Weighing the Week Ahead: Technical Danger Signals?

After a week of modestly strong data, what is next? This week has some second-level data, with the big news next week.  Expect plenty of action from technical analysts, who will wonder:

Do the charts suggest a new level of danger?

Last Week Recap

The housing news was OK.  Much attention was focused on the Senate version of the ObamaCare repeal.  That discussion will also carry over into the week ahead.

 

The Story in One Chart

I always start my personal review of the week with a chart of the price action.  The chart shows some swings, but the overall scale is very small.  Basically, nothing is happening to the overall averages.

Note to Readers

I am doing only a brief indicator update and a few thoughts on my weekend away.  Mrs. OldProf is already scolding me.

The News

Each week I break down events into good and bad. For our purposes, “good” has two components.  The news must be market friendly and better than expectations.  I avoid using my personal preferences in evaluating news – and you should, too!

The economic news last week was pretty good.  Home sales data beat expectations and initial claims continued at a very low level.  The only soft news came from the “newbie” PMI indexes.  Until further proven, I am paying little attention to these.

 

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

The Calendar

It is a calendar with some interesting news, mostly setting things up for the big data in the following week.  I will be especially interested in personal spending and Michigan sentiment.

Fed speakers are out in force.  Expect more color on the reduction of the Fed balance sheet.

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.

Next Week’s Theme

The story has not changed much in the last few weeks.  We have covered most of the main themes in the last few installments:

  • Low volatility
  • Bonds versus stocks
  • Sector rotation
  • Various threats to growth

I expect plenty of articles on “newly discovered” recession indicators, the yield curve, the Hindenburg Omen, and other similar threats.

 

Quant Corner

We follow some regular featured sources and the best other quant news from the week.

Risk Analysis

I have a rule for my investment clients.  Think first about your risk.  Only then should you consider possible rewards.  I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 

The Featured Sources:

 

Bob Dieli:  Business cycle analysis via the “C Score.

RecessionAlert: Strong quantitative indicators for both economic and market analysis.

Georg Vrba: Business cycle indicator and market timing tools.

Brian Gilmartin:  All things earnings, for the overall market as well as many individual companies.

Doug Short: Regular updating of an array of indicators.  Great charts and analysis.

 

 

Final Thoughts

 

Last week I noted that I was not much concerned about the unwinding of the Fed balance sheet.  I explained more fully this week.  If you missed it, please take a look.  I’ll have more on this subject in the week ahead.

This will include some discussion of the ACA repeal legislation.

 

Stock Exchange: Are Traders Joining the Yield Chase?

Our Stock Exchange is all about trading. Each week we do the following:

  • Discuss an important issue for traders;
  • Highlight several technical trading methods – including current ideas;
  • Feature advice from top traders and writers; and,
  • Provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders.

Review

Our last Stock Exchange we asked whether you can analyze the market using psychology. If you missed last week’s edition, check it out.

This Week— A tough stretch focuses attention on yield

This important topic has already attracted expert attention, as we see in today’s Trading Tips.

Trading Tips

  • Dr. Brett Steenbarger, who is a strong advocate of having method in your trading, has a typically insightful post on the need for flexibility. He always has a finger on the pulse of the trading community, and sees a lot of frustration. Many systems have hit a dry spell. Brett asks:

    Are you trading what you subjectively prefer, or are you trading what is objectively present in the market?

A great question.

  • Options trading may seem like the answer if you need some excitement. Steve Burns (See it Market) highlights ten pitfalls to avoid. If you are not an experienced options trader, you will definitely benefit (perhaps a lot) from spending a few minutes with this post. Here is my favorite pitfall:

    When used correctly options can be tools for managing risk by limiting capital at risk exposure and capturing huge trends, used incorrectly they can blow up your account.

[Jeff]I started in the investment world with Chicago market makers, who risked their own money along with that of some backers. Some of them scored big. Many others blew out. Some got a second or a third chance. Steve’s questions are definitely important.

I’ll have more in this week’s conclusions.

 

Expert Picks from the Models

This week’s choices are decidedly more conservative.

Athena: I have another choice this week – two in a row since my vacation. I am looking at the hotels sector, and my pick is:
Host Hotels & Resorts, Inc. (HST). This stock has made a nice move since November. It delivers consistent payments for its owners. Though the stock had a very slight dip this week, I expect the uptrend to resume.

Jeff: The security is a REIT, so it is not like a regular equity investment. People are reaching for the apparent yield of over 4%, but the P/E ratio is high for a pick like this.

A: You are telling me that current buyers are unwise.

J: Not necessarily. It depends upon their investment objective and the level of risk they are willing to take on. This is a “reach for yield.”

A: I am not troubled by that. I am interested in the stock price. I will make a quick profit and then sell.

J: You mean the REIT price.

A: Yes. My method is different from yours – and it is quite effective, as you know.

Oscar:
This week I like long-term bonds. Usually I trade a basket of names for each sector. The extra liquidity in this case means that using the 20+ Year Treasury Bond ETF (TLT) works well. Here is what I see.

 


 

The intersection of the 50-day moving average with the 200-day moving average tells me this sector is getting over the hit it took in early November. The recovery is for real, and we could be on a trend back up to the $135 level. If the next 4 weeks look anything like the last 8, I’ll be sitting pretty.

 

J: A further big move in bonds might mean that money is getting pulled from stocks. Don’t you have positions there as well? This was a very good week for biotech. I think we discussed that sector a few weeks ago.

 

O: Yes.

 

J: Do you think the move is based upon the President’s plans for drug pricing. It is much less stringent than expected.

 

O: I guess I missed that. The U.S. Open was pretty exciting. But biotech has done well. The only thing that would have made our 5/25 Biotech investments better would be if we had made them on 5/30. In any case, I won’t complain about a ~10% pop in one of my three holdings.

 


 

J: Do you expect the move to continue.

 

O: The charts will tell me. There are almost always attractive new sectors.

J: Did you analyze the sectors requested by your fans?

O: Yes. This week’s list includes everything that has been requested.

J: TLT is still not on the list. It was a “sell” a few weeks ago.

O: The rankings in the sell range do not imply a recommendation to “short” the group. They simply have very low ratings when other choices are much stronger. Bonds have improved dramatically, and have moved near the top of the list.

J: Some readers do not like the rankings based upon your requests. Why not just post your own ratings?

O: I’m working on that.

 

 

 

Holmes: My choice this week is HD Supply Holdings, Inc. (HDS). What a tempting chart!

 

 

Looking at the one-year chart, the shares which were trading above $36 last August had quite a fall to touch just about 30-31 in early September. However, its recovery was quick in November. Since then, for another eight months in a row, the shares have been consistently maintaining the highs even reaching close to 42. Early this June, the shares plunged to a low again though not to such lows as seen last September. I expect a nice rebound – perhaps not to the old highs, but good enough for a trade.

J: I checked this out with our go-to site for stock valuation – F.A.S.T Graphs.


While the earnings history is short, it looks good until the big 2018 decline. One of the firms gave it a “sell” rating.

H: That kind of over-reaction by analysts is typical of my choices. I will not be holding this stock in 2018. I need only a rebound.

Felix: Nothing new from me this week. That is not surprising given the lack of significant sector momentum.

J: I understand. Do you have your updated ratings?

F: Of course. My fans have made some new requests, which I added to the list. Keep those emails coming!

J: I don’t see RoadRunner here this week. He is leading in the YTD race in our group, barely ahead of Holmes.

F: RoadRunner has been checking his charts, but has nothing for us this week.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Conclusion

Getting active at the wrong time can be a fatal mistake. Brett Steenbarger effectively uses examples from poker. The strategy is similar and the odds calculated more readily. While we see the dramatic hands on TV, they omit scores of deals where the champions are just sitting there.

When there is an overall market move to bonds and bond substitutes, it has a dramatic effect on trading systems emphasizing stocks.

How do our own models deal with quiet times?

  1. Reducing size, or exiting altogether. That is the current RoadRunner approach.
  2. Switching to more conservative choices. That is the current Oscar plan.
  3. Not pressing for new choices. Felix and Athena have taken this approach.

What about Holmes? The dip-buying style nearly always finds candidates. Holmes is not bothered by quiet market times, but will exit completely if things turn dangerous.

Traders need to accept one or more of these methods – or perhaps switch methods with the times. What do you do?

Here is a summary of the cast of our characters. Find your own favorite!

Stock Exchange Character Guide

Character

Universe

Style

Average Holding Period

Exit Method

Risk Control

Felix

NewArc Stocks

Momentum

66 weeks

Price target

Macro and stops

Oscar

“Empirical” Sectors

Momentum

Six weeks

Rotation

Stops

Athena

NewArc Stocks

Momentum

One month

Price target

Stops

Holmes

NewArc Stocks

Dip-buying Mean reversion

Six weeks

Price target

Macro and stops

RoadRunner

NewArc Stocks

Stocks at bottom of rising range

Four weeks

Time

Time

Jeff

Everything

Value

Long term

Risk signals

Recession risk, financial stress, Macro

 

 

Background on the Stock Exchange

Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present, and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

 

Fed Balance Sheet Unwind? No Reason to Worry!

In the wake of the Fed decision to begin reducing its balance sheet, speculation abounds. Pundits of all stripes are speculating about what this will do to interest rates, the economy, and the stock market.

The answer is easy. Nothing.

Those commenting often make two types of mistakes – omitting important data and using pop economics instead of real analysis. Let’s consider each in turn.

Data

If we put aside the political debate and merely asked about the impact of reduced demand in a market, what would be our approach? We would take the rate of the change and compare it to the daily volume. If it was very small, we would expect little effect. In a Federal court where I was an expert witness the Fidelity Investments team opined that 1% would be small. While no one really knows, that seems reasonable. Let’s do the math.

The Fed plans to halt replacement of maturing Treasury securities at some point in 2018. We do not know the exact plan, so I’ll make a more aggressive assumption. Suppose that the Fed begins immediately—no replacement of maturing securities. Let’s do the math.

Amount of Treasury holdings expiring in the next five years: $1.4 trillion.

Dividing by five years: $280 billion per year.

Dividing by 250 (or so): $1.12 billion per day.

Total daily volume in the cash Treasury market: $500 billion or so, or about 0.2%.

And this does not count trading in futures markets, where a buyer can hold until delivery if desired.

This is a very deep and liquid market. The error made by many is to compare the size of the Fed balance sheet with net new issuance by the Treasury. Why is this comparison relevant?

Analysis

The net new issuance comparison makes a common, pop econ mistake. It treats a large and complex market as if it consisted of two parties. This may be easier to understand, but so was the concept of “flat earth.” It leads people, like a top TV bond commentator, to ask, “If the Fed and other central banks quit buying new bonds, who will step in?”

In the last few years we have also witnessed assorted experts asking, “who will buy our bonds?” And then shortly thereafter, shamelessly discussing a shortage of long-term bonds. These are great stories to attract viewers and readers, but a simplistic view of the market. It ignores the millions of participants making up the deep market. This cannot be represented as two parties. A beginning economics class is all you really need. Think about supply and demand in terms of distributions of many players. Consider these simple graphs from a helpful source.

If you look at the chart on the right, you might view the Fed absence from the market as an external shift in demand. This does not affect the plans of other participants, but it does mean less demand at each price, so a shift from D2 to D1. We should expect a lower quantity and price (higher yield), but not a hugely dysfunctional market. During the QE period, I sought estimates from many macro economists about the total effect of QE. Some Fed economists also made a similar estimate – about 1% in the ten-year note.

Over a period of several years, we might expect a gradual adjustment in the ten-year note by 1% — or perhaps less, since some of the balance sheet will be maintained. It is small enough that other factors will be the main drivers.

Conclusions

We can now see why past scary predictions did not come to pass. If every TV pundit was required to pass a two-part test:

  1. State the size of the bond market;
  2. Draw and explain one of the charts above…..

…CNBC would have a lot of air time to fill!

Weighing the Week Ahead: Is the Housing Rally Over?

With soft housing data last week and higher interest rates expected, it is a good time to ask:

Is the housing rally over?

Last Week Recap

The big economic news last week was the Fed policy decision and guidance. Friday’s announcement of the Amazon purchase of Whole Foods grabbed the headlines. Attorney General Sessions’ Senate Testimony got the gavel-to-gavel treatment.

Our question from last week – a possible change in market leadership – did attract some discussion. Friday’s grocery news is still being digested, but the sector shifts were pronounced.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. Despite the mid-week Fed announcement, the result for the week was barely changed.


Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read the entire post for several more charts providing long-term perspective, including the size and frequency of drawdowns.

Note to Readers

Thanks to all of those who offered suggestions for changes in WTWA and feedback on my first attempt. I am still working on many of the other suggestions.

I am off next weekend, but I will again try to post an abbreviated version including an indicator update.

The News

Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The economic news last week was mixed.

The Good

  • Jobless claims declined to 237K, maintaining the current record-low levels.
  • Forward earnings estimates are holding up. This may seem like faint praise, but those criticizing the use of analyst estimates point to excessive optimism and repeated cuts in forecasts. Brian Gilmartin tracks these estimates. He notes the comparative strength, but also warns about possible weakness in tech.
  • Chemical activity barometer “suggests continued growth through 2017.” See GEI for the full story.
  • Small business optimism remains high. I have upgraded my attention to this series, since the importance has increased. Sluggish business investment, hiring, and loans to small companies have all been issues. Improved confidence from small business owners is helpful on all fronts. While some have (already?) become pessimistic on the Trump agenda, those relieved of regulations have been more positive. Calculated Risk provides analysis and this chart:


  • CPI remained benign with an increase of only 0.1% in the core rate. Some see this as bad news since it is below the Fed’s target and/or the take inflation as a signal of economic growth. Growth without inflation is good. It gives the Fed a little leeway.
  • FOMC decision got a positive reception. The small increase in the Fed Funds target was expected by markets, demonstrated by the small change in bond yields. Prof. James Hamilton (Econbrowser) explains why the “balance-sheet reduction is not scaring anyone”. He explains, and also provides some interesting data, importantly noting the effects of other news.


The Bad

  • Industrial production was unchanged. The decline from April’s 1.1% gain was expected, but disappointing nonetheless.
  • LA port data is a subject of some controversy. Calculated Risk sees a positive trend, using a 12-month rolling average. Steven Hansen (GEI) prefers rolling unadjusted three-month averages, but notes some anomalies this time. Data nerds should read both pieces in detail to understand how the methods chosen affect what you conclude.
  • Michigan Sentiment declined to 94.5 from a prior of 97.1.
  • Retail sales declined 0.3% compared to the April gain of 0.4% and expectations of unchanged.
  • Housing starts declined and missed expectations. Building permits did the same. On the surface this was bad news, but there is some debate over the data. See below for more discussion.

The Ugly

Collateral damage from the Amazon decision to purchase Whole Foods. While it was obviously bad news for competitors in the grocery business, the reach was much greater. Here is a heat map that I tweeted an hour after Friday’s opening.


There may be some logical extensions of the Amazon strategy, but the effect on only four other stocks exceed the entire size of the deal. In some cases, the declines came because of mutual ETF membership, not any specific analysis. This topic deserves more scrutiny.

Noteworthy

Do you think that chocolate milk comes from brown cows? Does anyone? Mrs. OldProf, who grew up in Green Bay and graduated from Wisconsin, notes that most cows are at least partly brown. That would imply a lot of chocolate milk.

Somehow 16.4 million American adults (7%) hold this belief. These people vote and buy stocks. Check out John Harrington for the story and some other surprising examples.

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

The Calendar

It is a very light calendar. Housing data are most important, especially new home sales.

Fed speakers are out in force. Expect more color on the reduction of the Fed balance sheet.

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.


Next Week’s Theme

We have the combination of a light week for data, last week’s soft data on housing starts, the Fed rate decision, plenty of scheduled Fedspeak, and a calendar featuring home sales. The ingredients suggest a lot of attention to the housing market. People will be asking:

Is the housing rally over?

Here is a range of opinion.

  • The weakening market is a very bad sign. New Deal Democrat analyzes the turn down in permits, starts, and completions. Check out the post for the full story. He promises more to come.
  • Gains in homebuilder stocks and builder sentiment provide a better indication. (Scott Grannis).


  • Housing starts to remain in the expected range of 3 – 7% growth, year-over-year. Multi-family is solid, but the increasing trend is over. Single family starts are taking over. (Calculated Risk).


  • The monthly data present a misleading picture. Steven Hansen (GEI) explains how to interpret the difference between permits and completions.

As usual, I’ll have more in my Final Thought.

Quant Corner

We follow some regular featured sources and the best other quant news from the week.

Risk Analysis

I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 


The Featured Sources:

 

Bob Dieli: Business cycle analysis via the “C Score.

RecessionAlert: Strong quantitative indicators for both economic and market analysis.

Georg Vrba: Business cycle indicator and market timing tools.

Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.

Doug Short: Regular updating of an array of indicators. Great charts and analysis.

We should expect a raft of forecasts from newly-minted recession experts. This example takes the good record of the inverted yield curve and extrapolates from small recent moves. Part of the extrapolation is from some dubious “technical analysis.”

The yield curve is part of our recession forecasts. The influence of other important variables is considered, along with the likely timing. Articles that feature the ‘R’ word are popular, but usually misleading.

 

Insight for Investors

Investors should have a long time horizon. They can often exploit trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Wade F. Slome’s excellent analysis of the stock market rally – accompanied by “worry, pessimism, and skepticism.” He describes his list as a “small sample.”


He notes as follows:

the endless laundry list of crises and concerns has not broken this significant, multi-year bull market. In fact, stock prices have more than tripled since early 2009. As famed hedge fund manager Leon Cooperman noted:

 

“Bull markets don’t die from old age, they die from excesses.”

 
 

On the contrary to excesses, corporations have been slow to hire and invest due to heightened risk aversion induced by the financial crisis. Consumers have saved more and lowered personal debt levels.

 

Read the full article to see his warning signs – a combination of several trends.

 

Stock Ideas

Simply Safe Dividends does his usual careful analysis of restaurant supplier Sysco (SYS). The dividend is safe, but there are some issues on the horizon. Amazon, which he regards as unlikely to compete in this space, and extra debt taken on for a recent acquisition. That said, he assigns a “dividend Safety Score” of 97. DIY investors interested in dividends should read this post carefully. This is the kind of work required.

A brief digression – which I hope you will enjoy. On trading floors people are watching different things. There is no reason to have everyone covering the same news flow. When there is news, we often shout it out so everyone knows what is happening. This is one reason that managers often choose to work from a desk on the trading floor.

When I see a Sysco truck or news about the stock, I am reminded of a Cramer anecdote about how to avoid confusion:

“Wrong Sysco ( SYY) preannouncing!”

In a market that is so Cisco-dominated ( CSCO) — and believe me, this is Cisco-dominated — just the sheer possibility that someone might take Cisco shares on Sysco saying something positive required that our trader shout out the good news for the food broker.

Chuck Carnevale offers a comprehensive analysis of AbbVie, which he notes has growth, value, and high yield. The analysis uses the stock as an example that helps explain his method. You get both an interesting idea and some information strong stock-selection methods.

Energy stocks? John Butters of FactSet reports that this sector accounts for nearly half of the Q2 growth in earnings for the S&P 500.

And how about wind and solar energy? The EIA reports that monthly generation from these sources has reached 10% of the total.


A lagging railroad? Barron’s Trader Extra recommends a look at the Genesee and Wyoming railroad (GWR). You cannot guess where they operate! It is an interesting idea, although real value depends upon a resumption of earnings growth.

 

Personal Finance

Abnormal Returns always has first-rate, daily links for investors. His Wednesday topic is personal finance – of special interest to the individual investor. I especially liked the discussion about the recent reversal for value stocks, the underlying factors, and the long-term success. The Bloomberg piece includes a range of good sources and provides a balanced perspective. Also excellent is the advice from Todd Wenning on how an investor should avoid distractions. Hint: Why do you think your brokerage makes it easy for you to see online quotes?

Seeking Alpha Senior Editor Gil Weinreich has an interesting topic every day. This week I especially enjoyed the renewed discussion about thrift versus economic growth. Your own viewpoint is probably reflected and discussed.

Value versus Growth

GMO notes that value stocks showed strong gains in 2016, which have been erased in 2017. There are always shifts, but this has been much more dramatic than usual. They provide an exhaustive analysis of the trends and possible causes and highlight this conclusion:

Overall, the lion’s share of the performance gap between value and growth across the globe can be accounted for by an expansion in multiples that has outstripped even the habitually bullish analysts’ expectations for future earnings. This should be no small consolation to valuation-oriented investors: Multiples running ahead of fundamentals is a classic sign of over-extrapolation by investors

Watch out for….

What is in your ETF holdings. Here is a little test. If you own an ETF, try to name the top holdings. If you do not like a particular stock, go the other way. Is this a big holding for some of your ETFs?

 

Final Thoughts

This week’s topic raises interesting questions that have relevance for many other current issues.

Topping markets? The first sign of a rollover in an economic series always gets a reaction. One viewpoint is that it is a clear sign of a top – time to expect the worst. Often it simply puts us on alert, but requires more evidence. If you look at a data series of almost anything, you will see small declines from a top followed by further increases.

Economic relationships do not work like light switches. Changes are not accurately described as two-person transactions – buyer and seller. A change in mortgage interest, for example, affects the point of intersection of supply and demand curves. It shifts the supply at a given price. While we know that this reduces quantity, we do not know by how much.

Even after we improve the analysis by thinking of supply and demand curves, we must consider the micro – the behavior of the individuals making up the curve.

  • Some buyers, who have been on the edge of a decision and fearing higher rates, may step up. (See Diana Olick citing this as the reason behind the jump in mortgage applications). This changes the shape of the demand curve.
  • Some sellers, sensing a tightening market, may absorb some of the implied price increase. This changes the supply curve.

Anyone who begins with a conclusion that “buyers are priced out” is leading with his chin.

Demographic changes? Millennials are starting families and establishing homes. The worries about the overhang of foreclosure homes has decreased. The big wild card now is the level of future immigration. (See this excellent post from Calculated Risk).

One reason that I continue to love the homebuilders is that the factors moving interest rates higher – stronger economic growth and higher wages – are the same as those that will increase housing demand.

What worries me…

  • Continuing contention in Washington. We will need bi-partisan compromise to deal with the big issues like growing government debt and entitlement programs, not to mention infrastructure and tax reform.
  • The unknown effects of ETF trading.

…and what doesn’t

  • Concern about “escape velocity.” Those who do not understand the current economic cycle rely on mistaken metaphors. They are attempting to persuade through language alone, without analysis.
  • The unwinding of the Fed balance sheet. Any reasonable path will barely ripple the market.

 

Stock Exchange: Can Psychology be Applied to Market Behavior?

Our Stock Exchange is all about trading. Each week we do the following:

  • Discuss an important issue for traders;
  • Highlight several technical trading methods – including current ideas;
  • Feature advice from top traders and writers; and,
  • Provide a few (minority) reactions from fundamental analysts.

Our goal is to be both educational and fun. We welcome comments, links, and ideas to help us make this a great resource for traders.

Review

Our last Stock Exchange we asked whether you should buy the rip or the dip. If you missed last week’s edition, check it out.

This Week— Can Psychology be Applied to Market Behavior?

This great topic has attracted recent attention from the experts we follow.

Trading Tips

Dr. Brett Steenbarger, whose imagination continually creates new ways to view the evidence in front of us, challenges us to consider the psychology of the market. This is sharply different from the normal focus on the psychological challenges to the individual trader. Brett writes:

When we think of trading psychology, we typically think of the psychology of the trader and the factors that either contribute to or distract from a peak performance mindset.  Another facet of trading psychology is reading the intentions of other market players.  This is very similar to psychology in poker.  The mindset of the poker player is important, and it is also important to read the psychology of the other players at the table.  The skilled poker player reads those tells from other players to infer if they are bluffing or if they might be holding the nuts.  When short-term trading/market making occurred on the trading floor, reading the other participants in a market truly was more like reading other poker players.  With most market activity being electronic, we need other ways of inferring the intentions of market participants.

Michael Batnick has an interesting post about experience. One feature is a story about famous hedge fund star Stanley Druckenmiller – why he got a big promotion, leapfrogging eight more senior people:

…the reason he was given that position was because he didn’t yet carry the burden of experience. When he asked why he was promoted above the others around him, his boss said, “For the same reason they send 18-year-olds to war. You’re too dumb, too young, and too inexperienced not to know to charge. We around here have been in a bear market since 1968.’ This was 1978. ‘I think a big secular bull market’s coming. We’ve all got scars. We’re not going to be able to pull the trigger. So I need a young, inexperienced guy to go in there and lead the charge.”

His conclusion is that experience is overrated. I disagree. The real challenge for asset managers is to draw upon experience while avoiding the human frailty.

Let’s turn to this week’s recommendations from our group. They were all eager to put Brett’s poker advice into action, but we did get a few comments.

Expert Picks from the Models

This week’s choices cover a wide range, from energy to financials, to tech. There is something for everyone.

Road Runner: I recommended Netflix (NFLX) in my first appearance on the Stock Exchange. In late March of this year, it had come off of recent highs and reached the bottom of its 6-month channel. I happily held the position as it appreciated through this spring, selling at some point in late May. Now, I think a re-entry may be appropriate. Let’s review the chart:

The collapse of this stock, beginning in June, took it from the very top of its channel to the very bottom. We’re below the 50-day moving average, but not yet close to the 200-day moving average. Further significant declines are unlikely, and there is significant upside.

J: It is always interesting to revisit a trade we have held before. This stock has also attracted attention from one of our trading experts, Adam H. Grimes?

RR: And does he see what I do?

J: Almost. He notes the decline and potential rebound. He is not quite ready to pull the trigger.

RR: If he had spent some time being chased by that crazy coyote, he would move faster! Beep, beep.

Holmes: Range Resources (RRC) declined after a small rally last week. This is typical of stocks providing a good entry opportunity.

The stock showed some life after a patchy decline since mid-April. At its current price of $23.18, it is well below both the 50-day and 200-day averages. I am looking for a rebound to these points. With a PE of 18.6 the stock is also attractive on the fundamentals.

J: It looks like a consistent downtrend, along with the rest of the energy group. The price of oil looks stuck under $47 per barrel.

H: I am not trading oil. Whatever is happening in that market, this stock is showing attractive relative strength.

J: Have you been following the OPEC news?

H: You know well that I do not read news — just charts.

Felix: Micron Technology (MU) is my pick for the week. It’s a good bit sexier than my usual selections, but I have a good reason for it! Look at the chart:

Growth over the past year has been significant, and most importantly, it has been steady. Outside of a jump in mid-May, we’re seeing steady rises in stock price – reflected by the modest curves on the moving averages. I like that the stock has tumbled a bit this month. I’ll gladly take that as a buying opportunity.

J: This morning the pundit-in-chief opined that many people, focused on the stock symbol, thought it was some type of animal rights stock.

F: Who cares? It does not matter. Traders do not care what the company does. We succeed by identifying and exploiting the flow of trades. That is what I have done. What is this company anyway?

J: A chip stock.

F: So! It is in the food group!

J: Not that kind of chip; a semiconductor chip.

F: You should be more precise in your language.

J: Do you have updated ratings?

F: Of course. My fans have made some new requests. My assistant is supposed to respond to all of them.

J: Your assistant? I didn’t see any new additions to the payroll.

F: Oops. Here they are.

 

 

 

 

 

 

 

 

 

Athena: Discover Financial Services (DFS) is an interesting pick after a possible new uptrend. DFS saw a high upward run in the last two months of 2016 trading into 70’s from about 57.50 in early November. The stock had a fall into the higher 60’s territory in January this year. The past prices illustrate the market view of potential value. The recent basing signals a possible bottom.


J: Nice to see you back on the job! You understand that part of your vacation was unpaid.

A: Unlike human traders, I do not force it when nothing is there. That shows up in my long-term results.

J: I really do understand that, and I hope your vacation was refreshing. Turning to DFS, haven’t we discussed this stock before?

A: Not from me, but perhaps one of the others…

Holmes: Yes, I bought the dip in late April.

J: How did that work out?

H: Not well, as you certainly know. Please keep in mind: My batting average is above .500 and the winning trade size is much greater than the losers. My trading discipline helps me to avoid big losses. Small losses are just part of the game.

J: Thanks for explaining. You have indeed done well on limiting losses.

Oscar: I do not have a new sector this week.

 

J: That is a disappointment. Everyone is talking about a possible change in market leadership. The story is that all of the gains come from a few stocks. Why don’t you own those?

O: That general impression is completely wrong. Lawrence Hamtil looks at market leadership over the years. Most people would be surprised.

J: A very interesting article. How did you happen to see it?

O: Someone took my sports section.

J: An honest answer. Did you analyze the sectors requested by your fans?

O: Yes. This week’s list includes everything that has been requested.

J: An astute reader asks about TLT and TBT. You list both in the sell range. Since these are inverse holdings, how can both be a sell?

O: The rankings in the sell range do not imply a recommendation to “short” the group. They simply have very low ratings when other choices are much stronger. I would sell either one for a better opportunity.

J: Thanks for clarifying. You are basically saying that bonds are not a good choice – either long or short.

O: Exactly.

 

 

 

 

 

 

Conclusion

Psychology is a part of trading. Technical analysis, as Dr. Brett explains, is a way of reading the psychology of the market.

This week, a member of our analytical team was having trouble finding the Road Runner trading channel. He opined that the model seemed to be wrong. This is the human psychology question in a different guise. Our answer is very clear.

The model is not wrong! You are. It is based upon thousands of objective cases. If it does not look persuasive to you, grasshopper, you need to change your perspective.

 

After many years of looking at model charts and recommendations, I treat them as wise, but silent, advisors. In the Stock Exchange series, I try to make great advice come to life.

 

Here is a summary of the cast of our characters. Find your own favorite!

Stock Exchange Character Guide

Character

Universe

Style

Average Holding Period

Exit Method

Risk Control

Felix

NewArc Stocks

Momentum

66 weeks

Price target

Macro and stops

Oscar

“Empirical” Sectors

Momentum

Six weeks

Rotation

Stops

Athena

NewArc Stocks

Momentum

One month

Price target

Stops

Holmes

NewArc Stocks

Dip-buying Mean reversion

Six weeks

Price target

Macro and stops

RoadRunner

NewArc Stocks

Stocks at bottom of rising range

Four weeks

Time

Time

Jeff

Everything

Value

One month or long term

Risk signals

Recession risk, financial stress, Macro

 

 

Background on the Stock Exchange

Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present, and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Weighing the Week Ahead: Is it Time for New Leadership?

Friday’s eye-opening decline in the strongest gainers for 2017 has many people wondering:

Is it time for new market leadership?

Last Week Recap

The big news last week was the Comey hearing and speculation about what it meant. Markets have not been reacting to the political news, but it still commands media attention. CNBC provided non-stop coverage.

The punditry did spend time on my question from last week – bonds versus stocks – but seemed happy to turn to the action on Friday instead.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. The loss for the week was only 0.3%, but Friday’s trading added some excitement to a slow, summer Friday afternoon.


Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read the entire post for several more charts providing long-term perspective, including the size and frequency of drawdowns.

Note to Readers

Thanks to all of those who offered suggestions for changes in WTWA and encouragement about my main mission. There are many great ideas that I am trying to implement and many loyal readers who like things as they are. Here are the changes so far:

  • Eliminating much of the material repeated every week and placing it in a static source. I need to find a good way to encourage new readers to check out the background.
  • Reducing the calendar to summarize my own views on what is most important.
  • Moving the Silver Bullet to a standalone series. I am trying to make it more visible, not diminishing the importance. I realize that this is a bit less convenient for current leaders, but I hope they will help me out in establishing this.
  • Moving the trading ideas to the Stock Exchange series. Once again, please read and give this a chance. WTWA readers must be aware of the different time frame.
  • Changing the emphasis of the weekly theme to what I see as more important, with secondary consideration to media attention.

The News

Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The economic news last week was mixed, but the market reaction was positive.

The Good

  • Household balance sheets show new records in wealth in nominal, real, and per capita terms. (Scott Grannis).



  • ISM services registered 56.9. The strong value beat expectations. There was also strength in employment, business activity, and new orders. (ISM).
  • Commercial real estate is looking stronger according to the Dodge Momentum Index. This is claimed to be a leading indicator. See Calculated Risk for analysis and charts.

The Bad

  • Little progress in the debt ceiling debate.
  • Factory orders dropped 0.2%, the first decline in five months. (Reuters).
  • Wholesale sales declined to levels usually associated with recessions. (Steven Hansen at GEI). The lower inventories are also likely to affect Q2GDP.

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

The Calendar

It is a fairly light calendar. The FOMC meeting will be most important for markets – especially the press conference. Watch for hints about future policy and a resulting change in the slope of the yield curve. There will be some FedSpeak in the days after the meeting.

I am also interested in building permits

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.


Next Week’s Theme

The Fed decision will be a popular topic, but the week will begin with a deeper look at Friday’s trading. People will be asking:

Is there a change in market leadership?

Here some of the early explanations:

  • The FANG stocks were dramatically over-valued. A shift was long overdue. Anything might have started it.
  • The Amazon crash captured the attention of the CNBC crew, where they cited the rapid decline in a major name. The focus was mostly on Amazon, but partly on retail strength.
  • The rapid selling is evidence of inherent danger in the current market. Flash Crash redux.
  • Overall, the change in the major indexes was not that great. The differential effects happened too quickly to be called a rotation, but could it be the start of one?

Whatever the reason, it was not just a flash crash in AMZN.


 
 

As usual, I’ll have more in my Final Thought. I have an unprovable, but plausible hypothesis. It fits the evidence and timing from the chart above.

Quant Corner

We follow some regular featured sources and the best other quant news from the week.

Risk Analysis

I have a rule for my investment programs. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 


The Featured Sources:

 

Bob Dieli: Business cycle analysis via the “C Score.

RecessionAlert: Strong quantitative indicators for both economic and market analysis.

Georg Vrba: Business cycle indicator and market timing tools.

Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.

Doug Short: Regular updating of an array of indicators. Great charts and analysis.

Wisconsin economist Menzie Chinn (Econbrowser) Has his own helpful variant of the Big Four chart we often show here. He sees slowing growth, but no sign of a recession.


 

Insight for Investors

Investors should have a long time horizon. They can often exploit trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week it would be David Van Knapp’s comprehensive and thoughtful response to investors who buy good companies without regard to price.

He does a nice introduction and valuation. He explains that valuation affects probability, not certainty. And he uses some great examples. He explains that markets are not efficient, despite what you learn in school. He illustrates with another good example.

Especially devastating is his refutation of the facile and self-serving argument that has gained recent popularity: large cap stocks are never mispriced because markets are so efficient. He writes:

the idea that large-cap stocks are never mispriced ignores the data. It is clear that even the largest companies go through periods of mispricing. The following table shows the differences between the 52-week highs and lows for the biggest members of the S&P 500 right after the Brexit vote last June.

My summary cannot do justice to this fine work. Read it carefully. Read it twice!

 

Stock Ideas

Brian Gilmartin reviews the pluses and minuses for GE, including both fundamental and technical analysis. He notes the importance of the upcoming earnings report, and the attractions of a dramatic alternative for those with a growth portfolio.

Chuck Carnevale explains that attractive valuation based upon earnings is just a starting point – a way to avoid mistakes. As usual, he provides a helpful specific example.

Blue Harbinger analyzes closed-end funds, with special attention to risk. Mark produces a few ideas worth consideration.

Business Insider highlights an interesting chart from Twitter. It shows the lagging expectations for solar energy growth.

Subscription Sources

I read these sources, sharing a touch of the content so that you can decide whether to buy an issue yourself.

Barron’s has even more stock information than usual. It is the mid-year roundtable issue with ideas from nine participants. There are also interesting articles on energy stocks, tech stocks, and emerging market ETFs.

Personal Finance

Abnormal Returns always has first-rate links for investors. Once a year he takes a well-deserved vacation and substitutes a series of stimulating questions posed to the financial blogging community. I always appreciate being part of this project, and I give special thought to my answers. Looking at this year’s results, I see that my colleagues have done the same. You will find plenty of good advice.

Seeking Alpha Senior Editor Gil Weinreich reads extensively and has a great imagination. Nearly every day the raises an interesting topic for advisors and investors alike. This week I thought his discussion of financially fair divorce and divorce software was especially interesting.

[Mrs. OldProf wandered into my home office as I was doing this research and started scowling. Mystified by this, and eventually figuring out the problem, I explained that my reading was professional research, not personal. Her normal cheerful smile returned. There is a lesson there somewhere.]

Market Outlook

Fear and Greed Trader has another nice market summary. Especially helpful is his analysis of the recent claims of market skeptics. He also identifies some sectors that are benefiting from the rotation that is this week’s theme.

 

Watch out for….

Those turning good news into bad. Charlie Bilello joins in on one of my favorite topics. He lists many things that you might consider as part of the perfect market environment:

The following attributes might come to mind:

1) High returns with low volatility and 2) low drawdowns, with 3) global participation, 4) both stocks and bonds rising, 5) the economy expanding, 6) earnings growing, and 7) an easy Central Bank.

Sound too good to be true? Let’s take at where we are today…

He follows this introduction with a data-filled answer to each question. He then answers the key question: Is this as good as it gets?

I don’t know, but for investors it’s pretty darn close. The challenge, as we know from history, is that just because something is really good doesn’t mean the next stage has to be really bad. If it were, the game would be easy. You would just sell everything today and wait until everything is really bad next month to buy everything back at a lower price.

But that’s not how the market works. Most of the time, really good environments continue to be good for some time and even when they’re less good, they’re still ok. And importantly, investors can still make money in the transition from really good to ok.

Final Thoughts

 

Not every market ripple needs an explanation, but Friday’s trading was pretty interesting. None of the TV pundits had a good explanation. Here is what I observed:

Not much was happening; it was a typical, quiet summer Friday. I noticed a decline in Nvidia (NVDA), a company featured on the Stock Exchange a few weeks ago. It has been a profitable trade, and we still hold it in some programs. Since the decline was 10% or so in a few minutes, there must be some news. Checking out my sources I learned that a negative report had been issued by Citron Research, a noted short-seller. CNBC caught up with this, and invited Citron’s CEO to participate in the discussion. Jim Cramer and Josh Brown, both NVDA fans, were also part of the impromptu debate. One question was why Citron picked this particular moment for the report. The (rather lame) answer was “valuation” and some colorful analogies. There was no fresh news. Within a short time, the entire tech sector was selling off hard.

I remarked to my team that this was a pretty safe way to make money. You get really short, and maybe inform some friends about your plan. You write a report, release it, and your pals give it exposure. A slow Friday afternoon is a perfect time. You go on TV. As the stock craters, you cover your shorts and enjoy the weekend, having made a lot of money in a couple of hours.

This is a completely legal business model, if the reports are factual. By coincidence, Jesse Barron has a feature on The Bounty Hunter of Wall Street in this week’s New York Times Magazine. It features Andrew Left, the Citron CEO. I strongly recommend that you read it and study the examples. Compare them to Friday’s events.

What can you do to protect yourself? As I have often said, do not use stop orders that become market orders when your price is touched.

Does this mean new leadership for the market? We’ll have a better idea soon, but it is something important to watch.

What worries me…

  • Lack of compromise in government. Many believe that gridlock is good. Not so. We will need bi-partisan compromise to deal with the big issues like growing government debt and entitlement programs.
  • Growing tension with Russia, and within Russia.

…and what doesn’t

  • The idea of a “complacent” market. It is a poor description. We have a balance of widely divergent opinions and ideas. A stalemate – at least for now.
  • The Fed decision. We are far from the point when these rate hikes will make a difference. (See analysis by Fed expert Tim Duy).

Stock Exchange: Buy the Dip (VOYA) or Buy the RIP (DPZ)?

The Stock Exchange highlights the results from different technical trading methods. We also provide contrast, and often dissent, from a fundamental analyst. While the methods sometimes agree, our emphasis is on trading.

Review

Our last Stock Exchange took up an important question – how to deal with a losing trade. Any trader who has not planned for this in advance is headed for trouble. If you missed last week’s edition, check it out.

This Week— Buy the Dip or the Rip?

This is not the famous favorite slogan, but it fits today’s choices.

Road Runner: I have another great opportunity to buy a stock at the bottom of an up-trending channel. Domino’s Pizza (DPZ) shows great overall strength with an occasional buying opportunity. Now is the time.

RR: I suppose you will once again invoke Chuck Carnevale and F.A.S.T. graphs.

J: Naturally. Unlike last week, you are once again way out over the cliff.

RR: I am sorry that Mr. Carnevale does not appreciate my chart reading.

J: You do have some support. The research team at Société Financiers likes the explosive growth in revenue. Michael Vinci concludes that the stock is 22% undervalued. Julian Robertson’s Tiger Fund has increased its position.

RR: You see? I am not the only expert! Beep Beep!

 

Oscar: I have a new sector choice: 3D Printing. While I have my own basket of stocks for this sector, we can look at ExOne (XONE) as an illustration for the group.

This chart combines the best of little ball and big ball.

J: I knew you would get around to baseball.

O: It is relevant. When the stock declines a bit, it is as if they are playing in a one-run game. Bunting and sacrificing are OK.

J: Hmm-maybe. I suppose you do not care about earnings. I am not even going to post the F.A.S.T. chart since you would see a string of negative values. This is just a story stock.

O: And it has a good story.

J: Let’s turn to your responses to readers?

O: OK. Here is the current list.

J: Thanks. Let’s see what Holmes has to say.

 

 

 

 

Holmes: I buy dips, not rips. I take profits as stocks rise and always protect my gains. Here is an interesting opportunity – Voya Financial (VOYA).

This is a great setup.

J: Are you expecting higher interest rates? A takeover? Have you been watching those TV commercials with little orange rabbits?

H: I expect the chart to tell a story. I have no knowledge of interest rates or takeovers (whatever those are). I certainly don’t watch TV commercials. I don’t even watch TV.

J: I wouldn’t have noticed the commercials except for Allison Janney, a favorite for both Mrs. Oldprof and me. Turning to the data, you actually have some support from our fundamental analysts. Eric Gregg, a deep value investor, explains why he likes this one. Chuck’s methods also suggest some value here.

 

Felix: I have nothing new this week.

J: Again? I guess I am not surprised. It is still mostly a sideways market. I see that you still hold some big winners.

F: Yes, I have been doing fine. That does not always require a lot of trading.

F: Just so. We continue to follow your directions.

J: We? I suppose you mean that Athena has nothing fresh either?

F: Right. She said to tell you that you will see her again when something is happening.

J: The longest vacation in company history gets even longer. How about your weekly stock rankings? Still buy, hold, or sell, depending on the color?

F: Yes, and I welcome new questions. That is how the list is built.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Conclusion

The natural trader psychology is to buy dips and sell rips. It is fun to lock in profits. You get to score up the little gains that you have booked.

In fact, trend-following methods are among the most successful. If you are a trader who does not know the story of the Turtles, you should spend a few minutes learning about this great experiment. Trend-following can be a psychological challenge, but done correctly it is very profitable.

 

Here is a summary of the cast of our characters. Find your own favorite!

Stock Exchange Character Guide

Character

Universe

Style

Average Holding Period

Exit Method

Risk Control

Felix

NewArc Stocks

Momentum

66 weeks

Price target

Macro and stops

Oscar

“Empirical” Sectors

Momentum

Six weeks

Rotation

Stops

Athena

NewArc Stocks

Momentum

One month

Price target

Stops

Holmes

NewArc Stocks

Dip-buying Mean reversion

Six weeks

Price target

Macro and stops

RoadRunner

NewArc Stocks

Stocks at bottom of rising range

Four weeks

Time

Time

Jeff

Everything

Value

One month or long term

Risk signals

Recession risk, financial stress, Macro

 

 

Background on the Stock Exchange

Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present, and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Weighing the Week Ahead: Is the Bond Market Sending a Message for Stocks?

After the news-heavy calendar last week, there are few market-moving economic reports in the week ahead. It is also the quiet period for the Fed. How will the punditry fill those empty minutes?

Last week’s trading revived a question that many find puzzling. I expect pundits to be asking:

How can bonds and stocks both be so strong?

Last Week

Last week the economic news was mixed, but the market showed strength anyway.

Theme Recap

In my last WTWA I took note of the big economic calendar and short week. My conclusion was that we might finally see some volatility. Wrong! The news was close enough to expectations that the reactions were modest. Since there was little volatility, it never became the theme for the week.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. The gain for the week, achieved entirely on Thursday and Friday, was almost 1% and another new all-time high.


Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read the entire post for several more charts providing long-term perspective, including the size and frequency of drawdowns.

 

Personal Note

I am considering some changes in WTWA. Instead of launching “new Coke” without proper testing, I would like reader suggestions. I have outlined the ideas here, and I welcome comments and suggestions.

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something very positive. My working definition of “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The economic news last week was mixed, but the market reaction was positive.

The Good

  • Personal income and spending both increased 0.4%, positive but in line with expectations.
  • Household deleveraging has been “historic.” Since this news is contrary to most of what you hear, it is important to read the excellent global macro update from BlackRock.


To be balanced, we must also note the increasing leverage of corporations. BlackRock notes that this reflects the low cost of loans versus equity. More of the lending locked in for a long period.


Any assessment of debt and leverage must include government. It is a concern, and on my writing agenda.

  • Consumer confidence declined slightly, but remained at a high level – 117.9. Here is the analysis from the Conference Board:

    Consumer confidence decreased slightly in May, following a moderate decline in April,” said Lynn Franco, Director of Economic Indicators at The Conference Board. “However, consumers’ assessment of present-day conditions held steady, suggesting little change in overall economic conditions. Looking ahead, consumers were somewhat less upbeat than in April, but overall remain optimistic that the economy will continue expanding into the summer months.

  • ISM manufacturing beat expectations with a solid 54.9 reading. The Chicago PMI (Calculated Risk) notched its highest reading in 2 ½ years.
  • ADP private employment showed a gain of 253K. Regular readers know that I regard this as an alternative source on the jobs situation, neither better nor worse than the BLS.

The Bad

  • Pending home sales declined for a second straight month. (MarketWatch). Once again, low inventory was blamed. Steven Hansen (GEI) has an interesting take, comparing historical household formation and replacement needs, to new supply.

He writes as follows:

Based on the data in the above graph, since the beginning of the Great Recession there were almost a half million more new homes constructed than households formed. Up until the 21st century, there was good correlation between household formation and homes constructed.

However, historically 300,000 new homes are needed each year to replace those lost to fires, rot, other causes, or simply torn down to make way for new construction. Based on just replacements needs, 3 million new houses were needed since the beginning of the Great Recession instead of the half million above household formation actually constructed. The green line in the above graph is the combined need for new housing (year-over-year gain of households plus the replacement housing).

The bottom line is that the NEED for new construction is outpacing the supply. It seems the price for new and existing housing is above the price many buyers are willing (or can afford) to pay. It seems that there is a shortfall also of buildable land near many metros where people want to live.

 

  • Corporate profits may have peaked. (New Deal Democrat)
  • Legislative chaos from the Trump budget. Stan Collender’s pessimistic viewpoint has five negatives, including a 60% chance of an October government shutdown and reduced chances for tax reform. Stan is an experienced Washington insider, so we should pay attention. I strongly agree with the need for some compromise. That said, it seems overly pessimistic to me.
  • Auto sales declined slightly to a seasonally adjusted annual rate of 16.6 million and may have peaked. This means that companies will be competing for market share. Everyone will be watching to see if this is a peak or a plateau.
  • Initial jobless claims rose by 13K from an upwardly-adjusted prior week. The widely-followed four-week moving average also increased by 2500. Some observers are poised to see any increase in this level as a sign of danger. Doug Short has a key chart, which adjusts the results for the size of the labor force. It is great work, and something to keep in mind.

  • Construction spending dropped 1.4%, the largest decline in a year. (Reuters)
  • Employment situation disappointed in both the non-farm payroll report and the household survey. The headline net job gains of 138K significantly missed expectations. The prior two month reports were revised lower by 66K. The household survey was weak. None of my regular sources showed any enthusiasm about the employment picture. Calculated Risk summarizes the general reaction to this report.

    The headline jobs number was below expectations, and there were combined downward revisions to the previous two months.   Is this slowdown in hiring a short term issue, part of the normal business cycle, or due to a Trump Slump? My view is this slowdown in hiring is mostly part of the normal business cycle (my expectation was job growth would slow further this year).

    There was still some good news – especially with the unemployment rate falling to 4.3% (lowest since 2001), and U-6 falling to 8.4% (lowest since 2007).  But overall this was a disappointing report.

The Ugly

The opioid epidemic. Ohio is suing five drug companies for contributing to that state’s epidemic (Fortune). Some companies cannot find enough workers who can pass drug screening (Washington Post).

And at the low end of those trying to make a buck out of the, “addict brokers” find people whom they can induce to travel to a rehab facility. They qualify them for short-term insurance, and then abandon them after it runs out. (Stat).

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s award goes to David Templeton of HORAN Capital Advisors for his timely refutation of the latest “scary chart.” It is so easy to create these bogus parallels. If you want page views or retweets, this is the ticket. Here is the chart making the rounds:


And here is what you get if you use percentage changes, since the absolute price levels are not similar.


 

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

After the big reports last week, it is a light calendar.

The “A” List

  • ISM services (M). Continued strength expected.
  • JOLTS (T). Little understood report helps identify tight labor markets. A Yellen favorite.
  • Initial jobless claims (Th). Continues at near-record levels.

The “B” List

  • Factory orders (M). Noisy April data, but eyes remain on recent industrial weakness.
  • Wholesale inventories (F). More April data, subject to varying interpretations.
  • Crude inventories (W). Recently showing only modest impact on oil prices, and even less on stock prices.

     

FedSpeak is on hold for the quiet period in front of next week’s FOMC meeting. Those craving a “Fed fix” will have to rely on the pundits – most of whom claim to know more than Fed members anyway!

Next Week’s Theme

In a light week for data with no FedSpeak. That won’t stop punditry speculation about next week’s meeting, of course. And there is the constant possibility of a market-moving tweet. In this absence of this stimulus, what might be the theme for next week? There is already bemused head-shaking about Friday’s trading. If the employment news was weak, causing a rally in bonds, why did stocks move higher?

I expect pundits to be asking:

Is there a bond market message for stocks?

The divergence is simple.

  • Some believe that the bond market is “smarter.” This suggests that stocks do not reflect economic weakness.
  • Others feel that the markets are somewhat disconnected, with many stocks reasonably valued in a low-growth environment.
  • A few believe that bond yields reflect irrational recession fears or a distorted view of future Fed policy.

Most market participants seem to subscribe to the first of these three choices.

As usual, I’ll have more in my Final Thought.

Quant Corner

We follow some regular featured sources and the best other quant news from the week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 


 

The Featured Sources:

 

Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has several interesting approaches to asset allocation. Try out his new public Twitter Feed.

Georg Vrba: The Business Cycle Indicator and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli’s enhanced aggregate spread, considering when it might first give a recession signal. His interpretation suggests the probability creeping higher, but still after nine months. Here is an update of his recession indicator based upon the unemployment rate.


Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies.

Doug Short: The World Markets Weekend Update (and much more). His Big Four chart is the single best method to monitor the key indicators used by the National Bureau of Economic Research in recession dating. The latest update shows the most encouraging picture in over a year.


 

 

How to Use WTWA (especially important for new readers)

In this series, I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. Most readers can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have eight different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

Most of my readers are not clients. While I write as if I were speaking personally to one of them, my objective is to help everyone. I provide several free resources. Just write to info at newarc dot com for our current report package. We never share your email address with others, and send only what you seek. (Like you, we hate spam!)

 

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and the top sources we follow.

Felix, Holmes, and Friends

We continue with a strongly bullish market forecast. Most of our models are fully invested. The exception, Road Runner, is fussy about entry criteria. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our five technical experts, and some rebuttal from a fundamental analyst. This week we took up the important question of how to deal with a losing trade. Many traders do not really have a plan for this crucial issue. RoadRunner plays upward trending channels and likes NetEase (NTES). See the post for charts and a lively discussion.

Top Trading Advice

Pradeep Bonde has two interesting posts this week. He explains the advantage of looking at absolute momentum. This contrasts with most common methods, usually based upon a calculation based upon comparing with other stocks.

He also suggests some swing trading criteria, focusing on 8% moves. Look at his data to see why.

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Tom Brakke’s big picture take on modern investment analysis. In a helpful technique, he describes a persuasive example about new technology in farming. Readers who understand this are then invited to consider the use of volatility as the key measure of risk.

This is excellent, thoughtful analysis, and it is presented well. We pretend to understand issues with precision. We would do better to make modest improvements on the big risks.

Stock Ideas

 

Brian Gilmartin takes a multi-post look at the financial sector. He asks a question on the minds of many: Is the decline a buying opportunity?

Our Stock Exchange always has some fresh ideas. Holmes takes a look at Credit Suisse (CS).

Blue Harbinger summarizes the data on value stocks and what might be the catalyst for a rebound in this group. Hint: Volatility – which would hit riskier stocks the hardest.

Dividends and Yield

Chuck Carnevale is unhappy with current valuations for the top dividend stocks. I enjoyed his video, where he goes through a history of some past picks. I was happy to note that we currently own only the candidate he identifies as undervalued, while considering one that is close. I strongly recommend studying this to understand a great stock selection method, as well as the current market.

By contrast, Blue Harbinger finds some attractive candidates for a put-writing strategy. (This is similar to our own approach of writing OTM calls. Some of his names are in our universe).

Barron’s finds 6 dividend stocks that “hedge against inflation.”

This is a great topic for analysis.

Graduates

Check out the advice and links from David Snowball at the Mutual Fund Observer. One feature is his citation of Bill Gates who tweeted this year’s advice.

Personal Finance

Abnormal Returns always has first-rate links for investors in the weekly special edition. Investors will find value in several of them, but my favorite is from Bob French (Retirement Researcher). In his argument for investors to look less frequently at their portfolio results, he compares random data to actual performance. Can you tell which is which?


Seeking Alpha Senior Editor Gil Weinreich continues to provide advisors and investors alike with intriguing ideas and links. He frequently highlights articles that I would otherwise miss. I particularly enjoyed this post where he highlights Jim Sloan’s intriguing comparison of Buffett and Einstein. I’m not entire convinced, but it is a great topic for thought.

 

Market Outlook

Bill Kort takes up the ever-changing narrative on bubbles. Is Dr. Shiller really bullish?

 

Final Thoughts

 

Week after week we see focus on a specific issue when the underlying question is one of valuation. Let me take a slightly different approach to this question. Suppose that you anticipated ten percent inflation next year. What rate of return would you expect from your bank, from bonds, or from stocks? When inflation was that high, interest rates were even higher and stock PE’s were low. In a world of low inflation, why is it surprising that people are willing to accept lower anticipated returns.

The anticipated inflation rate of market participants can be determined from the constant maturity ten-year note yield, and TIPS. Here is the result:


 

With this in mind, let us revisit the “mystery?” Many analysts focus on inflows and outflows, risk on and risk off, Trump trade or not. This simple (simplistic?) interpretation presents stocks and bonds as an alternative.

While it is true that each asset class is always part of a relative comparison, the overall valuation in any asset reflects inflation expectations. Moreover, the long-term relationship between stocks and bonds is positive. Viewed in this way, we should not be surprised by Friday’s trading, or by similar reactions.

Those who consider inflation expectations as part of the valuation question will have more accurate results.

Possible Changes in WTWA

I have been considering some changes in my long-running WTWA series. While it is working well for its main function – focusing my own thoughts and communicating with clients and followers – some changes might make it better. It takes a very long time to prepare. I also find that many of my colleagues, who might link to a specific portion, have difficulty categorizing the entire post. While I am not particularly motivated by page views, I am energized by discussion from peers as well as readers. Shorter might be better for that purpose.

Perhaps most importantly, I am very disappointed that others have not joined me in recognizing Silver Bullet winners, or doing something like that themselves. It is vitally important. It is a good idea, but I need help. Even my annual review of winners was not cited by many of those who carry my work. It does not fit the normal boxes. Their boxes should be changed!

Finally, I understand that many do not like to read long posts, even when it is easy to scroll to a favorite section.

I am considering the following possibilities:

  • Shortening the article by removing some sections entirely.
  • Shortening the main article, but publishing some sections separately.
  • Reducing the number of links for investors.
  • Eliminating the “trading section.”
  • Publishing the theme, and my own ideas, as a separate post.
  • Eliminating references to Mrs. OldProf. (This is a test to see if anyone is reading this).

To help in your recommendations, here are the current sections I include.

  • Main theme – Focus for next week, alternative viewpoints, and often a foil for my message.
  • Summary of last week – just keeping things honest.
  • Overview and chart of the prior week. Needed perspective.
  • The good, bad, and ugly. Others have “succinct summaries” but these combine causes and effects. They also include dubious indicators while leaving out important information. I do it better, but it might not be worth the effort.
  • The Silver Bullet. Vital. Maybe should just be a standalone post.
  • The calendar. There are many efforts to do this, but they are all exhaustive. People need to know what is really important, and why. I am considering dropping this and developing a separate guide.
  • Indicator Snapshot – a summary of what I regard as important.
  • Featured updates – either from regular sources or outstanding posts from others.
  • Trading ideas. I try to separate trading and investing, mostly to prevent investors from excess trading.
  • Investment ideas, including “best of the week.” This takes a lot of work to screen and evaluate. I note that most of my blogging colleagues are talking less about stocks. If you are an investor looking for ideas, you will not get much help from the top-rated blogs.
  • My final thought – with a bit of market advice.

 

What do you think? Do you have some favorite items? What can I drop? Anything I should consider adding?

Please feel free to comment (which might stimulate some discussion) or to send me a private email.

Thanks to my readers!

 

Jeff

Stock Exchange: How to Deal with a Losing Trade

Each week the Stock Exchange highlights the results from different technical trading methods. We also provide contrast, and often dissent, from a fundamental analyst. Usually we get to celebrate winners and consider new picks. This week a couple of our participants need to face the music, discussing a losing choice.

Review

Our last Stock Exchange highlighted health care and biotech. The sector was OK after a mid-week dip. Some of the specific names did not fare well. Even worse, two weeks ago Road Runner picked RH. As I write this the stock is down over 20% after hours. Earnings and revenues were fine, but the announced outlook was terrible.

It is time for a frank discussion.

This Week— What About Losing Trades?

The two examples of losses are both interesting, but our team’s approach differs. For the key lesson, we turn trading (and trading coach) expert, Dr. Brett Steenbarger.

Stop losses

Brett has a great discussion in this post from 2014, The Psychology of Stop Loss Levels. He explains the value of a well-chosen stop. He notes that a trade involves both a direction and a path:

Being stopped out means that you were wrong about the anticipated price path.  It doesn’t necessarily mean that your underlying idea was wrong.  The loss can be a prod to help you better manage price paths, and it can also be a prod to take a fresh look at your idea. In both cases, the loss can help make you better.

This is a first-rate article, with both pluses and minuses about stops. Too many traders view stops as some magical method that generates only winners. They set stops too tightly, and instead miss out on winners.

Position Sizing

It is crucial to right-size positions, knowing how much risk to take. Brett writes:

 It’s not uncommon for small traders to have big dreams and take positions that are unusually large for the amounts of capital they’re trading.  Any trader can experience strings of losing trades merely by chance.  When position sizes are too large, those strings of losers incur a risk of ruin.  Once you’re down 50%, it takes a doubling of remaining capital just to return to break even.

There is no answer that fits all situations. Many years ago I offered some help, with discussion of the Kelly Criterion and some practical examples.  

I’ll comment further on this in the conclusion. Meanwhile, let’s see what the team members have to say for themselves.

J: Oscar, what about the weakness in biotech?

O: This kind of fluctuation is completely normal. No one should be surprised.

J: What action did you take?

O: Just like I do at the track. I don’t want my money on a loser, so I move on. Sometimes my pick is OK, but something else is more attractive.

J: How many sectors do you hold at a given time?

O: Three.

J: So the risk control comes from a limited about of sector diversification as well as trading stops. It is like the first of Dr. Brett’s methods.

O: I guess so. That is what I do.

J: Road Runner, what about that pick of RH?

RR: You said there was news after hours? I will evaluate the price tomorrow.

J: It appears that the company guidance was so bad, it will completely break your lower channel. How do you deal with such losses?

RR: It is a percentage game. I right-size each position. I know that most picks will win, and the wins will be larger than the losses. I trade about 5% on each pick.

J: So you are careful about “over betting your bankroll.”

RR: I’m not sure what that means. A single loss – even a big one – hurts my performance, but I do not take excessive risk. There is some expression about “betting the farm” that strikes close to home. Even a loss like RH will not make me jump off a cliff or something.

J: The loss puts you behind Holmes in the yearly standings. You were leading before this. (I can hear some enthusiastic barks in the background).

RR: I’ll get back on top.

J: What do we have for this week?

Road Runner: I have once again discovered my favorite chart pattern NetEase. Here is the rising channel and the current position at the bottom.

 

RR: I suppose you will once again invoke Chuck Carnevale and F.A.S.T. graphs.

J: Naturally. This time you have some support from the master instead of that silly coyote. It could be a good entry point for long-term investors, as well as a potential trade.

RR: I am delighted that Mr. Carnevale finally agrees with one of my excellent picks. Beep Beep!

Oscar: I have a new sector favorite: Utilities. You can readily see that the market has resumed the love affair with this sector.

Just look at the exciting jump above the 50-day moving average. And all of the trends are rising.

J: Aren’t you distracted by any sports streaks? How about the Cubs?

O: A short losing streak is not always meaningful.

J: Exactly. Neither is a winning streak. Let’s take a look at NextEra Energy (NEE). It is the largest component of XLU at 10%.

 

O: We do not actually own NEE. We have our own basket of representative utilities, each weighted equally.

J: Right. We do this because of erratic trading in the ETFs. There are plenty of choices. With a little work, you can find a collection of choices that has a near-perfect correlation. That said, our own choices have a F.A.S.T. graph that is very like that of NEE.

O: I plan to keep a close eye on this one.

J: It might be affected by a Fed rate hike decision later this month.

O: What’s a Fed? Do you mean the Nationals?

J: Get your mind out of the dugout. How about your updates on reader requests?

O: OK. Here is the current list.

J: Why no XLU?

O: I respond to reader requests. Our readers are not on that bandwagon.

 

 

Holmes: I love dips, followed by a period of basing. My most recent purchase, Credit Suisse (CS) is a good example. Let’s review:

For this stock, it is helpful to look at a longer time period – beyond my normal holding period. Here you can see the rebound a few weeks ago from this same level. There are also prior examples.

J: Are you encouraged by the French election? Worried about the British vote?

H: I do not worry about elections or which humans are conducting one. The chart shows the dip and the potential. That is really all that you need to know.

 

Felix: I have nothing new this week.

J: I am not surprised. When we have a sideways market, you have few chances to spot momentum.

F: That is exactly right. You and Vince always tell us not to reach. We are just following orders.

J: We? I suppose you mean that Athena has nothing fresh either?

F: Right. She said to tell you that you will see her again when something is happening.

J: This is the longest vacation in company history. How about your weekly stock rankings? Still buy, hold, or sell, depending on the color?

F: Yes, and I welcome new questions. That is how the list is built.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Conclusion

Whatever trading method you use, you must analyze risk and anticipate losses. A record with no volatility is a sign of faked data.

Many traders err because they choose position sizes based upon what they want to gain rather than what they can afford to lose. Most of the failed traders in my experience — including many good ones – did so by getting too big.

There was a test of this idea where a group of subjects with PhDs were given a bankroll and invited to play blackjack. They were accurately informed that the game was rigged to give them a 5% edge. A few hours later they were all broke. Even smart people underestimate the chance of a losing streak, even when the odds favor them.

 

Here is a summary of the cast of characters. Find your own favorite!

Stock Exchange Character Guide

Character

Universe

Style

Average Holding Period

Exit Method

Risk Control

Felix

NewArc Stocks

Momentum

66 weeks

Price target

Macro and stops

Oscar

“Empirical” Sectors

Momentum

Six weeks

Rotation

Stops

Athena

NewArc Stocks

Momentum

One month

Price target

Stops

Holmes

NewArc Stocks

Dip-buying Mean reversion

Six weeks

Price target

Macro and stops

RoadRunner

NewArc Stocks

Stocks at bottom of rising range

Four weeks

Time

Time

Jeff

Everything

Value

One month or long term

Risk signals

Recession risk, financial stress, Macro

 

 

Background on the Stock Exchange

Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present, and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!