Interpreting the Monthly Market Dashboard

The monthly market update contains information at a glance on market returns, economic indicators, and correlations of financial markets. The importance of these is laid out in this post. The market update is published during the first week of each month and contains information pertaining to the data as of the close of the prior month.

The Economic Dashboard

The economic dashboard contains 3 data series. These are the three most important data series in markets/economics for the following reasons:

  • Buffett Indicator: This is a measure of long-term stock market valuation. It is calculated as the total market capitalization of US equities divided by US Gross Domestic Product. Since GDP is published quarterly, this data may be subject to revisions. This metric is important because (as Robert Shiller proved), valuation determines nearly 90+% of longterm stock market returns. Higher values of this directly predict lower long term returns. This is covered in some detail in this post. 
  • Initial Unemployment Claims: This is the number of individuals applying for unemployment benefits, averaged over the preceding 4 weeks. This is a measure of how many people are being terminated/laid off from their employers. Generally, this metric corresponds quite well to the real-time health of the economy. If this rises materially, it is likely a recession is underway. This is, at a glance, a terrific metric of how the economy is performing right now.
  • 10Y/2Y Yield Spread: This is the difference between the ten year treasury rate and the two year treasury rate. The yield spread is the single best predictor of both economic output and stock returns in the intermediate time frame. It predicts future GDP quite well as detailed here, and furthermore, it has predictive power on equity valuations as detailed here. An inverted yield curve is heavily associated with a recession in the following years.

In general, as a stock investor, caution is warranted when the Buffett Indicator is high and the yield spread is very low or inverted. This means stocks are overpriced and the economy is heading for a recession.

Returns

These are year to date and month to month total returns for the major asset classes held by investors: S&P 500, EAFE (international), Bonds (defined by the Vanguard Intermediate Term Bond Index Fund), and Gold.

Also included are projected 10 year forward returns.

Correlations

Portfolios benefit when assets are included that 1) have positive expected return (like bonds and stocks) and 2) are poorly correlated with each other (again like bonds and stocks). The more negative the correlation between assets, the lower the total risk of a diversified portfolio will become. This is because as one asset loses value, the other is compensating. A more full, intuitive depiction of why this works is presented here.

2 sets of correlations are presented:

  1. A matrix of correlations of all the different asset classes with each other, presented for beginning of year, prior month, and last month.
  2. Correlations over time of EAFE, bonds, and gold with the S&P 500 dating back to 2001. Note that bonds carry their water in 2008 and 2011 and in times of duress where stocks plummet in value and bonds increase. This is why you want to diversify.

 

1 Response

  1. October 2, 2018

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