How to Avoid the Big Market Downturns

david-frazierIn my last educational article, I gave a few examples of how using a combination of fundamental and technical analysis can help one to achieve superior investment results.

In this article, I discuss ways in which investors can use fundamental economic indicators to profit from the major upturns and to avoid the big downturns in the financial markets.

Let’s began by briefly reviewing a few of the economic indicators that are discussed regularly by the general financial media and many of the so-called financial market “experts”. Those indicators include personal spending, personal income, newly-created jobs, gross domestic product (“GDP”), and interest rates.

Although the economic indicators mentioned above are very significant, all of those indicators are coincident indicators, meaning that they provide information only on what is happening currently or in the very recent past. But, they provide little, if any, information on what’s likely to happen in the future.

That’s a very important difference because staying abreast of the readings on coincident indicators will rarely, if ever, help you to generate big returns or to protect the value of your portfolio.

Related: 5 ways to protect your portfolio—and profit—when the Fed raises rates.

In contrast, monitoring the readings on some key leading economic indicators will enable you to profit from the major upturns and to avoid the big downturns in the financial markets. Those indicators include the following:

  • Non-defense capital goods orders
  • Household installment debt
  • The ratio of business sales to business inventories
  • The Institute of Supply Management’s (“ISM”) Purchasing Managers’ (“PMI”) Index
  • The ISM Suppliers Deliveries Index
  • Corporate profits

As you can see from the charts below, stock prices in general, as measured by the S&P 500 Index, tend to move in the same direction as the leading economic indicators outlined above and to peak and bottom at about the same time as the readings on those indicators peak and bottom.

Although that’s not always the case, I’ve found over the past 25 years that stocks do tend to peak and bottom at about the same time that a weighted-average of the leading indicators mentioned above (and several other indicators that my firm monitors on a regular basis) peaks and bottoms.

For example, the S&P 500 Index peaked only three and a half weeks after my firm’s Buy-Sell Index, which is derived from the readings on 23 leading economic indicators, registered a sell signal on September 14 2007. Over the ensuing 17 months, the S&P 500 fell a whopping 57 percent while investors who adhered to the readings on my Buy-Sell Index were able to avoid that catastrophic downturn.

And, the S&P 500 Index bottomed only four weeks before our Buy-Sell Index registered a buy signal on April 3, 2009. Since then through May 29 of this year – when my Buy-Sell Index registered another sell signal – the S&P 500 had gained 185 percent.

Although you might miss out on some minor stock market gains by adhering rigidly to the readings on leading economic indicators, you’ll likely avoid any substantial downturns in the financial markets by monitoring and reacting appropriately to the readings on those indicators.

Hence, you’ll be able to sleep comfortably while others are panicking. And, you’ll have much more money to put back to work in the markets once those indicators bottom and suggest that stocks will trend higher.

Editor’s Note: Will you have enough money to retire?

In regard to the current investment environment, the readings on numerous leading economic indicators, including the ones that compose my firm’s Tactical Asset & Sector Allocation Model (and associated Buy-Sell Index), suggest that stock prices, in general, will trend lower over the next few months.

Meanwhile, the readings on the majority of technical indicators that compose my firm’s stock market forecasting model, which I plan to discuss in my next educational article, are also in negative territory.

Those indicators include the cumulative advance-decline line for the New York Stock Exchange, the percentage of NYSE-trade stocks that closed recently above their respective 200-day moving average, and cash flows into (or out of) stock mutual funds.

Until next time,

David Frazier

David Frazier is President and Chief Market Strategist of Frazier & Mayer Research, LLC, an independent investment research firm that offers customized research and analytical services to registered investment advisors, hedge funds and high net-worth individual investors. You can check out his latest insights at: