Howdy, gang!  I trust that all is well for you and yours during this fine Christmas season.  I’ll be honest…I’m secretly hoping that you took my challenge last week seriously and have reached out to someone (anyone who is likely to be alone this Christmas or just needs to feel the warmth of the human spirit) to invite them to your house.  I’ve accepted my own challenge and reached out to someone I know…and the invitation was accepted!  It’s been an interesting experience and I feel more invigorated and excited about this Christmas than in years past.  If anyone has an experience to share then please, by all means, post it in the “comments” section and fill us in!  If you’re too bashful or reluctant to share (because you’re AWESOME) then I guess I understand.

If you’re anything like me then you’ll readily admit that you’re motivated by challenges.  When someone challenges me to do something it usually compels me into a “motivational mindset” especially if it revolves around and idea that I genuinely feel is intriguing, interesting, or important.  Last week, aside from challenging you to open your home to someone this Christmas, I also challenged you to start putting the time into learning about macroeconomics.  I even suggested that you buy a notebook that is specifically dedicated to only economic information as you come across it.  This is something that I’ve done and I’ve personally experienced the benefit thereof.  As mentioned last week, learning about the complexities of economic indicators is not impossible regardless of how daunting it may seem.  It simply takes time and dedication.

So, if you’ve already accepted my challenge to start your personal journey towards an advanced understanding of macroeconomic analysis then my hat’s off to you!  As you continue on in this journey, your notebook will likely have more questions than answers, but that’s to be expected.  One of the more frequent questions that I remember asking myself dealt with what kind of reaction the market would likely see as a result of any particular economic report.  Would the markets react bullishly, bearishly, or not at all because of the report?  It’s a valid question, for sure.  Let’s take a look at trying to simplify things.

The cyclic nature of the markets is one of the more interesting aspects of trading.  There’s ups and downs, rallies and sell-offs, peaks and valleys.  Along the way, we have these individual reports that temporarily upset the basic nature of the markets simply because they invoke raw emotion among market participants.  This emotion is usually highly reactionary and, as a result, temporary in nature.  It would be fair to compare some of the regular economic reports to that of a company’s earnings report.  We all know that when a company announces its quarterly earnings the volatility of said company’s stock is likely to hit the fan!  After a little bit of time has passed, the volatility dwindles and things get back to normal until the next earnings announcement!  Some of the economic reports mirror this type of reaction, but on a much grander scale because it affects the entire market rather than just one stock.  We can’t do anything about the emotional response in the markets generated by some of these reports, but we can learn what type of reaction is likely.  These are called “cyclic actions” and there are three of them: procyclic, countercyclic, and acyclic.

Let’s take a look at the first one listed this week.

One of the more common definitions of procyclic is a condition of positive correlation between the value of a good, a service, or an economic indicator and the overall state of the economy.  Basically, an economic report that is procyclic will manifest itself in the markets by the same manner it was reported.  When our Gross Domestic Product (GDP) is reported, for example, we will be told if our economy increased (in sheer size), decreased, or remained unchanged.  If GDP increases from where it was at during the previous quarter then the likely manifestation we’ll see in the markets is bullishness.  That’s what we call a positive correlation because the economic report increased and the markets increased, as well.  They both moved in the same direction!

Not all procyclic reports move up!  The general nature of a procyclic indicator has nothing to do with an upwards move, bullishness, or an increase.  It can absolutely move in a downward direction, too.  If the GDP report was “bad” and we are told that our economy essentially shrunk during the previous quarter then the likely reaction we’ll see in the markets will be bearishness.  The report went “down”; the markets went “down”.  They’re both still moving in the same direction, thus they are still procyclic.  It could also still be a procyclic indicator if there is no change (no movement; up or down) as long as we’re likely to see the same manifestation in the markets.  If GDP went unchanged from the previous quarter then it would be a safe assumption that the markets will also be essentially unchanged as a result of the report.  I could argue, however, that no growth in our nation’s economy is more of a negative report than anything else, but it could’ve been worse.  That’s why we’re unlikely to see any major reaction (bullish or bearish) in the markets based on a neutral report.

Learning how to identify the various reports will absolutely take some time, but most of the identification process is centered on the obvious.  I mean, it just makes sense that an economic report showing an “increase” will usher in a reaction of an “increase” in the markets, right?  Well, not all of the time.  Those types of reports/indicators are what we call countercyclic…and we’ll discuss those next time!

As always, my friends: Be good.  Do good.  Know good.

Kleiny (@KnowGoodThings)

Columbus, Indiana