Q:......
Hi Tom, What are the four risk indicators you are using?
Everyone else, are there risk indicators that are different than Tom is using that you find useful?
Me, I'm stumbling around on this as the various ideas I've tried, as well as the ones from various web sites I've looked at are all a jumble with little proven track records although many claim a good history.
Conference Board Leading Economic Index (LEI) is one that Zacks suggests as well as US Department of the Treasury Yield Curve.
The University of Michigan Consumer Confidence numbers is another possibility but I'm not sure I trust it all that much as it is quite subjective. There are other indices that attempt to measure comfort with risk but my perception is that in reality, this kind of indicator relies more on intuition than data.
Thanks, Allen
A:......
Hi Allen, Re: Market Risk data and how it's used............
I use four things that measure the following:
Market Valuation relative to risk free rate of return or CPI
Inflation rate, whichever is larger (Elaine Garzarelli first pointed out
this component with her combination of market P/E + ST Interest Rates)
Speculation as determined by how well the best performing stocks
are doing compared to the worst (My own creation determined from pattern
recognition over many years)
Investor Consensus as measured by a modified version of the
Fosback High/Low Logic Index
IPO Activity as compared to merger/acquisition activity (my own
creation determined from pattern recognition over many years) This one shows a different type of investor speculation.
Generally I used one standard deviation from the median value of each component as a determination of its bullishness or bearishness. Each is smoothed, weighted and summed as a part of the total so that any one component can potentially drive the total to bullish or bearish sentiment.
Interpretation comes with consensus of the components. If just one is bullish or bearish I take note. But if more are also aligning themselves in the same sentiment I pay far deeper attention. For instance, in late January of 2016 I had three of the four components showing a strong Bullish signal which proved to be the right thing to understand. From that date (01/22/2016) with the NASDAQ at 4488 and the S&P 500 at 1880 for the previous week's close we've had a nice run-up.
In 2007 we had a string of bearish signals with the last being on 11/12/2007. At that time the NASDAQ was at 2628 and the S&P 500 was at 1454. A year later the NASDAQ was at 1647 and the S&P was at 931. This again was a pretty good call but had just two components in bearish harmony (valuation and investor consensus).
Going back to 2008, the bullish signals started in late October and continued each week through June of 2009 when the risk indicators finally moved generally back to a neutral status. During that time three of the four components were all bullish. Occasionally all four were bullish.
Of the four, the valuation component has been the most reliable over the years since 1982 (the earliest for which I have data). Investor consensus has been the most erratic and seems to be better at short term forecasting. Speculation has been very good at making bullish calls going 6 to 12 months out. The IPO activity component doesn't give many signals but when it does, they seem to be very good.
I look at, but don't track, Advances vs Declines on a weekly basis. It's better at reflecting the previous week's sentiment than predicting the future. However, it has some value as a short term indicator.
Norman Fosback's book "Stock Market Logic" is a worthy read on learning about dozens of market risk indicators. He reviews each, offers statistics on their effectiveness and then, occasionally, improves on them if possible.
Hope this helps.
