The Investment Clock

26 ביולי 2022

The Investment Clock was most likely introduced to the general public in a research paper distributed by Merrill Lynch. It’s a simple yet useful framework for understanding the various stages of the US economic cycle and which asset classes perform best in each stage.

The Investment Clock splits the business cycle into four phases, where each phase is comprised of the orientation of growth and inflation relative to their sustainable levels:

• Reflation phase (6:01 to 8:59): Growth is sluggish and inflation is low. This phase occurs during the heart of a bear market. The economy is plagued by excess capacity and falling demand. This keeps commodity prices low and pulls down inflation. The yield curve steepens as the central bank lowers short-term rates in an attempt to stimulate growth and inflation. Bonds are the best asset class in this phase.
  
• Recovery phase (9:01 to 11:59): The central bank’s easing takes effect and begins driving growth to above the trend rate. Though growth picks up, inflation remains low because there’s still excess capacity. Rising growth and low inflation are the Goldilocks phase of every cycle. Stocks are the best asset class in this phase.
  
• Overheat phase(12:01 to 2:59): Productivity growth slows and the GDP gap closes causing the economy to bump up against supply constraints. This causes inflation to rise. Rising inflation spurs the central banks to hike rates. As a result, the yield curve begins flattening. With high growth and high inflation, stocks still perform but not as well as in recovery. Volatility returns as bond yields rise and stocks compete with higher yields for capital flows. In this phase, commodities are the best asset class.
  
• Stagflation phase (3:01 to 5:59): GDP growth slows but inflation remains high (sidenote: most bear markets are preceded by a 100%+ increase in the price of oil which drives inflation up and causes central banks to tighten). Productivity dives and a wage-price spiral develops as companies raise prices to protect compressing margins. This goes on until there’s a steep rise in unemployment which breaks the cycle. Central banks keep rates high until they reign in inflation. This causes the yield curve to invert. During this phase, cash is the best asset.
  

Additional notes from Merrill Lynch:

• Cyclicality: When growth is accelerating (12 o'clock), Stocks and Commodities do well. Cyclical sectors like Tech or Steel outperform. When growth is slowing (6 o'clock), Bonds, Cash, and defensives outperform.
  
• Duration: When inflation is falling (9 o'clock), discount rates drop and financial assets do well. Investors pay up for long duration Growth stocks. When inflation is rising (3 o'clock), real assets like Commodities and Cash do best. Pricing power is plentiful and short-duration Value stocks outperform.
  
• Interest Rate-Sensitives: Banks and Consumer Discretionary stocks are interest-rate sensitive “early cycle” performers, doing best in Reflation and Recovery when central banks are easing and growth is starting to recover.
  
• Asset Plays: Some sectors are linked to the performance of an underlying asset. Insurance stocks and Investment Banks are often bond or equity price sensitive, doing well in the Reflation or Recovery phases. Mining stocks are metal price-sensitive, doing well during an Overheat.
  

About the indicator:

• This indicator suggests iShares ETFs for sector rotation analysis. There are likely other ETFs to consider which have lower fees and are outperforming their sector peers.
  
• You may get errors if your chart is set to a different timeframe & ticker other than 1d for symbol/tickers GDPC1 or CPILFESL.
  
• Investment Clock settings are based on a "sustainable level" of growth and inflation, which are each slightly subjective depending on the economist and probably have changed since the last time this indicator was updated. Hence, the sustainable levels are customizable in the settings. When I was formally educated I was trained to use average CPI of 3.1% for financial planning purposes, the default for the indicator is 2.5%, and the Medium article backtested and optimized a 2% sustainable inflation rate. Again, user-defined sustainable growth and rates are slightly subjective and will affect results.
  
• I have not been trained or even had much experience with MetaTrader code, which is how this indicator was originally coded. See the original Medium article that inspired this indicator if you want to audit & compare code.
  
• Hover over info panel for detailed information.
  

Features: Advanced info panel that performs Investment Clock analysis and offers additional hover info such as sector rotation suggestions. Customizable sustainable levels, growth input, and inflation input. Phase background coloring.

⚠ DISCLAIMER: Not financial advice. Not a trading system. DYOR. I am not affiliated with Medium, Macro Ops, iShares, or Merrill Lynch.

About the Author: I am a patent-holding inventor, a futures trader, a hobby PineScripter, and a former FINRA Registered Representative.

26 ביולי 2022

הערות שחרור

Critical Update: Definitions of the four phases.

Other Updates: Colors. Settings menu. Tooltip typos. Code cleanup.