiveness of our political system) rising. It’s hard to bet on such things one way or another, so the best that one can do is be neutral to such possibilities.

“When it comes to assessing political matters (especially global geopolitics like the North Korea matter), we are very humble. We know that we don’t have a unique insight that we’d choose to bet on … We can also say that if the above things go badly, it would seem that gold (more than other safe haven assets like the dollar, yen, and treasuries) would benefit, so if you don’t have 5-10% of your assets in gold as a hedge, we’d suggest you relook at this. Don’t let traditional biases, rather than an excellent analysis, stand in the way of you doing this (and if you do have an excellent analysis of why you shouldn’t have such an allocation to gold, we’d appreciate you sharing it with us.)”

Although I am sympathetic to Ray’s view that the dysfunction in Washington will cause American financial assets to underperform in the coming quarters, I wonder if we aren’t maybe overthinking the whole situation.

And in that vein, I represent one of my favourite indicators. I have written about Ed Yardeni’s ‘fundamental stock indicator’ many times in the past. It appears overly simple, and the fact that it doesn’t directly include interest rates or earnings, seems to make it destined to break. Yet, somehow it magically continues to work.

Is the Yardeni ‘fundamental stock indicator’ confirming the bears’ thesis that it is time to exit stocks?

Well, let’s have a look at the indicator over a long time frame to get a feel for how it has performed in the past.

As you will notice, the correlation is not perfect, and there are definitely times when the indicator ran ahead of the stock market, but its ability to match large moves in the stock market is remarkable.

Let’s quickly review Yardeni’s secret sauce. His indicator is a combination of;

  • consumer confidence
  • initial jobless claims
  • CRB raw industrials

That’s it. Nothing more. It’s surprising that it tracks the stock market as well as it does with nothing more than these three inputs.

Look closely at the chart. I am hard pressed to find an example where the stock market declined by a meaningful amount that the indicator hadn’t foreshadowed, or at the very least, mirrored.

So let’s zoom in on the recent action to get a feel for the potential of a stock market sell off.

Contrary to most pundits’ warnings, the Yardeni indicator is sitting at new highs.

Wow. How can that be? That doesn’t make any sense. Aren’t things rolling over?

Well, maybe we should have a look at the various components a little more closely.

First of all, jobless claims are sitting at cycle lows.

With all the help wanted signs littering store windows, I don’t see this changing anytime soon.

And given all the reporting about the recent rise in Chinese centric commodities, it is no wonder the CRB Raw Industrials index is pushing up against the previous highs.

Finally, even though the news seems awful, consumers are still an optimistic bunch.

When you add up these three inputs, you get a Yardeni ‘fundamental stock indicator’ that is pushing up to the highs.

Now maybe this is the period where this indicator finally stops working. Maybe all those billionaire bears will prove smarter than Yardeni’s simple system. Yeah sure. Maybe my homemade boat will also pass my upcoming coast guard safety inspection.