Monthly Macro Risk Monitor – 5 Jun 19
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
We use Global Monetary Policy to evaluate inflation risks, deflation risks, and interest rate risk.
Monetary policy is ineffective at this point in time. Central banks are easing but have no impact on the slowing global economy. The focus is on data (which is sour, like the PMIs) and market-based measured. Recently Ray Dalio and other gurus have been discussing the inevitable end of central bank efficacy. When rates have been lowered to 0% and QE (purchasing of financial assets) no longer works, what next?
Global Volatility Meter
Source: TradingView & NYU Stern V-Lab
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, the Eurostoxx and Crude Oil, we can see the composite indicator as “the cost of hedging a price decline” in each market.
Volatility conditions are back in the “red zone” and this is mirrored by the breakout into a bear market by the Equity/Bond spread. Risk aversion is hitting the market although in it’s early stages.
We have introduced the FX Volaility measure also, as a tool for traders. Currently we are still in a downtrend in Vol, which means conditions in FX will be rather dull with intraday directional trading and more conservative targets the better option. We need volatility to break above the May highs in order to see some acceleration and “trendiness” in FX.
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.
Global PMI surveys signalled that manufacturing downshifted into contraction during May. Business conditions deteriorated
to the greatest extent in over six-and-a-half years, as production volumes stagnated and new orders declined at the fastest pace since October 2012.
To Sum Up
Our Macro Risk Monitor (MRM) is currently showing heightened degree of instability in the markets. There is more than a bit of risk-aversion here. The world is facing a global slowdown and policymakers do not have the tools to assist the recovery. Defensive assets would seem like the proper place to turn at the moment, but not wholeheartedly. We are not yet in a real bear market. It would take a break of December 2018 lows in the Dow to do so.
Right now we’re just seeing increased volatility – which has failed to materialize in FX. So better trading conditions are to be found in stocks and indices for the time being.
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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