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Did The CFNAI Prompt The Fed To Act?

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    September 28, 2012

    It was reported this week that the Chicago Fed’s National Business Activity Index (CFNAI) fell in August, and sharply, from –0.12 in July to –0.87 in August.

    Its more important 3-month m.a. fell from –0.26 in July to –0.47 in August, its sixth straight negative reading. A reading below –0.70 for the three-month m.a. is considered an indication that the U.S. economy has entered a recession. Now with six straight negative readings, it’s been heading in the recession direction, and at –0.47 is getting too close for comfort.

    Although unfamiliar to most investors, the CFNAI is considered an important economic indicator since the Fed calculates it from a broad range of 85 individual economic reports and conditions. Fifty-nine of the 85 indicators made negative contributions to the index in August. And of those that improved from July, 12 were still at negative readings.

    Or perhaps it was not just concern about the slowing U.S. economy that prompted the Fed to act in spite of signs of improvement in the housing industry.

    Perhaps it was information like this chart showing the collapse of economic growth globally.

    Global Growth

    The chart is from Morgan Stanley, and is featured on Business Insiders this morning.

    Which side will be right.

    We’re in one of those periods of an unusual divergence between the sentiment of individual investors and the so-called ‘smart money’.

    We’ve been noting since the June low how investor sentiment, bearish at the June low, expecting further decline, became increasingly bullish on the ECB and the U.S. Fed promises they would come to the rescue if needed. Markets around the world surged up on those hopes from the June low.

    But usually savvy corporate insiders not only did not take part, but sold into the rally at an unusually aggressive pace.

    Here’s another group of usually savvy operators, hedge funds, that also went the other way. So far it’s been embarrassing for them as they are experiencing a bad year.

    The following chart from Bloomberg, Factset, and Deutsche Bank, clearing shows the divergence since June between the buying of investors and the selling of hedge funds. The dark blue line shows the activity of hedge funds, and the light blue line shows the surge in the S&P 500 in spite of the selling by insiders and hedge funds.

    Equity long-short hedge fund positioning

    And now Duetsche Bank is reporting that in the last two weeks, after the ECB and FOMC actions, underweight positions remain the strategy of hedge funds, while, as I noted in Saturday’s blog, the four-year outflow of investor money out off equity mutual funds has reversed dramatically to inflow.

    Interestingly, Deutsche Bank notes that this is opposite to the bullish reaction of hedge funds after QE1, QE2, and ‘operation twist’, when they piled into equities helping drive the market higher.

    So hedge funds, like corporate insiders, disbelieved the June rally and sold into it, and do not expect QE3 will be positive for equities, while investors piled into the market from the June correction low on hopes the worsening economic conditions would force the ECB and U.S. Fed to take action, and now that actions have taken place are confident they will create rallies like QE2 and ‘operation twist’.

    Who will be right this time, insiders and hedge funds again, or newly confident investors who have finally reversed four-years of pulling money out of equities throughout the bull market, to pouring money in? 

    To read my weekend newspaper column click hereIf You Like QE3 But Stock Market Makes You Nervous – Buy Gold! Sept. 22.

    Subscribers to Street Smart Report: The next in-depth Markets Signals and Recommendations Report will be out tomorrow in your secure area of the Street Smart Report website.

    Images: Flickr (licence attribution)

    About The Author

    Sy Harding publishes the financial website www.StreetSmartReport.com and a free daily Internet blog at www.SyHardingblog.com. In 1999 he authored Riding The Bear – How To Prosper In the Coming Bear Market. His latest book is Beat the Market the Easy Way! – Proven Seasonal Strategies Double Market’s Performance!