Macro-Markets Risk Index: Business Cycle Risk Remains Low

by: James Picerno

US economic conditions remain relatively stable after a sharp but so far brief deterioration in June, according to a markets-based profile of the macro trend. The Macro-Markets Risk Index (MMRI) closed at 12.6% on Friday, August 2—a level that suggests that business cycle risk remains low. The latest 12.6% value is well above the danger zone of 0%. If MMRI falls under 0%, that would be a sign that recession risk is elevated. By comparison, readings above 0% imply economic growth. (Note that MMRI is now calculated as the daily median change of four key market indicators. A brief review of this adjustment is discussed below).

MMRI represents a subset of the Economic Trend & Momentum indices, a pair benchmarks that track the economy's broad trend for signs of major turning points in the business cycle via a relatively comprehensive set of indicators. Analyzing the market-price components separately offers a real-time evaluation of macro conditions, according to the "wisdom of the crowd." By contrast, conventional economic reports are published with a time lag. MMRI is intended as a supplement for developing perspective on the current month's economic profile until a complete data set is published.

MMRI measures the daily median change of four indicators based on the following calculations:

• US stocks (S&P 500), 250-trading day % change, plotted daily
• Credit spread (BofA ML US High Yield Master II Option-Adjusted Spread), inverted 260-trading day % change, plotted daily 1
• Treasury yield curve (10-yr Treasury yield less 3-month T-bill yield), no transformation, plotted daily
• Oil prices (iPath S&P GSCI Crude Oil Total Return Index ETN (NYSEARCA:OIL)), inverted 250-trading day % change, plotted daily

As noted, MMRI is now calculated as the daily median change of the four indicators above. The historical data has been restated based on the median change. Previously, MMRI used average daily changes. Why the switch? The median offers a superior measure of the core change for the four indicators. The average, by contrast, is susceptible to extreme values, which is a practical concern with a small data set that's subject to extreme differences among the indicators. As such, the median change is better suited for analyzing the indicators listed above in search of the primary trend. For instance, as a general rule, the year-over-year change in oil prices is expected to be extreme vs. the daily yield spread. The median change, which reflects the middle value of the data set, limits the effects that can arise with such an unbalanced pairing.

After revising the historical record with median changes, here's how MMRI compares on a daily basis since August 2007:

Here's a closer review of how MMRI stacks up so far this year:

1. The credit spread data uses a 260-day window rather than a 250-day window that's used as a proxy for one-year changes because the High Yield Master II Index data set is published on weekends as well as weekdays. As a result, a slightly longer time window is required for the high-yield numbers to approximate a one-year period that aligns with the one-year (250-day) window used for stocks and oil prices, which aren't published on weekends. ^