Hello ladies and gents,
Since my last publication, I’ve dived into learning new things in the world of investing. The main driver for it was because I was trying to better understand what on Earth is going on in the stock market these days… it’s been pretty choppy lately if you haven’t realized.
Because your time is precious, let’s get to the bottom line. This should be insightful for you if you’re looking to manage your investments more actively or are trading options/stocks.
Otherwise, dollar-cost averaging the S&P 500 index over a long time horizon is the best if you don’t want to care about shorter-term price movements. I wrote an article on it here.
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Here’s what I’ll be covering should you read on:
4 Different Market Regimes
How to trade/invest in each market regime
4 Different Market Regimes
In essence, stock markets are affected mainly by economic growth and inflation. (because stocks listed on exchanges are also real-life businesses)
The Four Market Regimes:
1) Inflation —> Growth ⬇️, Inflation ⬆️
2) Deflation —> Growth ⬇️, Inflation ⬇️
3) Reflation —> Growth ⬆️, Inflation ⬆️
4) Goldilocks —> Growth ⬆️, Inflation ⬇️
Barring a major black swan event like when Covid-19 crashed the markets, under normal circumstances, the rate of change of growth or inflation will lead to a change in market regime.
Some of the growth/inflation indicators I’ve learned to look out for (let me know if there are more useful ones):
Economic growth indicators: purchasing manager index (PMI), new home sales, retail sales, non-farm payroll report, job openings.
Inflationary indicators: consumer price index (CPI), interest rates/long duration bond yields, personal consumption expenditure (PCE), oil prices, commodity prices
How did the 4 regimes play out since the 2020 market crash?
Looking back on 2020, when Covid-19 crashed the US stock market in February-March, the stock market was in a deflationary regime. After which, with the help of large stimulus packages, the stock market transited into Goldilocks as economies started recovering and then towards the end of 2020 to February 2021 it transited to reflation regime as supply chains couldn’t keep up with the reopening growth rate of economies causing raw material prices to soar which affected almost every other’s sectors pricing. When inflationary indicators peaked in June, the US market transited back into Goldilocks as the rate of change of inflation decelerated.
In recent weeks and months since June, we’ve been seeing economic growth start to slow in the US together with continued deceleration in inflationary indicators. It could be possible that we may go into the deflation regime if both economic growth and inflation continue to decelerate or drop sharply. However, with the continued existence of the FED’s backing of quantitative easing and liquidity, do not rule out other market regimes. (This is my personal take after deep-diving into this topic, remember to do your own due diligence before investing your money)
How to trade/invest in each market regime
1) Inflation —> Growth ⬇️, Inflation ⬆️
Equity Sectors (Brackets represent the related US ETFs):
Utilities (XLU), Healthcare (XLV), Real Estate (XLRE), Consumer Staples (XLP), Communication Services (XLC), Defensive (SPY), Low Beta, Mega-Cap Growth (MGK), Bitcoin (BTC), Gold (GLD)
Generally, economic sectors/business that can command pricing power is good in inflationary times. *Low Beta simply means stocks that don’t fluctuate much in price.
2) Deflation —> Growth ⬇️, Inflation ⬇️
Equity Sectors:
Cash/USD (UUP), Long Duration Bonds (IEF, TLT), Utilities (XLU), Real Estate (XLRE), Consumer Staples (XLP), Consumer Discretionary (XLY)
Usually, in a deflationary environment, everything sells off initially so cash is king. But if you’d still want to be invested, the other sectors especially long-duration bonds are good to be in.
3) Reflation —> Growth ⬆️, Inflation ⬆️
Equity Sectors:
Technology (XLK), Industrials (XLI), Financials (XLF), Consumer Discretionary (XLY), Energy (USO, OIH), small-cap growth (IWO/ARKK/ARKG), cyclical, high beta, Bitcoin (BTC), Gold (GLD)
*high beta stocks are ones that are heavily influenced by economic conditions
*cyclical stocks are ones that are influenced by economic cycles
4) Goldilocks —> Growth ⬆️, Inflation ⬇️
Equity Sectors:
Technology (XLK), Financials (XLF), Consumer Discretionary (XLY), Materials (XLB), Industrials (XLI), Bitcoin (BTC)
Goldilocks and Reflation regimes are probably the best regimes to trade or see price increases across many sectors/stocks.
I’ll end this article by thanking Darius Dale from 42macro for sharing his data-driven insights. Check him and his work out here.
You may also check out my full list of resources where I learn here.
As always, invest safe and I hope this has helped you!
Feedback and comments are welcomed always!
Have a great week,
Justin