Leading Economic and Stock Market Indicators

1. Leading Economic and Stock Market Indicators

2. Presentation Objective • This presentation talks about leading Economic and Stock Market Indicators which would help investors determine the trend of the Equity Markets and the Economy. • Its impossible to predict market levels, but its very possible to judge the direction in which markets will move in near term. This decision can be made based on the indicators discussed in this presentation.

3. Baltic Dry Index – Economic Activity Indicator • What is Baltic Dry Index? • The Baltic dry index is a measure of shipping activity in dry cargo. It gives the daily average price to ship raw materials. • Dry cargo, whose shipping cost is measured by BDI mainly consist of commodities such as coal, steel, iron ore, copper, cement and others. So any drastic fall in the index indicates slump in demand globally for these commodities and vice versa. • Baltic Dry Index values also have a high positive correlation with the equity markets. Thus, when the BDI increases, there is a high probability that the stock markets would also rise.

4. Baltic Dry Index Chart Chart Source: Bloomberg

5. BDI Chart – Key Observations • The Baltic Dry index peaked out at 11,793 on 20th May 2008. The commodity prices also peaked out at around the same time. • The Baltic Dry Index then crashed to 666 by 4th December 2008. This was the time when the commodity prices hit the bottom and the global economy had slumped during the October to December quarter. It is also worth noting that the equity markets also had a major crash in the second half of 2008. • The Baltic Dry Index is again back to over 3500 levels currently. This is an indication of sparks of upside in economic activity globally. The global stock markets have also moved up significantly after bottoming out in March 2009.

6. TED Spread – Liquidity Indicator • What is TED Spread? • TED Spread is the price difference between three-month futures contracts for U.S. Treasuries and three-month contracts for Eurodollars having identical expiration months. • In very simple words, TED Spread is the willingness of banks to lend to each other and thus also to the consumer. So when the liquidity scenario globally is tight, the TED spread goes up. • In a tight liquidity scenario the economy would slump as credit growth is minimal or negative. Stock markets would also go down as liquidity is one of the major market drivers.

7. TED Spread Chart Chart Source: Bloomberg

8. TED Spread Chart – Key Observations • During the months of September – October the TED spread surged up. This meant that there was hardly any liquidity in the markets and the consequence was a major stock market crash. • The major economic slump also began at around the same time. This prompted governments around the world to go for quantitative easing which subsequently lead to lowering of spreads. • TED spreads currently are almost at pre crisis levels. This means there is ample liquidity in the system. Thus, in near term one can expect a stock market correction but a major crash can be ruled out. There is enough liquidity in the system to support asset markets.

9. Dollar – Relation with Asset Classes • The U.S. Dollar is the prime source of global liquidity. The global economic boom, from the period 2003-2008, was largely fuelled by the excess Dollar flowing from the U.S to the rest of the world. • From 2003 to mid 2008, the US dollar was going down and all the asset classes (stocks, bonds, gold, and commodities) were going up. In May 2008, when the commodity prices peaked out, the US dollar also bottomed out (see chart in next slide). • After the second quarter of 2008, the US dollar started to appreciate and all asset classes collapsed one by one. • After March 2009, the US dollar has again started to show signs of weakness and again stocks and commodities are moving up. So Dollar and other asset class movement share an inverse relationship.

10. Dollar Index Chart Chart Source: Bloomberg

11. Treasury Yields – Money Movement Indicator • Money moves from one asset class to another. • The yields on short term and long term U.S. Treasury bonds are a great indicator of money movement and the perceived economic risk. • When economic and financial markets risks are high, yields go down (as bond prices move up). Money is thus moving from riskier assets (equities & commodities) to relatively safer assets (treasury bonds and gold). • When yields go up, it is indicative of money moving out of Treasury to riskier assets. It is also indicative of an impending economic recovery or inflation.

12. Yield Curve – Economic Direction Indicator • Yield curves track the relationship between interest rates and the maturity of U.S. Treasury securities at a given time. • Yield Curve is often used by analyst because they may provide clues to financial market conditions and future interest rates. By understanding the direction of future interest rates, the strength of the economy can also be gauged. • There are three main patterns of yield curve namely normal yield curve, flat yield curve and inverted yield curve.

13. Normal Yield Curve • This yield curve is formed in normal market conditions. Investors expect economy to grow normally and expect no major fluctuation in interest rates. Long term bonds offer higher yields then short term bonds in this case.

14. Flat Yield Curve • This yield curve suggest that short term and long term rates on bonds are equal. This is generally an indication of confused market conditions, where investors are not sure of the direction of the economy and interest rates.

15. Inverted Yield Curve • An inverted yield curve is when short term bonds have higher maturity then long term bonds. This is generally indicative of weak future economic conditions. Hence investors are willing to settle even for lower yields on long term bonds.

16. Humped Yield Curve • A humped yield curve is generally during a transition from normal to an inverted yield curve. Thus, a humped yield curve is an indicator of a coming recession.

17. Credit Growth – Money Multiplier

18. Credit Growth – Implications • Money is essentially Debt. Had there been no debt there would have been no money. • Debt creates money in the system and this spurs economic activity and consumption. • U.S interest rates have fallen but banks are still not lending. This is indicated by declining credit growth in previous chart. • Reversal in credit cycle signals: • Improving health of banks • Higher economic activity through consumer spending or industrial growth.

19. Volatility Index – Market Uncertainty Indicator Chart Source: Bloomberg

20. Volatility Index – Market Uncertainty Indicator • The Volatility Index (VIX) is a measure of market risk and is often referred to as the “Investors Fear Gauge”. • VIX value of above 30 is generally indicative of large amount of volatility owing to investor uncertainty. • Investors can avoid taking positions in times of high VIX (volatility) as such times can easily erase 30-40% of investors capital in a matter of days. • Example : The VIX went up to around 75 after the collapse of Lehmann Brothers. That was one of the worst times for all investors globally.

21. Consumer Price Index – Demand and Inflation Indicator Source: BLS

22. Consumer Price Index – Implications • In a weak economy the CPI would typically fall as demand for goods and services slumps. This in turn is bad for the equity markets. • As there are hints of recovery in an economy, the CPI would generally rise indicating higher demand as well as inflation pressure. • This is positive for equities because of two reasons • The increase in demand would lead to higher GDP growth and hence an economic recovery. • As inflation expectations increase, investors would look to move to relatively riskier assets such as equities. This would give them higher returns which would beat inflation. Source: BLS

23. Consumer Spending – Backbone of the Economy

24. Consumer Spending – Backbone of the Economy • Consumer spending accounts for 73% of the U.S. GDP • Growth in consumer spending would spur economic growth • Growth in exporting nations like China largely dependent on Consumer spending • Government spending data gives clues on direction of economy • Consumer spending numbers also help in estimating the performance of consumer goods related stocks. Positions can be taken in them accordingly

25. Consumer Confidence Index – Sentiment Indicator • Consumer Confidence Index (CCI) is a monthly release from the Conference Board. It helps understand the financial health, spending willingness and overall confidence of an average consumer. • Important in a consumption driven economy. A high CCI can drive equity markets by making investors more willing to purchase equities on the back of improving economic activity and sentiments. • CCI has historically been a good indicator of consumer spending and hence the GDP. Tracking the monthly numbers can help making equity investment decisions.

26. Unemployment Report – Private Sector Weakness Indicator Chart Source: BLS

27. Unemployment Report – Private Sector Weakness Indicator • In a weak economic scenario, the government sector can expand while the private sector goes on contracting. For a healthy economic recovery the private sector should also start expanding. • Unemployment report gives an indication of jobs lost and hence a ongoing contraction in businesses. • Unemployment creates reduced spending on luxury and also to some extent on necessity goods. This drives down consumer spending which in turn affects GDP growth. Unemployment rate was 9.5% in June 2009. Expected to go up further.

28. Other Indicators • Major Sector Productivity and Cost Index (http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=PRS85006092) • Advanced Monthly Retail Trade Report (http://www.census.gov/retail/) • Producer Price Index (http://www.bls.gov/news.release/ppi.toc.htm) • New Residential Construction (http://www.census.gov/const/www/newresconstindex.html)