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Tools that have helped us the most #4
This is the fourth post in a series where we share the best tools and principles that have helped us understand the business cycle. The fourth tool below is diffusion indicators - excerpt from the VP Cookbook, June 2021.
Diffusion indicators measure the breadth of trends and help to extract signals from underlying trends and ignore noise from the absolute levels. Looking at a diffusion of VP’s country leading indicators (left-hand chart) gives us a great health check on global growth conditions. Similarly, looking at how many central banks are hiking rates across the world (VP BCFI: right-hand chart) gives us a pulse on liquidity conditions.
Market bottoms are events, while market tops are processes. Therefore extremely poor breadth often presents the best buying opportunities (left-hand chart) but very high breadth readings are not good contrarian sell signals, rather we have to wait for breadth to roll over. Aggregating our individual country equity forecasts has a powerful lead on index prices: the whole is greater than the sum of its parts (right-hand charts).
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