It is important for all investors to observe this as any rise in the TED spread again would be alarming and would mean that the global liquidity problem is again coming back. This in turn is bad for the markets as the stock markets are a function of liquidity more then anything else.
Many investors are now wondering why the markets have gone to 14,000. Is it because of a big reversal in global economic activity? The answer is no. The markets are up because the market participants have too much money in their hands indicated by the easing spreads in the above chart.
Just remember the simple rule: Rise in TED Spread is bad for the stock markets and economy and fall in TED spreads is good for the stock markets and the economy (but more for the stock markets).
Investors can track the TED spread using the link below:
3) Movement of the US Dollar
The movement of the US dollar is a great indicator of the direction in which the stock markets will move. Consider this:
Ø From 2003 to mid 2008, the US dollar was going down and all the asset classes (stocks, bonds, gold, and commodities) were going up. In May 2008, when the commodity prices peaked out, the US dollar also bottomed out (see chart below).
Ø After the second quarter of 2008, the US dollar started to appreciate and all asset classes collapsed one by one.
Ø After March 2009, the US dollar has again started to show signs of weakness and again stocks and commodities are moving up.
So I hope this simple relation between US dollar and all asset classes is clear to investors. A weak US dollar is all asset class supportive.
The chart below gives the US Dollar Index and a sharp decline in US Dollar Index is evident in the last few months.
Investors can track the Dollar Index using the link below:
4) US Treasury Bond Yields
In very simple terms the bond yields are the interest rates payable by the government on their issued bonds. The bond yield is a great indicator of several key things as discussed below:
Ø A lower bond yield means that people are putting their money in bonds. As bond prices and yields are inversely related (when bond prices go up, yields go down). Thus, when global economic risk is high, investors prefer to park their money in safer assets like Treasury Bonds. So when bond yields go down it indicates there is risk aversion globally and people are not willing to invest in risky assets such as stocks and commodities.
Ø Conversely, when bond yields go up it indicates that the investors are getting their confidence back to invest in other assets and are pulling money out of safer assets like bonds. Thus, its time to put money in the stocks when yields are going up and to exit stocks when yields slump. This chart below will make things clear for investors.
The chart above shows that the bond yields slumped in the last quarter of 2008. The same time the equities also slumped (because money was moving from equities to bonds which are relatively safer assets).
The bond yield started to move up from early 2009. So money was being pulled out of bonds from early 2009, but it was not going into equities. Thus, there was huge cash holding in the first quarter of 2009. The result of this is what we see now. All the cash is now moving into stocks and commodities globally.
Remember, that money just moves from one asset class to another. If an investor is smart enough to understand to which asset class money will go next, then he/she will make big profits.
For bond yields simple rule is:
When yields go up then stock markets are most likely to go up and it also means the economy is recovering. When yields fall then take money out of the markets as people are taking money out of the equities and re deploying it into bonds.Investors can track the movement of the 10 year US bond using the link below:
5) Volatility Index
No investor would like to invest in a market where the big market participants are unsure of where to invest or what is happening in the economy and financial system. For this reason, tracking the volatility index is of great importance for all investors.
When the volatility index is high, an investor can easily lose 40-50% of his/her capital in a matter of few days. A high volatility also shows that the markets are very unstable and so is the economic scenario.
The chart below showing the 5 year volatility index would make things clear for investors.
As evident from the five year chart, the index was below 25 levels in a stable market and economy. However, it surged to over 75 in the worst phase of the crisis. With more liquidity coming back in the markets and signs of economic recovery evident globally the index is again back to near 25 levels. The fall in the index is reflected in the bullish sentiments in the stock markets.
Any reversal in trend should be looked for to determine the future direction of the markets.
Investors can track the volatility index using the link below:
India Specific Indicators
There are some good India specific economic indicators which can be used by investors to determine the direction of the economy. Some of these are discussed below.
a) Rail Freight Index – In India, most of the commodity transport within the country is through rail containers. Hence, the rail freight index is one really good indicator of local economic activity. If the rail freight index has shown de growth or very low growth as compared to prior year then one can safely assume that there is not much industrial activity happening. The table below shows the rail freight revenue earning growth and also some other major service sector economic indicators.
It is very clear from the above data that all service related areas have contracted as compared to prior year. This proves that the economy is still in a downturn. Moreover if one observes big slump in commercial vehicle production or the rail freight revenue, he/she can safely assume that these sectors will come up with poor results in the quarter.
a) Credit Growth – It is debt which creates new money in the system. Thus, looking at credit growth is very important to measure if banks are willing to lend. Robust lending not only creates new money in the system but also helps businesses to survive. To a good credit growth is an indicator of good times to come ahead in terms of economic activity and growth. The data below shows the credit growth for public sector and private sector banks in India.
Clearly it is the foreign banks and private sector banks that are not lending and have become risk averse. The public sector banks on the other hand still have robust credit growth. This also shows that in the near term the public sector banks might do relatively well in terms of their results.
This and many more amazing economic indicators are available in the monthly bulletin from the RBI. Any investor who wants to know the health of the economy should read this monthly bulletin from RBI in my opinion.
The link for downloading this monthly bulletin is:
Investors can make use of all these resources and charts to figure out the direction of the economy and also the stock markets.
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1 comments:
Hi Faisal,
Excellent post. Keep up the good work. I am studying your post 'Peer Analysis for STock Selection' Just trying to learn about the stock market.
Haifa Lopes
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