In the wake of coronavirus-related volatility in the stock market, investors are asking: “Is the economic data showing that there will be a depression?”
The No. 1 mistake investors make as they try to figure out the answer is that they are mostly focused on one dimension of a two-dimensional problem.
The second dimension is the time frame, or the duration. As an example, new weekly jobless claims published Thursday came in at 5.245 million versus a consensus of 5.0 million. On the surface, that is a terrible number.
In our analysis at The Arora Report, the number of new jobless claims is in the process of peaking in the near term. In isolation, at this time it can be considered positive for the stock market. However, in a longer time frame, investors need to consider the possibility of a second wave of job losses if opening the economy takes longer.
Let’s explore this issue with the help of two charts.
Charts
Please click here for an annotated chart of the SPDR Dow Jones Industrial Average ETF DIA,
Please click here for an annotated chart of the SPDR S&P 500 ETF Trust SPY,
Note the following:
• The first chart, which is monthly, gives investors a long-term perspective. For more details, please see “Wall Street wants you to believe everything is peachy.”
• The second chart, which is daily, gives investors a short-term perspective.
• Both charts show RSI (relative strength index). RSI is an indicator of internal momentum of the stock market.
• The first chart shows that RSI is barely poking its head over the oversold level.
• The second chart shows that RSI is overbought.
• Those with less experience may ask: “How come RSI is both overbought and almost oversold at the same time?” This question is wrong because it omits the second dimension of the time frame. RSI is almost oversold on a long-term basis but is overbought on a short-term basis.
• The second chart shows two moving averages.
• The moving average in green shows the stock market trend is up. The moving average in red shows the stock market trend is down. Both are right, at the same time, because one is over five days and the other is over 200 days.
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Will there be a depression?
Less experienced investors are looking at the economic data and projecting a depression. It is true that the economic numbers are depression-like. However, stock market conclusions should not be based on the data we are seeing now because the second dimension of duration is missing. It is conceivable that, in a few months from now, economic data may look much better.
The correct way to analyze the impact of economic data on the stock market at this time is to not focus on the depth but to focus on the duration.
How popular stocks are affected
Wall Street advocates diversification by sectors and geographies. Nobody talks about another view: diversification by time frame. If you diversify by time frame, you can be more selective in your trades and investments.
For example, stocks such as Zoom Video Communications ZM,
For that reason, those stocks may provide good short-term trades, but it is difficult to make a long-term investment case due to present valuations and the competition.
For example, Slack faces stiff competition from Microsoft MSFT,
Answers to your questions
Answers to some of your questions are in my previous writings. You can access them here.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.
