I will define and show results from a new indicator that effectively explains long-term market motion.
Three elements compose effective demand in a closed economy. i) Consumption demand, ii) Investment demand, and iii) Government spending.
Consumption demand will be defined as the ratio XLY:XLP, (Consumer Discretionary Spending)/(Consumer Staples). Investment demand will be defined as the ratio of the total value of calls to the total value of options for SPY. Government Spending will be defined as IEF (7-10 Year Treasury Bill).
To eliminate noise within this analysis smoothing will be used. Also, for the purpose of comparison, Consumption Demand and Government Spending will be scaled to between 0.2 and 0.8. The Investment Demand element already tracks primarily within this interval.
The following utilizes data from 3/28/06 to 11/26/12.
As you can see both the Investment Demand and Consumption Demand indicators track closely, and even predict market action. Keep in mind these are 200 day sma's, so have significant lag.
It follows that to calculate the effective demand you sum these three elements. When grouping the three elements I give equal weight to Consumption and Investment Demand, and a 33% weight on Government Spending (0.3,0.3,0.4). The result is the indicator below. It has been arbitrarily scaled (AAD(200) = f(x)*2-0.3) to line up with the SPY (S&P 500), and a 200 day moving average of the scaled SPY has been added for lag comparison, keep in mind that both indicators have equivalent lag.
Below is the same chart but with the Arbitrary Aggregate Demand components smoothed with a 20 sma.
Now that the model has shown some significance it would be interesting to see how this model would function in a trading environment (stochastically). To do this the scaling, which is a function of minimum and maximum over the entire interval, must be subjected to time constraints. Under time constraints the AADI(200) does not significantly differ from the AAD(200). So below is a time constrained scaling of the AADI(20) next to the unconstrained AAD(200). Note that as the indicator progresses along the timeline the more information exists for each of the three components to scale along.
I'm frac'ing in the middle of no where and bored out of my mind. Any comments would be fantastic. This was an idea that I had yesterday while reading Keynes' "General Theory of Employment". Threw this together in the last few hours using excel. Inspiration and criticism appreciated.
Back to frac'a'lacking...
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.