How we were able to predict the last 7 recessions and financial crises using a simple system model
How we were able to predict the last 7 recessions and financial crises using a simple system model
Predicting an impending recession is very difficult, mainly because it is usually preceded by a very good mood in the markets, a sharp growth of stocks, indices and the economy. A lot is invested, a lot is consumed, people are in a good mood, unemployment is low, euphoria sets in, and stock prices are often in a bubble. Although the first signs of bad news come, investors ignore them and, thanks to reflexivity theories , even the prices of shares and indices themselves continue to support real investments in the stock market, because the inflow of capital to the stock market also means the inflow of money into development, advertising, trade, the inflow of better people (managers, employees, developers) to the given industries. And so the growth continues and the bubble gets bigger. You can see that the bubble is already big and share prices are many times higher than their standard and classic p/e ratio . You will sell, but the shares will still go up for another year or two and you will have missed the period of rocket growth. No one expects a crisis anymore, and all negative economic data and news/news will drown out other positive data and we continue to grow. Nevertheless, something is often happening in the background of the economy, something that may portend an approaching crisis. Usually, in the event of an overheated economy, cooling will come in the form of the so-called Black Swan event (war, pandemic , unpaid mortgages, other reasons and sometimes they don’t even have to come and the recession comes somehow by itself) and stocks start falling sharply, the index reaches such losses in a few weeks or months that they often erase up to 50%-70% of their profits or even 10 years of growth period is suddenly lost in a few months. Experienced investors and traders began to sell off at the peak and moved into bonds, gold or other safer assets, while the less experienced and informed are only looking at the collapse in shock and stress. After the crash, a small upward correction will come and they say to themselves, ok , it was only temporary, we will go back up, we will wait, they wait, and in between another series of crashes will come and they will remain totally paralyzed – they just look at how they suddenly lost 50% or more of their assets and wiped out all profits accumulated over 10 years or more. Others say ok let’s wait and with unpleasant feelings wait sometimes years, sometimes much longer, to return to the original level if they invested in the S&P500. However, many stocks have never recovered or will never recover. In the case of indices, it is questionable, in the past there were long periods before investors waited for at least the return of the investment, so that they could sleep at zero (especially if we look at inflation adjusted chart SP500 100-150 years into the past) see our second article. In short, recessions are worth anticipating and reacting promptly. We personally start to reduce our positions when there are indicators of a recession and do a quasi-inverted pyrimiding , if we are wrong we can usually jump on the moving train again if the price returns to the same level (see our other articles on positions management , hedging , etc.). Predicting a recession is very difficult and many economists consider it a very difficult task, yet experienced wall street traders did not have a problem with it even during many decades of operation.
We will show you one of the models that is used in many hedge funds – this model / system was able to predict the last 7 crises since 1970, when the data is available. We did not invent the model, although we also created our own improved modifications and improvers . The method is based on the expectations of investors, the rational behavior of economic laws such as supply / demand / own benefit / interest, the development of monetary policy and the behavior of the FED .
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