Chemical Activity Barometer Signals More Market Gains by Todd Sullivan, Valueplays

“Davidson” submits:

“Its the economy stupid!” is a phrase which came out of President Clinton’s successful run against President George Bush in 1992. That it is the economy is something often used in politics but not in fact understood by investors. The overwhelming majority of investors attempt to pull gains from the investment markets through rapid trading applying the ‘Greater Fool’ philosophy’

‘Greater Fool’ philosophy-No one really knows what something is worth so traders trade in and out of markets hoping to capture small gains in apparent short term tends before the market psychology moves against them.

But, if one looks back on our investment history, I think it becomes clear that even with the misplaced beliefs of the majority of investors it is in fact the economy which eventually drives investor psychology over any multi-year period. This can be seen in the two charts below. The 1st chart shows how the Chemical Activity Barometer (CAB) varies compared to Industrial Production(IP) and Employment(Emp). If you look at the major peaks and valleys, you will see that the CAB is the first to turn at economic lows and peaks with IP turning next and Emp turning last. There is an order to how demand for goods impacts various measures of economic activity. There is predictability!!  It is precisely because chemicals have limited inventory capability and are intermediates to many basic as well as major products in our lives that they are highly sensitive to the pace of economic activity. Reminder: I hold a PhD in Physical Organic Chemistry and in the 1970s worked as an industrial/research chemist at GE Plastics.

Chemical Activity Barometer vs. S&P 500

The 2nd chart shows the relationship of the Chemical Activity Barometer vs. the SPDR S&P 500 ETF Trust (NYSEARCA:SPY). It should be obvious that for the most part the Chemical Activity Barometer (and other economic indicators I have discussed over the years) is highly predictive of significant market lows and peaks if you are an investor not a trader. Being an ‘Investor not a Trader’ places one’s perspective in line with the economic cycle which plays out over a range of 6yrs-10yrs+. It means that month-to-month speculation(or even day-to-day or week-to-week) is simply not part of our lexicon. If one learns to select CEOs and portfolio managers with a high level of skill, then one can hold as long as the economy permits.

Chemical Activity Barometer
Chemical Activity Barometer

Being an ‘Investor not a Trader’ would not have helped one to avoid the market decline of 9/11. If one looks at both charts, it should be clear that 9/11 was a geopolitical event not an economic one. The 2nd chart shows this most clearly as the Chemical Activity Barometer made its low October 2001 and continued in an uptrend after the events of 9/11 even though the markets as represented by the SP500 tumbled on investor fears making its low September 2002. Many investors carried along by market psychology sold out at the market lows while those investors using economic trends not only held to positions even added to positions as reflected in their market comments at the time. Over the long term(3yrs+) the investment markets are propelled by the underlying economics; over the short term(a couple of years) market psychology can prove a greater influence. While the economy has a good level of market predictability, the impact of market psychology is completely unpredictable and not tradable.

Being an ‘Investor not a Trader’ is the approach I recommend.  Investing with the economic trends is the only approach which makes sense to me.