What Is Relative Demand Telling Us About Stocks and The Economy?

By: Chris Ciovacco | Wed, Jan 8, 2014
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What Is Relative Demand Telling Us About Stocks and The Economy?

Businesses Appear More Confident

The U.S. economy is highly dependent on consumers buying and consuming. It is much easier to buy and consume when you are employed. Consequently, investors monitor the labor market very closely. Wednesday brought some encouraging news on that economic front. From The Wall Street Journal:

U.S. businesses added jobs at a quick pace last month, notably in construction, according to a tally of hiring released Wednesday. Private-sector payrolls increased by 238,000 positions in December, according to the national employment report compiled by payroll processor Automatic Data Processing Inc. and forecasting firm Moody's Analytics. The gain is the highest ADP estimate since November 2012. "My sense is businesses are feeling good," said Mark Zandi, chief economist at Moody's Analytics. "CEOs are deciding it's time to expand."


Relative Demand As Polling Mechanism

Bull Vote Cartoon

The expression "put your money where your mouth is" applies to the market's pricing mechanism; the same mechanism that determines the value of your investment portfolio. When investors are confident about future economic outcomes, they prefer to be in growth-oriented stocks. When they are fearful, they prefer the relative safety of bonds. You can argue interest rates skew the value of this analysis, which is valid in the short-run. However, stock corrections and bear markets are deflationary events, which means the longer fear persists, eventually bonds will be in greater demand than stocks.


2011: Bond Demand Was Waving Yellow Flags

As investors, we would prefer to reduce our exposure to stocks prior to, or in the early stages of, a sharp decline in prices (see point B below). The meat of the chart below tracks investor demand for stocks (SPY) relative to bonds (AGG). When the ratio falls, it is indicative of rising demand for conservative bonds relative to growth-oriented stocks. Notice the ratio was making a series of lower highs and lower lows (see 1-5 below) before the plunge in stocks near point B. Rising fear was observable five months before point B, sending a "be careful with stocks" signal.

$SPX:AGG Chart


2014: Our Survey Says

How does the stock vs. bond poll look in early 2014? Much better than it did in 2011. Rather than making a series of lower highs and lower lows (bearish for stocks), the ratio is making a series of higher highs and higher lows (bullish demand for stocks relative to bonds).

If you are still skeptical of using a stock/bond ratio in a rising rate environment, Tuesday's analysis looked at a similar risk-on vs. risk-off ratio (long vs. short); the results are very similar - still bullish.


Rate Of Growth Expected To Pick Up

The Fed's QE process has unquestionably contributed to the recent rise in risk assets, such as stocks. The most recent Fed minutes were released Wednesday. The basic takeaway was the economy is improving from the Fed's vantage point, which increases the odds of additional tapering. From MarketWatch:

Meeting participants viewed the information received over the intermeeting period as suggesting that the economy was expanding at a moderate pace. They generally indicated that the broad contours of their outlook for real activity, the labor market, and inflation had not changed materially since their October meeting, but most expressed greater confidence in the outlook and saw the risks associated with their forecasts of real GDP growth and the unemployment rate as more nearly balanced than earlier in the year. Almost all participants continued to project that the rate of growth of economic activity would strengthen in coming years, and all anticipated that the unemployment rate would gradually decline toward levels consistent with their current assessments of its longer-run normal value."


Investment Implications - Treading In Bullish Waters

Uncertainty about the strength of the economy relative to Fed tapering has contributed to a pause in stocks. However, the pause has not yet resulted in any significant changes in the observable evidence tracked by our market model. Consequently, we continue to maintain significant positions in U.S. stocks (VTI), financials (XLF), energy (XLE), small caps (IJR), Europe (FEZ), and global stocks (VT). If the current stall morphs into weakness, we will be watching how buyers and sellers interact near the key S&P 500 levels shown below. We will continue to let the market be our guide.

$SPX S&P 500 Large Cap Index INDX

 


 

Chris Ciovacco

Author: Chris Ciovacco

Chris Ciovacco
Ciovacco Capital Management

Chris Ciovacco

Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC. More on the web at www.ciovaccocapital.com.

All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors and tax advisors before making any investment decisions. Opinions expressed in these reports may change without prior notice. This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. Past performance is not necessarily a guide to future performance. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. All prices and yields contained in this report are subject to change without notice. This information is based on hypothetical assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION CONTAINED IN THIS ARTICLE.

Ciovacco Capital Management, LLC is an independent money management firm based in Atlanta, Georgia. CCM helps individual investors and businesses, large & small; achieve improved investment results via research and globally diversified investment portfolios. Since we are a fee-based firm, our only objective is to help you protect and grow your assets. Our long-term, theme-oriented, buy-and-hold approach allows for portfolio rebalancing from time to time to adjust to new opportunities or changing market conditions.

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