Monthly Macro Risk Monitor – 2 Mar 19

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My greatest discovery was that a man must study underlying conditions, to size them so as to be able to anticipate probabilities. – Jesse Livermore

In this recurring monthly analysis, we will look at three global risk factors in order to assess the current market state and attempt to foresee risks on the horizon.  The factors that we will be using, in order of weight, are:

  • Global Monetary Policy
  • Global Volatility
  • Global PMI readings

Together, they can assist us in shaping up underlying macro conditions, so we don’t get caught off guard by some change in market dynamics that was foreseeable.

Global Monetary Policy Stance

 Source: cfr.org

We use Global Monetary Policy to evaluate inflation risks, deflation risks, and interest rate risk.

Into 2019, monetary policy has been tightened once again and continues to enhance the probability of a collision of risk factors with tighter policy & slower global growth (see PMIs).  Volatility levels have dropped in February as the market recovered lost ground but (as you will see below) our risk on/off monitor is still in a long-term sideways market type, so caution is still warranted.

Global Volatility Meter

Source: TradingView

We use the Global Volatility Monitor to capture economic growth risks and liquidity risks.Since we are tracking the implied volatility on the S&P 500, China and Crude Oil, we can see the composite indicator as “the cost of hedging a price decline” in each market.

Volatility is back in “no man’s land” but the long-term chart on Stocks/Bonds shows a more realistic picture: we’re in a sideways market type so declines can still happen. We need more higher lows/higher highs to change the stance. So this is a tentative risk recovery at best.

Global PMI Monitor

Source: IHS Markit

We use the Markit/JPM Global PMI analysis as a gauge for economic growth risks, inflation risks and deflation risks. PMIs are known to be a leading indicator for GDP growth rates.

PMIs are where the action is, and the reason why markets are now concentrated on growth. We have been highlighting the slowdown for quite some time now, and finally (as PMIs are approaching the 50 mark/contraction territory) even the central banks are paying attention. This is the main concern in the markets for the time being.

From the report: Slower growth in the US and contractions in Japan and the euro area were offset by a stabilisation in China. The outlook remains lacklustre, as stagnant new order growth, declining international trade volumes and weak business
confidence rein in the prospects of output growth staging a meaningful revival in the coming months

To Sum Up

Our Macro Risk Monitor (MRM) is currently showing a collision of risk factors on the horizon with PMIs slipping below the 50 mark while monetary policy is being tightened and only volatility conditions have normalized. The focus is now on global growth and it will remain this way until we see PMIs starting to rise again – which might not happen for some time. Expect further volatility going forward. Defensive assets and market neutral strategies look like the best bet for now.

About The Macro Risk Monitor

What we are doing is neither new nor original. Anyone with a basic comprehension of macroeconomic theory, and a bit of real world experience, can do the same thing. We’re just doing it for you.  What follows is a brief explanation of why we are monitoring precisely Monetary Policy, Volatility and Purchasing Managers’ Index.

  • During periods of real (non-inflationary) growth, the main cyclical classes (Developed and Emerging Market Equities, Real Estate, High Yield Bonds) tend to have low volatility.
  • Vice versa, during periods of economic uncertainty or outright contraction, cyclical assets have high volatility.
  • However, we can also have inflationary growth, which is the best environment for Commodities (Energy, Industrial Metals).

When volatility is high, or global growth expectations (measured via the PMI) are low and monetary policy is tight/tightening, there is a collision of risk factors that produces a high uncertainty/high risk environment that is usually only favourable to fixed income and counter-cyclical assets.

When volatility is low, or global growth expecatations (measured via the PMI) are high and monetary policy is loose/loosening, there is a combination of easing factors that produces a low uncertainty/low risk environment that is favourable to cyclical asset classes.

By using just these three measures, we can create discrete market environments that can assist in selecting the right asset class to target given the current situation.

If any of this is a bit foreign or complex, our Forex Fundamentals Mastery course can bring you up to speed.

About the Author

Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.

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