A Perfect Signal

"Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell."

"If you want to have a better performance than the crowd, you must do things differently from the crowd."

"The four most dangerous words in investing are 'This time it's different'." - All three are quotes from one of the world's best traders Sir John Templeton

In trading there are a number of keys to making money, a few of which are presented in the quotes above.  Traders are constantly searching for a signal that will give them an edge over their fellow traders and the market.  Using this edge they can amass a small fortune by timing the market and predicting the direction of the move.  In order to keep that fortune a high level of discipline is required to exit poor positions, but that topic will be left for another day. 

When a trader finally finds a signal that works he or she will protect that signal fiercely as once the word gets out, more and more people will use the signal and its value will eventually vanish.  Interestingly that does not mean that the signal is lost forever as once the signal losses its predictive value everyone moves on and, guess what, the signal will suddenly start to work again.  So traders spend their time trying to find signals that work, move on when they don't and circle back around to check old signals to see if they are "working" again.

So what if there is a signal that has worked remarkably well for the last 150 years?  I would think that you would take notice of that signal unless the signal has no economic merit.  I will explain this by way of an example.  The so called Super Bowl Indicator says that if the team from the AFC division wins the Super Bowl then the market will decline the following year and if the NFC team wins then the market will rally.  Now while there is a relatively high level of correlation between the team that wins and the following year of market returns, no-one takes this too seriously as there is no economic link between a football team winning a game and the stock market, it is just a happenstance!

Now what if the signal does have some economic merit?  Well obviously we would take serious notice of this.  So does the Skyscraper Index have economic merit and what is the Skyscraper index?  This index was first discovered in 1999 and has been providing a good indicator of economic recessions for over 150 years.  It turns out that every time a country decides to build a building that once completed will become the tallest in the world, it signals the beginning of a severe economic slowdown in that country.  The most recent signal was the building of Burj Khalifa in Dubai in 2008 right at the beginning of the worst financial crisis since the Great Depression.  Prior to that the Chrysler Building was built right at the start of the Great Depression and the World Trade Center was completed right on the eve of a recession.

So with this is mind it is a little eerie to see ground being broken on the Sky City building in Changsha China.  It is not hard to see that this signal may once again prove itself valid and point to an economic slow down in China.  Already their economy is stuttering and it will not take much of an exogenous shock to push it right off the rails.  So the question is should we take this signal with a pinch of salt or seriously, in other words does it have any economic merit?

While building a tall build in and of itself has no economic merit, the fact that it is the world's tallest does in fact have some merit for the simple reason that building a structure of this magnitude is normally a sign of economic ego.  The authorities are trying to show the world that they are financially strong and it is a signal that the underlying economy is burgeoning.  It is a show piece of economic strength.  The problem is that it takes years of planning to finally get a shovel in the sand and by that time economic euphoria has set in or is fading; just as is the case in China (see the quotes above as a point of reference).  This is the reason that the signal works.  These buildings are thought of at the peak of economic euphoria which is the exact time when caution should be taken.

Looking out a year or two I would not be at all surprised to see that this signal once again marked the time when the economy (in this case it will be China's economy) took a tumble.  The problem is that with China slowing down this could be a signal that marks the beginning of the next global recession.  Certainly not a time to be euphoric.