This is a timely post. The pseudonymous Jesse Livermore is one of the finest writers in finance, and one of his most interesting series of posts relates to predicting recessions. Why that may be important I’ll get to at the end.
In Growth and Trend: A Simple, Powerful Technique for Timing the Stock Market, he goes into detail on the subject of momentum and trend following, essentially strategies attempting to identify periods of weakness in markets to proactively reduce exposure and risk (and increase risk in periods of anticipated strength). There is no shortage of money managers that have built whole careers on strategies like this, although Jesse also goes into detail about when and why a strategy of this style will not work.
He also touches on the importance of economic growth (particularly recessions) in determining the success of such strategies. This is a key differentiator of Livermore’s post, along with the earlier in-depth analysis of why we’d even expect a strategy like this to work instead of just taking that as a given.
In In Search of the Perfect Recession Indicator, Livermore builds on this analysis to put together an elegant strategy that relies on just two inputs (unemployment and the S&P500) and delivers excess returns, half the maximum drawdown, and lower volatility than simply owning the stock market. The best part is that it spends nearly 90% of the time fully invested in the market. There’s no point in having a strategy if you aren’t going to have the time to monitor and implement it.
Why is this timely? The last time the model actually gave a signal was 2008. Subsequently, the last time we came very close was early 2016, which had any number of pundits making recession calls and expecting the worst. My own personal view was that we were headed there as well. Funny enough, though we flirted with a sell signal, it never came, and the market soared another thousand points in the following three years.
We now sit right at the edge of a sell signal once again. On my work PC, it’s already here, though Jesse’s stated he doesn’t include the current month’s data in his calculations. Either way, we appear to have tip-toed up to a boundary that has captured major drawdowns in market history. There’s no guarantee that we’ll trigger it or that the same results will follow, but it is absolutely worth reading Jesse’s writing on the topic and considering whether you find it convincing yourself and how you might use it. I’m personally not one to do anything in an all-or-nothing approach, but I expect to continue to pivot towards safety should we see this develop in conjunction with the already elevated concerns of my other favorite writers in the space. I’ll highlight the other main financial writers that I follow in future posts.