By Nigam Arora
Central banks across the globe have been waging a war against the natural economic ebb and flow. Like any war, it has had many battles. Since 2008, central banks have won every battle. Now their luck is running out.
I do not know how the war will turn out, but last week my model gave a definitive call that central banks are likely to lose this battle.
Economic indicators can be broadly divided into three categories: the lagging indicators, the coincident indicators, and the leading indicators.
The focus of our research at The Arora Report is leading indicators from 23 countries. As the name implies, leading indicators provide an early indication of the direction of an economy. Examples of such indicators are vendor delivery schedules, hours worked in a week, and new construction permits.
Early last year, when the consensus was that the world may enter into a recession, our models based on the leading indicators were forecasting a slower economy, but no recession in the U.S. or Asia, and only a mild recession in Europe. This correct call by our economic models was primarily responsible for generating profits last year.
This time the picture is different. The leading indicators are warning that the probability of a recession has increased.
We do not rely solely on economic indicators for market timing.
At present the following are the key ingredients of our timing model.
1. Aggressiveness of fund flows
2. Leading global economic indicators
3. Commodity price movements
4. Relationship between currencies
5. Risk appetite as demonstrated by the relationship between the price movements of the assets deemed safe vs. assets considered speculative.
6. Price action of the markets at key technical support/resistance levels
7. Price action of the markets as various classical technical patterns become apparent
8. Changes in internals of the markets as the prices push through or fail at key support/resistance levels
The ZYX Global Multi Asset Allocation Model now predicts that the U.S. will enter a mild recession; the recession in Europe will be deeper than the consensus, and Asia will slow down more than generally expected.
Setting aside all the complex math and extensive amount of data we use, it is common sense that the business cycle has not been repeated. As hard as the central bankers may try, they are fighting a natural economic order. There have been 47 recessions in the United States since 1790. The last recession ended in June 2009. After three years of growth, even though the growth has been subpar, for the first time since 2007, I am making a call for a recession.
Of course, all bets are off if central banks decide to throw in a few more trillion dollars to prevent the recession.
Investors can take protective measures by buying puts, by short-selling ETFs such as SPY -0.03% , QQQ -0.30% , and DIA -0.35% . Another way is to go long on volatility through an ETF such as VXX -0.69% .
Gold bugs as well as gold momo crowd complain about the shenanigans of central banks. Unfortunately, concentrating a portfolio in ETFs such as GLD +0.37% and SLV +0.83% will not offer much protection if a recession were to materialize.
If a recession were to materialize, it would be great news for long-term investors who prepare now to pick up the bargains.
Disclosure: Subscribers to The Arora Report have a short position in QQQ, a long position in VXX, and an arbitrage position in GLD and SLV.
