The US leading index for June fell by 0.3%, more than the expected 0.2% drop. Data from the previous month was updated from an initial decline of 0.1% to remain steady at 0.0%.

Potential Recession Indicator

This index has been indicating a possible recession for several years. It is meant to forecast future economic activity, but its accuracy has been questioned when it doesn’t match actual economic trends. The latest leading index figure shows a continued negative trend, adding to a series of recession signs. However, Mr. Michalowski points out that this indicator has been predicting a downturn for a long time without one actually happening. This ongoing disagreement has raised doubts about its current relevance. Market skepticism is backed by stronger economic data, which appears to be the main focus right now. For instance, the US economy added a solid 206,000 jobs in June, and the first-quarter GDP still reflected a 1.4% annualized growth. These figures suggest resilience that contradicts the warnings from the index.

Market Complacency Strategy

This confidence shows in the derivatives market with low implied volatility. The CBOE Volatility Index, known as VIX, is trading near historical lows, recently around 13-14. This indicates that traders are not expecting major market turmoil in the near future. Given the low cost of options, it makes sense to buy downside protection against a possible slowdown later this year. The ongoing weakness in leading indicators shouldn’t be ignored, making inexpensive put options an appealing form of insurance for our portfolios. Buying these hedges when volatility is low is a smart strategy. Historically, a consistent decline in this index lasting over two years, as we are currently witnessing, strongly correlates with an eventual economic downturn. For example, before the 2008 recession, the index also dropped for several months before the recession was officially recognized. The current situation may not be any different, just postponed. So, our strategy in the coming weeks is to capitalize on the market’s complacency. We will look to buy longer-dated puts or put spreads on major indices. These options are relatively cheap due to low volatility but could yield significant gains if the economy eventually aligns with the ongoing warnings from the leading data. Create your live VT Markets account and start trading now.

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