Watch These Leading Indicators!

Issue #412: Monday, March 16, 2009

By Sean Hyman For about the last year and a half, readers have been constantly asking the same question. They all want to know when this “credit crunch stuff” will be over. It’s a great question and deserves a response.

Let us a look at this issue for a moment.

While no one can give you the exact day or time that a crisis will end (and if they try, you can trust they’ll be flat-out wrong), there are what I call “sign posts” that will give you clues along the way about when this crisis will finally end.

These sign posts will tell us when the worst is behind us and when things are returning to some semblance of normality once again.

First, let’s examine the problem. A great deal of our worldwide recovery depends on banks and mortgage lenders because that’s where so much of this mess started.

For one, banks will need to learn to trust each other once and trust their customers, so they can start lending freely again. Some analysts maintain that this is already beginning (at the EXTREME early stages). And I must say I tend to agree with them.

Why do I say that? Well, the charts that show bank liquidity are beginning to show signs of improvement. Liquidity is slowly starting to rise. This means the fears are starting to die down, as a result. Notice I said, “starting.” We’ve still got a ways to go. But how can I say this may have started?

I look at a couple of things. One is called the TED spread. It’s the difference between the interest rates on interbank loans and short-term U.S. government debt (T-bills). When this difference (spread) is high, so are the fears in the lending market.

Check out a recent chart of the TED spread below.

The TED Spread Plummets Finally!

So this is one indication that the crisis is starting to settle down a bit. However, another indicator seems to back this up as well: LIBOR rates.

LIBOR rates are a daily reference rate based on the interest rates at which banks borrow unsecured funds from banks in the London wholesale money market (or interbank market).

Note the huge drop there as well in the last few months.

Therefore, things are starting to thaw out in the markets…slowly. Now keep in mind, these things take time, and they could only get worse before they get better. But at least for now, it appears the data is improving slightly.

Even the fears in the stock market are starting to die down off of their highest levels too. This can be seen by looking to the VIX index, otherwise known as the “fear gauge” in the markets. This fear gauge hit a never-before-seen reading of 90 just months ago. However, today it sits at around half of that level.

Here are the Final Pieces of the Puzzle that Have to Fall into Place

So what do we need from here to complete the picture? In other words, what are the final pieces of the puzzle?

Like my colleague, Chuck Butler often says, it all comes back to these indicators right now. In this case, it comes back to housing and employment. This crisis will continue until we see Existing Home Sales numbers normalize and a decline in the Weekly Jobless claims (which have still been climbing recently).

An improvement in just these two areas could collectively normalize the major stock indices. Once we see these last few pieces of the puzzle come together, then we’ll be at least headed out of the woods if not out of the woods completely. However, at this point, we’re not out yet.

Once we see the housing market stabilize then we will have proof that people can get loans once again on a major scale. Once the weekly jobless claims start to fall, then we’ll know that corporate America can start to heal. And once all of this starts to happen, you will see stocks finally calm down.

This will start to process of wealth building once again. When that happens, you will see more consumer spending spur on economic and corporate growth.

So keep your eyes open for these final pieces of the puzzle to fall into place. In other words, follow the clues and you’ll have a better indication of when the markets could finally stabilize.

I believe currencies will preemptively jump slightly ahead of all of this cycle. You can see this happening already. The yen, the major “risk-adverse currency” is starting to lose its luster even now as things begin the long process of getting back to normal. It probably won’t be too much longer and you’ll see the dollar follow suit.

The USD/JPY has already come off of its lows and FXY (the yen ETF) has started to arch over. So get ready for a shifting in currency, which could come even a bit sooner than the turn, comes for stocks.

Best Regards,
Sean

Sean Hyman, “Professor FX” and Long-Time Currency Analyst Explaining How You Can Succeed in the Currency Markets.
Sean Hyman spends his days teaching his fellow professionals in the industry how to trade the $4 TRILLION currency market. Now he brings his 15 years of financial experience to you. From long-term currency strategies, to quick FX-trading moves usually reserved for the professionals, Sean will tell you everything you need to know to succeed in the currency markets.