Thursday, 31 May 2012

Big Macro Picture 2011 - The "How We Analyse" Tutorial

Diving straight into analysis for Wednesday May 30th 2012 would probably be confusing without explaining how we analyse economic and market trends in practice.

So instead, as a tutorial article, we'll explain how we navigated 2011 - what we got right, what we got wrong, and what we learnt. Then for context, we'll run a similar "2012 so far" article to explain what we're looking at today. The previous two articles might help shed some light on how we view the markets on different timeframes.


The start of 2011. The S&P is around 1257. The Dow at 11577. The FTSE opens the year in the ballpark of 6000, the highest point since mid-2008. The new bull cycle is almost 2 years old, having begun in March 2009, the bottom of the bear market at the peak of the financial crisis. The leading economic indicators start showing signs that the real economy is troughing in January 2009, with the probability increasing to confirmation by April.

We will explain these indicators shortly - the important thing to note is that at this stage of our story, the start of 2011, confidence in the market is high in the broadest sense. A typical Santa Claus rally has pushed the market to new highs in the bull cycle.

Our "LONG TERM" analysis, that we are in a bull market, is unchanged from 2009 or 2010. We have no doubt of this in January 2011 - and only once in 2011 do we run the risk of questioning it. Our focus in this article will be on what we describe as "MEDIUM TERM" analysis, attempting to navigate the cycles of the market on a month-to-month basis. There isn't much point of using examples of "SHORT TERM" Daily chart analysis as we go along, other than at critical points.

EARLY 2011

We'll start our medium term analysis with some context from a bullish percentage chart. This is a market breadth indicator, useful for short to medium term market analysis, which you can read more about at Analysts use this indicator in a variety of different ways - we use it to confirm questions such as "is the market overcooked in the short/medium term?", "is it a good time to be entering medium term long/short trades?", "what is the prevailing market mood?".

Bullish Percentage Index for the New York Stock Exchange - a brief explanation is given at:

This is how the weekly chart looked as we entered 2011, courtesy of, with a 20 week moving average. In a strong market, such as 2009-2010, the indicator is capable of entering the "overbought" condition (over 70) and staying there for a prolonged period, entering the 80%-90% level. That we are over the 20 week MA indicates that the market is very strong, but at 80%, inevitably will be prone to a pullback. From this potentially "overheated" level, we note that if this indicator peaked, dipped back below the 70s, and especially if crossing under the 20MA, we'd have good reason to reduce market exposure at each of those stages.

For measuring short term fear and greed in the market, the "overcooked" indicators (usually over 70 or below 30) might tell us we want to be cautious about adding positions. But the trend, the relationship with the 20MA and the direction of the moving average also serve to highlight market momentum and sentiment. We see it troughed in July 2010 and closed above the 20MA in September, the Dow and S&P increasing 16-17% between then and the start of 2011. Depending on the degree of conviction, as UK investors, a MEDIUM TERM trade in XSL2 (db 2x S&P ETF) might have garnered 32% over that time period, to illustrate an example of how we might use this analysis.

At Big Macro Picture, we review over 100 leading economic indicators each month. We do this both to evaluate our rarely-changing LONG TERM stance, but also because economic momentum is important to global equity markets in the MEDIUM TERM. The stock market is constantly looking forward, concentrating on whether conditions for businesses will improve or decline in the next quarter. This "quarter to quarter" mentality is what enables us to buy stocks cheaply for the LONG TERM accounts when the short-sighted market drives equity prices down. But in the MEDIUM TERM, instead of playing the contrarian against Mr. Market, we try and anticipate what will drive his mood swings (see The Intelligent Investor by Ben Graham, or Joel Greenblatt's Magic Formula books for more about the Mr Market analogy).

Some say this is impossible - at Big Macro Picture, we disagree. We believe it is difficult, but reliable enough to make informed trading decisions and navigate difficult market conditions. With thorough, on-balance evaluation of forward-looking indicators, it may be possible to roughly anticipate month-to-month market cycles, and develop strategies to identify the regions, industries or sectors likely to outperform others. This form of analysis is often subject to opinion, preference and experience in dealing with each of the indicators -- which is why we place so much focus on this type of analysis. Conditions, and our conclusions, can change very quickly as new data is released to the market. At Big Macro Picture we want to present these broad viewpoints as they develop in real-time, as part of our "MEDIUM TERM" analysis.

Back to early 2011. This article will be long enough as it is without mentioning the approximate 1200 data releases for the year, so we'll save the majority of our economic indicators for future articles.

One of the most significant MEDIUM TERM indicators we look at is the Purchasing Managers Index for each of the major regions (United States, Europe, Asia). These are released around the 22nd of each month for China and Europe, and on the 1st for the UK and United States. Here is how they lined up in early January 2011 - courtesy of the excellent ForexFactory calendar.

Global PMI Data for 2007-2011, charts from

We note that in line with the market's strength, many of the global PMIs are making new highs in their current trend. The exception is China - and missing from the above image, Australia. Although generally still in an uptrend since mid-2010, we take note that it has missed expectations and failed to make a new high. These are just a handful of the 100+ indicators released each month which we take into account - but it reflects the attitude in the BPNYA indicator. Our MEDIUM TERM signals are bullish, but in market terms, possibly reaching an overbought level. We take note of the Chinese and Australian data which has peaked for the time being, and start asking whether it is a blip or a leading indicator for a decline. We wait for the next piece of data in February to give us more insight.

Our mentality may be to continue buying the dips in major US indices for short term trades, depending on what the SHORT TERM technical analysis indicates is likely in terms of momentum and significant price levels. As we'll discuss later, we prefer to use Ichimoku Cloud technical analysis with moving averages to evaluate significant price levels and market trends in the short/medium term.


We gain another 5% on US indices and another 3% on the FTSE as we move into mid-February. Over the same time period the Chinese Hang Seng rallies briefly before ending the same period down around 1-2%. The trends in data mostly continue, with Chinese PMI disappointing again while European and US equivalents reach new highs in their current trend again.

However, expectations and market optimism seemingly catch up with major indices. With the Arab Spring, rising oil prices and tragedy in Japan, confidence and global economic activity for 2011 appears to peak between March and April. The BPNYA indicator peaks, and slips below its 20 week MA in March.

Below shows how these cyclical indicators were performing by early June, keeping in mind that meanwhile, the market continued to hover near the highs for the year.

A new trend (red line) forming - but not yet reflected in the stock market?

Other PMI charts that could have been included - Italian Manufacturing and European Manufacturing would show very similar conditions - starting new downward trends in April. China Manufacturing PMI meanwhile demonstrated that concerns at the start of 2011 were well founded, indicating a decline which would continue until the end of 2011. The BPNYA meanwhile significantly deteriorated from February onwards, despite the S&P making new highs in May, and rallying into July.

Is any of this useful? How can an investor or trader make use of this analysis? The majority of market participants in early 2011 were optimistic, investor confidence surveys (another leading indicator which we use at Big Macro Picture) peaked in March 2011 at highs unseen since 2007. Had they seen what we see here at Big Macro Picture, their confidence might not have been so misplaced.


When leading MEDIUM TERM indicators begin telling us the market is missing something, we often say that we will start "taking leads from the technicals", ie SHORT TERM analysis to evaluate whether our suspicions are starting to play out in reality. This can serve as confirmation (to open new trades or close existing ones), a signal to change our market exposure (either positively or negatively), or for some investors to completely stop trading until further notice (if for example they are long-only, and we get confirmation of bearish signals across multiple timeframes). It simply adds another layer to our broad base of analysis - at all times we want to know what areas are likely to be significant as price targets or triggers on the Dow, S&P and other indices.

A very roughly annotated chart for "SHORT TERM" category analysis.
Check out Youtube for helpful explanations of Ichimoku Clouds - and Oscar Carboni's videos for a similar day-to-day TA style to ours.

In June, Ichimoku trend analysis flagged a fake short term bearish signal as we broke through the blue 2009-2011 trendline - but found support at the green trendline from the "flash crash" and summer 2010 lows. We rallied back up to near the 2011 highs before viciously selling off  - crashing through previous support and the 200 day moving average. A variety of different TA methods could be used for the short term chart analysis (momentum, CCI, fib levels, support/resistance etc), much depends on your personal preference.

Most importantly, it served to confirm our worries about the market earlier in the year, when leading indicators and market analysis diverged from the overly-optimistic market.

The MEDIUM TERM analysis continued to indicate a worsening condition as the SHORT TERM indicators confirmed them. On August 1st, the ISM Manufacturing PMI was even lower than expected, alarmingly near recessionary levels. UK Manufacturing PMI indicated recessionary forward-looking conditions, having peaked in February and now dipped below 50. EU and Italian Manufacturing told the same story, barely above recessionary levels having peaked and declined in a straight line since March. HSBC China PMI fell below the 50 line also, continuing the slowdown in real economic activity since the start of the year.

The market entered a mode of panic, clear to see from the oversold BPNYA indicator in August-October, which collapsed to 20%. Volatility became extreme, with several hundred point moves almost every day on the Dow.

Attempting to navigate such market conditions is dangerous, and at Big Macro Picture, we take the view that volatility should be met with extremely reduced position sizes - and adequate risk management for any position. In terms of our analysis, in mid/late October we started to see some early signs of market strength.


On the above charts we can see that by taking our leads from technical analysis, we note that for the first time since August, we have a close in neutral territory (the Ichimoku cloud). Shortly afterwards, in mid-October the BPNYA chart shows the indicator troughing - moving out of oversold territory - and closing above the 20 week moving average.

We should note that this is not explicitly a buy signal - merely a sign of underlying market strength from our SHORT/MEDIUM term market and technical analysis, within a very volatile market. We begin evaluating the possibility that for the time being we've seen a market bottom, or at the very least, we start to look for attractive investment opportunities for our long-term accounts. In later articles we will go into greater detail about our investment selections for different timeframes.

In terms of the leading economic indicators we're covering in this article, the ISM Manufacturing PMI did not record a lower low in the October reading, but spent August-November hovering around the 50 level. The severity of the market's decline indicated the market's expectation of a double dip recession in the United States, as noted by analyst expectations of a 48.7 reading in September. We mentioned at the start of the article that only once in 2011 did the LONG TERM "bullish" signal from 2009 come under threat -- if the majority of global PMIs had moved beneath 50, it might have marked the start of a new bear market.

Having made an astonishing 20% move in a few short months, and reached oversold levels relative to the real economy, any signs of stabilising forward-looking economic indicators would help the market bounce, and perhaps recover.

THE END OF 2011, START OF 2012

Signs of stabilisation were apparent in the US first, which remained the most resilient economy throughout the European-centric issues of 2011. We note that it did not signal recessionary or contractionary conditions at any point in 2011 - simply a marked slowdown in activity. In Europe, the decline was far more pronounced, and leading indicators continued to decline until the end of the year.

Gradually, both the indicators mentioned in this article and our other favourite leading economic signals began to support the idea of economic recovery between October and the end of 2012. Meanwhile, as we become more convinced of the underlying divergence between the volatile market and the developing new economic trend (green line), the bullish percentage indicators were in support.

We can see that from our original flag as the BPNYA broke above the 20 week moving average in October, the market strength persisted into the end of the year. However, the chart below shows the risk inherent in making bold investment decisions in volatile markets.

Looking at the SHORT TERM category of analysis, we might been convinced to add tentative market exposure after the close above the Ichimoku Cloud and above the previous swing high at 1230 on the S&P. There we see the danger of making bold decisions during volatile market conditions - the S&P strongly rejected its 200 day moving average on four occasions from October onwards, before seemingly closing above it consistently at the start of 2012 - when the majority of our leading indicators confirmed "with confidence" the new trend in the market.

This often is how our analysis forms - when a new trend is beginning, we get the grass-root leading signals from the first of our indicators, which we wait to be confirmed over time by the other regularly released economic releases. We look forward to explaining what these different indicators are in later articles.


2011 was an astonishing year to be an investor or trader - and the perfect year for this type of tutorial into how the Big Macro Picture's broad analysis works. Perhaps most surprising is that the S&P closed 2011 within 1pt of where it finished 2010 - despite being up 8% in May and down 15% in October.

Our longest timeframe of analysis was unchanged (refered to as the category "LONG TERM" during articles), as it was unchanged since 2009 -- a continued bull cycle.

Number of LONG TERM trends: 1

Our medium term timeframe analysis, which we refer to as "cyclical analysis" (and "MEDIUM TERM" during articles), began 2011 as continued bullishness from 2010 - but gradually faded from February-March onwards. Our skepticism turned to bearishness gradually as we took into account the mounting evidence of divergence between the market and leading indicators. This intensified from June onwards and culminated in the extreme volatility after August. Despite the ongoing market volatility, from October onwards this trend started to reverse - both in terms of the market's underlying strength, and the leading indicators. Only by the beginning of 2012 could we have much confidence in this new trend, as other leading indicators began to confirm it - but the first signs started to appear in October.

Number of MEDIUM TERM (cyclical) trends: 3

The SHORT TERM analysis at Big Macro Picture serves as a guide rather than "signals", a series of potential outcomes and important levels for the market, for evaluating market trends. However, for confirmation we begin taking leads from the technicals once we feel reasonably confident in our MEDIUM TERM economic and market analysis. In June and more significantly in August, we took the market sell-offs to be more significant than ordinary market pullbacks. In October, and more significantly in December, we began to believe the rallies to be more than just random volatility. Both sets of views were aided by SHORT TERM analysis.

And that just about summarises the year 2011! A pretty formal evaluation in under 3000 words. Keep in mind though, that over the course of a year, with over 1200 relevant economic indicators to consider each month, we're barely scratching the surface in this brief review. At Big Macro Picture, we like to be thorough, objective and balanced when analysing market and economic conditions.

This serves as an introduction to the sort of analysis you can expect from us. In the coming days we'll present the sequel - 2012 so far - which should bring us right up to date with our current analysis for June 2012. 

Please don't hesitate to contact us via the comments section or at:

Thanks for reading.

Mark A. Rogers
Big Macro Picture (founder)

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