With the amount of news, views, blogs, opinions and general chit-chat that abounds in the markets it can become somewhat difficult to form a view on where the macro-economy is headed. For each bull there is a bear and the extremes of both can be bewildering for readers.

Some years ago I watched closely for those indicators that were predicting a slowdown or recession going into 2000 and again I looked for those that predicted a lift in the economy in 2002/3. Surprisingly many indicators did what they were meant to do, they got the direction of the economy correct. What hid a lot of their effectiveness was the “spin” and delay (“we need to see more data”) that was used by the media which stopped people making the correct investment decisions.

Sometimes it’s best to look at the raw data and make your own mind up. Although the future cannot be predicted by looking at the past, it often holds lessons that should not be ignored.

So this week I thought I would share my some of my favourite indicators with you and of course give you my opinion. First up is the Y (blue line) versus the $, Euro and the Dow:

With thanks to Stockcharts.com.

This chart reflects the rise and fall of the aforementioned assets but the one I really like is Y Vs the Dow. Simply put when the Y appreciates the Dow drops and vice versa. This comparison is particularly helpful when Central Bankers, especially the Bank of Japan and the Japanese Ministry of Finance make noises about the level of the Yen.

Interestingly, the last major low in 2008 and the recent peak in the Dow have led the move in the Y. Are Japanese and carry trade speculators attempting to front run the BoJ and MoF? We can benefit by monitoring the next move in the Y to see if it confirms the recent drop in the Dow. If the Y does not rise above the last 2 small peaks, traders may have called this move incorrectly.

Second up is the yield curve. Unlike many commentators, I use my eyes to compare a falling or rising interest rate environment, initiated by Central Banker action, with stock markets. How many times have traders and investors fallen for the line that rate cuts are good for the economy or help stock markets?

Here is the present yield curve for US Treasuries and Bills. The darker the banding, the more recent the rate move. The black line shows the current level:

With thanks to Stockcharts.com

Yields are moving higher across the board but there is a subtle warning in the picture. The short (time duration) end of the curve is rising faster than the long end. The curve is flattening. Markets expect short term rates to rise. If the long end remains anchored, the curve will flatten or invert (and yes, all those who decried the yield curve inversion as no longer “useful” last year were wrong) possibly signalling a double dip recession.

If the long end keeps climbing then bond markets are anticipating a longer period of inflation (in keeping with extended Federal Reserve largesse) and a re-steepening of the curve at higher rates will occur. Credit conditions could remain tight for quite some time yet.

Finally, here is a chart that I check weekly:

(Federal Reserve)

The ability to raise short term funds is essential for banks et al to borrow short and lend long or fund current positions. So far we have seen a deleveraging of such borrowing since mid 2007. That deleveraging is continuing and possibly accelerating in Asset Backed Paper. Credit conditions remain tight and short term lending is only possible due to the Fed and its facilities enabling the rolling of debt by supplying asset (bonds) liquidity. If the yield curve flattens or inverts the use of CP becomes problematic.

From a macro-economic point of view the situation is far from settled and further disruption in credit markets should be anticipated.

Commentary by Mick Phoenix

on behalf of CA Letters

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. The views in the article are for informational purpose only.