Compass: Canary Gauge Special Edition
14 March 2023
Dear subscribers,
Below you find a special edition of our Compass series introducing our Canary Gauge concept. Note that this kind of content that responds to current events using Swissblock’s proprietary indicators will be available to our upcoming Founders Tier. If you’re interested, please join the waitlist below.
The Founders Tier will launch in the coming weeks. It will be priced at around $150 per month, and its offering will include premium access to signals and metrics from the Swissblock hedge fund.
Let’s dig in!
Back in the early 1900s coal miners used canaries as an early indicator of potential danger or failure. Today, we introduce our framework that uses bitcoin, the business cycle, and liquidity as the canary, which is very much alive and well.
Business Cycle
Most analyses found online stipulate that we are in a recession, or that a recession is imminent, in view of the development of Leading Economic Indicators (LEI). This is somewhat correct as these indicators tell us where the economy is headed, but do not provide the complete picture. It is the combination of looking ahead (LEI) while focusing on the now, Coincident Economic Indicators (COI), and considering the past, Lagging Economic Indicators (LAI), that paints the complete picture.
Below, we show the thought process behind the LEI, COI, and LAI framework and provide a 360-degree analysis of the economy under our Compass layout.
A recession signal has flashed due to the strong decline in LEI. It is clear that a recession is coming, it is only a matter of when. The recession is at least 6-9 months out according to the LEI.
The framework suggests that the recession will be confirmed once the COI caves. At the moment, COI is rather strong. LAI shows a similar picture with today’s CPI print at 6% YoY as expected.
The combination of robust COI and LAI is not characteristic of a recession. However, there is no doubt that one is imminent when looking at the aggressive decline of the LEI.
In the complete report - which you will be able to access soon via our Swissblock Insights Founder Tier- we break down the LEI, COI, and LAI into their subcomponents to understand the dynamics at a deeper level and reinforce our hypothesis. For this report, we deep dive into the labor market (COI subcomponent) to make the case for a bottoming SP500, contradictive of a recession.
Recessions have always been accompanied by massive layoffs in the US economy. At the moment, the US labor market is robust and uncharacteristic of a recession.
Non-farm payrolls remain within the strong (green) zone indicative of an expanding labor market.
The implication of the above is, that the economy is not in recession, and hence we should not expect outcomes in the market that are normally associated with recessions - like a stock market crash in the near term.
Liquidity
Ever since the introduction of QE in 2008, liquidity has been one of the main drivers behind major rallies and the economy. Therefore, we introduce liquidity as the second dimension of our framework to get a better understanding of the state of the economy. From a liquidity standpoint, our framework suggests that we are not in a recession and that a stock market crash is not imminent.
Below, we build the bridge between the business cycle framework and markets via liquidity, starting with our Leading Global Liquidity Index, which has been strongly correlated to equities for the last 2 decades, and finishing with liquidity expectations.
If you wish to receive an update on our Leading Global Liquidity Index and framework join our Founders Tier Waitlist here:
Global liquidity has been retracing ever since late 2021. This was the time when crypto and risk assets started to top out and entered a long decline into October 2022.
However, for the last 4 months, our global liquidity gauge has been turning up again as central banks from around the World step off the hawkish path. The crunch of liquidity has come to an end - for now.
When global liquidity comes back into the system, equities, and indices rally - and vice versa.
Fed follows the US02Y rates closely and based on this, we expect that the Fed will pause any further rate hikes soon. Maybe as soon as at the next FOMC meeting.
We observe in the chart below how negative divergence on RSI preceded the top in rates before the top in 2018. In fact, we have had RSI divergences before every top for the last 15 years.
Notice how bitcoin has taken off as the US02Y started to drop and the Fed paused. We are in that exact same scenario again.
Crypto
Despite being a nascent asset class, we can use bitcoin as another proxy for the state of the economy. A strong bitcoin, like the one we see, is not characteristic of a recession. In fact, with fresh liquidity coming in we expect to see bitcoin rally throughout Q2-Q3 2023.
Bitcoin is very sensitive to liquidity as seen in the chart below. Whenever USD Market Liquidity has gained momentum bitcoin has logged stable or bullish price action (purple areas).
At the moment, USD Market Liquidity is improving as the Treasury General Account decreases and the Fed sells more Overnight Reverse Repo Agreements, and bitcoin sets a local bottom.
Outlook
So, where do we stand today and how can we prepare ourselves for the mid-term (3 months - 1-year outlook)? The business cycle framework is telling us that the supertanker is slowly sinking (LEI turning negative), but is still afloat as seen by the robust COI and LAI.
We believe this sets the ground for a last, aggressive run-up for risk assets, especially with liquidity coming back into the system. With small/regional banks on the brink of collapse in the US, the Fed will be forced to pause and drive risk assets higher.
In terms of crypto, we already see the foundations for the last leg up. The Bitcoin Risk Signal is decreasing fast and altcoins are stabilizing. This has confirmed local bottoms in the past. It is a matter of time before fresh liquidity begins to spill over to the crypto market. However, beware of the daunting correction that follows once we do fall into a recession.