The Indicators of Stock Market Macro Turning Points During Global Financial Crisis - Application to Dynamic Asset Allocation Investment Strategy Using Index and Exchange Traded Funds

Abstract

The formulation of a winning investment strategy for the 2007-2009 Global Financial Crisis (GFC), also known as the 'Great Recession', essentially required making one key judgement that the global banking system would survive the Lehman Brothers collapse and identifying the two macro turning points: 2007 top and 2009 bottom of the market. Back in late 2008, investors should have concluded that the massive Central Bank liquidity injection supported by the global fiscal stimulus had the capacity to save the global banking system after the September 2008 Lehman Brothers Bank collapse. There was a good chance the GFC would not turn into a 1930s style Great Depression contrary to a popular bearish conviction.Investment strategists need non-subjective indicators to help them make rational decisions in times of irrational and emotional market behavior. The Author has developed a proprietary Corporate Profits Growth Leading Indicator (CPGLI) for this purpose (not fully disclosed here), supplemented by the analysis of coincident indicators of the macro-turning points discussed in this paper.The analysis identified the following macro indicators of the 2007 market top: subprime write-downs, M&A at high prices, overleveraged shadow banking system, Central Bank’s interest rate cuts, massive Fed liquidity injection and market disconnecting from corporate profits trend.The 2009 market bottom was signaled by the following indicators: extremely bearish investors, very low valuations, dominating 'risk-off' trade, interest rates near zero, falling liquidity injection, expansion of Fed’s balance sheet, corporate profits turnaround, falling initial unemployment claims and rising ISM Manufacturing Index.The paper provides evidence of validity of the active investment methodology. It describes the Author’s actual independently audited CPGLI Dynamic Asset Allocation Investment Strategy based on the coincident indicators discussed here and the CPGLI that after extensive testing has proved to work in 'normal' markets as well as the most unusual conditions of the start and end of the GFC. The CPGLI signals not just the direction of corporate profits growth but also the strength of growth which determines conviction and thus whether to use gearing as well. The strategy returned 83% for the 5 year period from 2006 to 2010 (or 12.9% compounded per annum) whilst S&P 500 recorded a negative return during the equivalent period. Exchange Traded Funds were the ideal, most convenient, and cost effective investment products for the execution of this actively managed CPGLI Dynamic Asset Allocation investment portfolio strategy.