How RTD and MRI Work Together
The RTD series is our most forward-looking indicator. The MRI series assesses current market dynamics. While supported by completely different underlying data, the RTD and MRI have similar structural components and give complementary insights to current and future market dynamics.
The RTD and MRI each have long-term (Macro) and short-term (Micro) cyclical components. When both cyclical components within a set are in the uplegs of their cycles, the indicator registers that conditions are supportive of higher index prices. When they are both in the downlegs, conditions are least supportive of higher prices and the index is vulnerable to declines. When one component is in an upleg and the other is in a downleg the assessment is for neutral sentiment. Both sets also have indicators for temporary bursts of sentiment.
The RTD series reflects the natural cycles of optimism that investors collectively experience. This series is based on non-financial, exogenous variables independently shown to correspond to changes in human physiology and decision-making. The RTD are unrelated to economic merit, which means that shifts in the RTD say little about shifts in investor beliefs. However, in times of economic stress the RTD tend to be catalysts for important inflection points in the MRI and, in turn, the market index. An important advantage of the RTD series is that they can be reliably forecast eight weeks or more into the future. The RTD allow us to anticipate potential inflection points in the MRI and therefore the stock market.
The MRI series shows the cycles of investor optimism and pessimism based entirely on the price movement of an index (e.g., DJIA). We believe they reflect the collective investor consensus regarding evolving market conditions (i.e., earnings growth, valuations, interest rates, inflation expectations, and geopolitical events) plus the natural cycles of risk tolerance (indicated by the RTD). The MRI tend not to be affected by very short-term price cycles and news-of-the-day influences. Thus, they allow us to see current market conditions in terms of actionable resilience cycles. We can forecast the paths of the MRI approximately three weeks into the future.
Thus, we see the following sequence of effects with these two sentiment indicators:
- Risk Tolerance Drivers: Natural cycles of investor risk tolerance, unrelated to economic merit.
- Market Resilience Indexes: The above plus the current consensus regarding evolving market conditions.
- Stock Index Prices: The above plus very short-term price cycles and news-of-the-day factors.
The RTD enable our clients to form more accurate assessments of the current consensus regarding evolving market conditions. We have observed occasions when informationless shifts in the RTD are misinterpreted by the business press and professional investors as meaningful shifts in market consensus.
While the RTD and MRI can be used in various ways, we focus our own asset allocation decision-making on the MRI. We watch how the MRI respond to inflection points in the RTDs to see how those shifts will affect the markets. Including RTD in our investment approach reduces the level of uncertainty about market direction and allows us to reduce trading activity compared to what we otherwise would have by using the MRI alone.
See this page for possible use cases.