The WSJ Guide to the Fifty Economic Indicators That Really Matter by Simon Constable

Author:Simon Constable
Language: eng
Format: epub
Publisher: HarperCollins

What it means: Refining oil into gasoline is more (less) profitable.

What steps to take: Buy (sell) refinery-heavy stocks like Valero.

Risk level: High.

Profit possibility: $$$

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Chapter 26

Credit Availability Oscillator

Leading

(See also Libor)

THE FILM CABARET’s famous song “Money, Money” gets it almost right when it says “Money makes the world go around.” The truth is that for businesses and the economy it’s credit, or borrowed money, that really keeps things going.

The world found out exactly how much credit keeps things going when it all dried up in the fall of 2008 during the Great Credit Crunch, which quickly went on to become the Great Recession.

If the credit crisis of 2008 taught the world anything, it’s that without the free flow of borrowed money, the world of business quickly comes to a standstill, and with that so does the economy.

Broadly speaking, when loans are more available to both businesses and individuals, more economic activity occurs and the economy expands. When loans are hard to come by, you can expect business activity to slow down and the economy to falter.

That was the idea in mind in 2007 when some savvy bond market analysts at Philadelphia investment bank Janney Montgomery Scott developed the Credit Availability Oscillator. That their work predated the credit crisis only shows how prescient they were.

Guy LeBas, head of fixed income strategy at Janney and a key architect of the CAO, says he was keenly aware of the economy’s dependence on credit.

“Borrowing availability is a huge part of consumer spending,” says LeBas. In 2007 he was particularly worried about what would happen to spending if homeowners couldn’t refinance their mortgages. That’s why he developed the CAO, which is pronounced “cow.” No joke.

Although Janney keeps the CAO’s exact internal workings top secret, LeBas does detail some of the many metrics used, which include both qualitative and quantitative inputs. They are all focused on determining how easy or hard it is to borrow money.

A survey of qualitative data is collected quarterly on the difficulty of obtaining different types of loans. That quarterly data is supplemented with daily quantitative inputs. (Those inputs should be called moos—moos in the cao. Geddit!) The result is a daily CAO reading.

The quant data includes the prices at which certain types of bonds are trading, particularly those involving automobile loans made to consumers as well as borrowing by people with a less than stellar credit history, so-called subprime borrowers. Also included are the interest rates at which banks lend to each other, the Libor rate, a key measure of how well credit is flowing between lending institutions.

Although the CAO was only developed in 2007, Janney has developed historical data to provide context, as shown in the following chart.

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