Trying to understand the business cycle is tricky. There are hundreds of indicators used to try to predict the business cycle, including the slope of treasury curves, PMI, home sales and retail sales among many others.
We propose a different approach. One based on the idea of a beauty contest by John Maynard Keynes:
"It is not a case of choosing those [faces] that, to the best of one's judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees." (Keynes, General Theory of Employment, Interest and Money, 1936).
So, let’s recreate this idea of a beauty contest. First, let’s create a jury of three types of traders: Bond, Metal and Equity, in order to try to understand what the market is thinking about the business cycle. The Macrowise business cycle GPS covers more than 100 ratios across a multitude of industries and uses machine learning to make better forecasting. In this free version, we show a few of these signals with interesting results:
Bond Traders:
Bond traders think the business cycle is rebounding from the lows of 2019. PMI is a lagging indicator with respect to the signal of bond traders captured in the ratio of the High Yield Index and the Long Term US Treasuries Index.
Equity Traders:
Equity traders are expressed in the ratio between industrial stocks and consumer staples and believe we are still in a contractionary period of the business cycle.
Metal Traders:
Metal traders expressed by the Copper/Gold ratio and are thinking that we are still in the contractionary part of the cycle. The Zinc to Gold ratio is giving the same signal.
The three indicators have a high probability of mean reversion within the next 150 days.
Fernando Gudiño
Guillermo Valencia
Macrowise
February 7, 2020