Weighing the Week Ahead: Time for Tax Reform?

With the FOMC decision behind us and a moderate data calendar, the financial world will be focused on Washington. Expect people to be asking:

Has the time come for tax reform?

Last Week Recap

My expectation for last week was partly correct. The focus was certainly on the Fed, but the market reacted quite calmly.

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. There was little change on the week, and little change during the week. The range was only 50 bps even during the Wednesday Fed announcement.

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

My plans changed, so I was able to write today. I’ll get a weekend off soon!

The Silver Bullet

As I indicated recently I am moving the Silver Bullet award to a standalone feature, rather than an item in WTWA. I hope that readers and past winners, listed here, will help me in giving special recognition to those who help to keep data honest. As always, nominations are welcome!

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 remained quite positive.

The Good

  • Fed decision led to little market reaction. I am scoring this as “good” because no one expected a statement that was friendly for stocks. The actual announcement was a bit more hawkish than most expected, but the market reaction was muted. Perhaps the Fed obsession will take a back seat and we can focus on earnings. Scott Grannis calls the decision “cautious and correct.” Eddy Elfenbein is a bit less sanguine.
  • Corporate earnings outlook is even better. FactSet reports that “a record number of S&P companies have issued positive revenue guidance for Q3”. Information Technology, Health Care, and Consumer Discretionary have been especially strong.
  • Leading indicators increased 0.4% up from 0.3% in July. (Conference Board).
  • Trucking continues to improve. Steven Hansen (GEI) explains why we should emphasize the CASS index and notes that the improvement remains “moderate.”
  • Jobless claims had a surprising decline in the face of hurricane effects. Will it continue? Bespoke has the story and one of their great charts.

 

Bespoke’s take on permits:

 

The Bad

  • Existing home sales declined 1.7% in August. Calculated Risk is not very concerned, citing low inventory. He does note that hurricane effects are still to come.
  • Escalation in the war of words with “Rocket Man,” “dotard,” and aggressive threats. A key to the story is the situation of South Korea. Brookings has a great background article by Kathy Moon, a Senior Fellow and Professor at Wellesley.

    For the United States, a nuclear armed North Korea undercuts its security and traditional policy objectives, such as nonproliferation, and destabilizes the East Asia region. But for South Korea, it is an existential threat. Given the high tensions of late, Seoul fears being dragged into a war or, at the very least, falling victim to limited military exchanges between Washington and Pyongyang.

  • Rail traffic declined. This is especially true when using Steven Hansen’s “intuitive sectors” which remove coal and grain from the analysis.
  • Builder confidence decreased to 64 from a revised 67 in August. Calculated Risk notes that this is “a solid reading.” Mortgage applications were also down 9.7% from the week before.


  • Mortgage delinquencies are 0.7% higher. This is especially true in the hurricane-affected areas. (Calculated Risk)

 

The Ugly

Earthquakes in Mexico, Hurricane Maria – Mother Nature keeps bringing new challenges. The cooperation of people in the affected areas, and the tireless work to find and help survivors, is an inspiration. Meanwhile, the advanced technology helps to find the important affected areas.


Noteworthy

It is often a challenge to imagine ordinary life around the world, even if you are a frequent traveler. Sometimes the comparative price of a commonly purchased item is helpful. Statista looks at the iPhone X.


 

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

We have a normal economic calendar. Most important are personal income and spending. New home sales and the consumer confidence data will be interesting. There are plenty of Fed participants on the rubber chicken circuit. The GOP tax proposal will take center stage.

Briefing.com has a good U.S. economic calendar for the week (and many other good features which I monitor each day). Here are the main U.S. releases.


Next Week’s Theme

Much of the attention to Congressional action this year has been a waiting game. The key market issues relate to trade, tax reform, and infrastructure spending. These are now coming to the fore. If the GOP is to pass legislation with a simple majority in the Senate, it must be done as part of the “reconciliation” process. That opportunity ends this week.

Breaking news suggests that the “Big Six” group of Republicans has reached agreement on a proposal. This will have everyone wondering:

Is it time for tax reform?

The expected proposal includes tax benefits for top-bracket individuals and large corporations. There are also some breaks for the middle class and elements of simplification. President Trump is expected to announce the outline on Wednesday.

The key viewpoints will be clearer after details are known, but here is the general outline:

  1. Support from those seeking tax relief for top brackets and business, which they view as economic stimulus;
  2. Opposition from the deficit hawks, who will not see this as revenue neutral;
  3. Opposition from some businesses, who will perceive a competitive disadvantage;
  4. Opposition from Democrats, who will argue that it tilts toward high-income taxpayers.

The time frame does not permit much time for specific coalitions to form. As usual, I’ll have more in the Final Thought, where I always emphasize my own conclusions.

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


 

Notes on changes:

We have added a distinction between the technical appeal of the market on a short-term (two months or so) and a long-term basis. The mildly bearish interpretation for last week did not imply a full exit from trading. It was a warning that conditions are not as attractive. As you will see, this indicator can move fairly rapidly.

The Featured Sources:

 

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

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

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

Georg Vrba: Business cycle indicator and market timing tools. It is a good time to show the chart with the business cycle indicator.

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

Featured Guest Sources

Earnings expert Brian Gilmartin compares forward earnings estimates with the actual results. His conclusion will be surprising to many (but not to regular WTWA readers).

The forward estimate does a pretty good job of estimating SP 500 in what might be considered “normal” years. For instance, in late 2007, the forward estimate for 2008 was looking for roughly $100 in EPS, and the actual 2008 EPS was closer to $65. Another example might be 2015: in late 2014, the SP 500 forward estimate was looking for $122 in SP 500 EPS and the final was $118.78 thanks to the collapse in crude oil, the strength of the dollar and the China yuan devaluation that occurred in late summer, 2015.

Still those events only cost the SP 500 approximately $5 in EPS in 2015, which tells you what a tremendous shock the Financial Crisis was to SP 500 to cause a decline of roughly 35% from “estimated-to-actual” SP 500 EPS.

Brian’s work explains an inconsistency in the conventional wisdom about forward earnings. First, that analysts are too optimistic. Second that companies have a high “beat rate” because of low estimates.

At some point in the process of reducing estimates, the indication must be pretty good.

Dr. Ed Yardeni rebuts the latest scary story from Dr. Shiller. He describes several other valuation indicators that are regularly ignored. It is worth a read, if only to understand the varying perspectives. It is also quite consistent with Brian Gilmartin’s work.

Insight for Traders

We have not quit our discussion of trading ideas. The weekly Stock Exchange column is bigger and better than ever. We combine links to trading articles, topical themes, and ideas from our trading models. This week’s post showed how model-driven trades worked despite the popularly-cited worries. Blue Harbinger has taken the lead role on this post, using information from me and from the models. He is doing a great job.

Insight for Investors

Investors should have a long-term 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 Econompicdata’s look at compounding. This basic principle should be familiar to all investors, yet many forget the importance. The post concludes with practical advice, including minimizing taxes. Here is one of the charts.


 

Stock Ideas

 

Cardinal Health (CAH) is a dividend aristocrat trading near its all-time high yield. Simply Safe Dividends takes a closer look. I like this choice, but we have written short-term calls against the stock to enhance yield. We do this on solid choices where there is not explosive upside.

The Barron’s cover has an interesting Andrew Bary story on gene therapy, with explanations that will make sense to the average financial reader. The stocks are still very speculative, highly dependent on FDA decisions. Check out the story for a list of names.

Permian basin stocks? These are worth a look, especially if you think oil prices have bottomed. (Lee Jackson, 24/7 Wall St.).

Digital Realty Trust? (DLR) Simply Safe Dividends does a thorough review. Everything looks good except the valuation. That makes it worth watching in case there is a dip. (This is one we owned, but sold for valuation reasons).

Brian Gilmartin takes his normal careful look at Bed, Bath, & Beyond (BBBY). He raises some questions before their report and then writes a nice recap.

Bank stocks? WSJ’s MoneyBeat highlights the recent strength. My own take is that the regional banks (which we sold a few months ago) are still way too expensive, but some of the money center banks are closer to our buy range.

Personal Finance

 

Seeking Alpha Senior Editor Gil Weinreich has an interesting topic every day. His own commentary adds insight and ties together key current articles. As usual this week he had several good posts, but I especially liked his “ignorance is bliss” column. He highlights Charlie Bilello’s look at market history since 2009. Gil focuses on the implied definition of “evidence.” He agrees with Bilello that emotions should be put aside. That still leaves one to consider what sort of evidence to use.

He has a compendium of market worries in that time frame, including the repeated assertion that the “easy money has already been made.” Chart lovers will find plenty to study. Here he analyzes the popular claim that volume declines are bearish.


The Fear and Greed trader has a similar review as a backdrop for his current conclusions.

 

Watch out for….

 

Market timing. Another analysis of the futility of this approach. (For comparison, we are trying to help people with risk-timing. We reduce risk when necessary, even though it is probably not the market top).

REITs on the edge. Brad Thomas explains how to analyze a REIT at a “tipping point.”

REITs with “excessive” yield. Marc Gerstein suggests a method that screens out the most dangerous candidates – well worth a look. He provides his current list, while warning that it changes frequently.

ETFs? Simply Safe Dividends raises the question of whether it is better to buy your own portfolio or to choose an ETF. He concludes that the decision is often one of personal convenience. The main drawback?

The main drawbacks to owning ETFs over individual stocks are that you are stuck with whatever dividend yield they offer (which is often too low for investors needing income today), their income streams can be riskier because they own good and bad quality businesses, and they can lack reasonable diversification depending on how they are constructed.

All of these factors can be a bigger deal for dividend investors than simply comparing total return potential of different ETFs and hand-picked dividend portfolios.

 

Final Thoughts

 

Most people including the thought leaders in financial media, watch political events with a rooting interest. Having strong opinions is fine. Discussing them with friends and using them for voting are also fine.

Mixing your politics with your investing is a not fine. It is a serious mistake.

Thinking strictly in terms of your role as an investor, what do you want from Washington? Probably the following:

  • Stronger economic growth
  • Tax reform
  • Better infrastructure
  • Avoiding surprises and shocks

What is the best way to achieve these goals?

Compromise. Many years of gridlock have thwarted any progress on these fronts. You can monitor various measures of Congressional progress (or lack thereof) at the Bipartisan Policy Center. You will find plenty of data and charts – not just opinions.

The potential for compromise has increased dramatically in the past few weeks. There is no imminent threat to government funding. The ObamaCare repeal failure illustrates the need for bipartisan efforts on health care. It probably sets the pattern for tax and spending issues as well. This will be a very interesting week. There is real potential to form more lasting bipartisan alliances.

What worries me…

  • An “accident” involving North Korea. Intentional action is mostly belligerent rhetoric.
  • Strident positions that waste the chance for some meaningful compromise.

…and what doesn’t

  • Market valuation. Growing earnings and a healthy economy have provided support for current stock prices. See Dr. Ed above, in the quant section.
  • The Fed. As I expected, this has proven to be a benign and gentle policy shift.

 

 

Stock Exchange: Climbing the Wall of Worry

The 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. If you have some ideas, please join in!

Review

Our previous Stock Exchange asked whether your trades fit your style, and reviewed how this can help improve your success. If you missed it, a glance at your news will show that the key points remain relevant.

This Week: Climbing the Wall of Worry

It’s been a powerful recovery since the depths of the financial crisis over 8 years ago, and the S&P 500 hit another new all-time high this week.

However, the recovery has not been as perfectly smooth as many seem to think. It has been the fear and bumps along the way that continue to create attractive opportunities. And even though market wide volatility (as measured by the VIX) is near all-time lows, there are plenty of stock-specific trading opportunities.

This week’s Stock Exchange expands on how our models trade on market fear, both generating profits and protecting against losses. We highlight several specific picks from our models, and we also dig in to the methodology. All three of this week’s picks highlight how we are able to buy in the face of fear, such as implementing mean reversion trades, buying smaller dips within larger rising channels, and simply using momentum strategies to climb the wall of worry. And of course, we impose strict risk management techniques along the way.

Expert Picks from the Models

This week’s Stock Exchange is being edited by our frequent guest: Blue Harbinger (also known as Mark D. Hines). Blue Harbinger is a source for independent investment ideas focused on value and income opportunities.

Holmes: This week I bought Discovery Communications (DISCA). This stock’s dip over the last month is the sort of set up I like to see. From the chart below you can see it is below its 50-day and 200-day moving averages. However, it has attractive upside over the next six weeks.

Blue Harbinger: Interesting pick, Holmes. As you know, Discovery is global media company providing content across multiple distribution platforms, including television, websites, digital distribution arrangements and content licensing agreements. Can you give us little more color on why you like it?

Holmes: As you know, my style is based on dip buying and mean reversion. However, you may not be aware that I’m really into protecting assets too. My process drastically reduces vulnerability to drawdowns while attempting to stay invested for the longest possible period of time. I use a mix of advanced trading techniques (including profit taking, stops, and trailing stops) and technical analysis.

BH: Interesting. The last broad market downturn I recall was in early 2016, when markets started off the year terribly due to depressed energy prices. How’d you do during that time period, Holmes?

Holmes: I did well, thank you. I did not completely exist the market, but positions were significantly reduced, and I avoided a significant amount of the market wide declines.

BH: That’s impressive. By the way, I am assuming you are aware that Discovery is buying Scripps Networks, and that announcement is a big part of the reason the price of DISCA is down so much since the end of July?

Holmes: I am aware.

BH: Well, from a fundamental standpoint, Discovery has some attractive qualities such as its large library of content. Plus the company has fairly wide global distribution of its programming. Specifically, every once in a while, I enjoy watching the Discovery Channel, TLC, and Animal Planet. However, the company is dependent on cable to a large extent, and the continuing “cord cutting” trend could create problems, especially considering it has a fair amount of debt and so does Scripps.

Holmes: I’m only looking to hold this position for about six weeks. And during that time period I suspect Discovery will rise despite your concerns about the Scripps acquisition and the so called “cord cutting.”

BH: Thanks. I’ll watch this one closely. And honestly, I think this is a decent pick, however I prefer to hold my positions for longer than six weeks. How about you RoadRunner—what have you got this week?

RoadRunner: I like Abiomed (ABMD). It’s a $7 billion market cap medical device company. It provides mechanical circulatory support devices to aid heart recovery for heart failure patients.

BH: And you like Abiomed because?

RR: I like to buy stocks that are at the bottom of a rising channel, and if you look at the chart below you can see why I like Abiomed this week.

BH: I can see the rising channel, and I can see why you’d think it has more upside within that channel, but what about the company specifics. Are you aware that the CFO resigned last month? Or that they just received FDA approval this week for their Impella heart pump after five years of research?

RR: I am aware, but I mainly like this stock over the next 4 weeks based on its location within its rising channel. Plus, we have certain risk management procedures in place if anything goes wrong. For example, we limit our position sizes, and we only trade highly liquid stocks.

BH: What about short-term gains taxes? If you’re only holding this position for 4-weeks then any gains you generate will be taxed at the higher short-term gains tax rate. Ignoring Uncle Sam is one of my 7 Deadly Sins of Long-Term Investing.

RR: I am aware, however I expect to generate more than enough profit to offset any additional short-term gains taxes, and I’ve been doing exactly that for many months now. I am not a long-term buy and hold investor. As I mentioned, I typically hold things for about 4 weeks, and my strategy continues to generate outsized profits, even after taxes. How about you, Athena, what have you got this week?

Athena: I don’t have any trades this week, and I’m not going to force anything.

Felix: Same here. No trades stood out for me this week, and I’m not going to force anything either. However, for your reference, here is a look at my rankings this week.

BH: Thanks Athena and Felix. How about you, Oscar, what have you got?

Oscar: I still like the China Consumer ETF (CHIQ). Emerging markets have been performing very well this year, China in particular. Plus, the consumer segment of China is increasingly strong.

BH: I recall that was your pick back on September 1st, and you’ve been doing well on that trade so far.

Oscar: That is correct, despite the strong gains so far this year, and the increasing volume of fearful investors, I’ve been happy to hold shares as this ETF climbs the wall of worry.

And as a general reminder, I typically hold these ETFs for about six weeks. Also, as I’ve mentioned before, my exit strategy is to rotate into a new sector, and I control my risk with stops. And if you’re curious, here are my ETF rankings for the week.

Conclusion

Whether it’s the 8+ year rally since the financial crisis, or one of the many shorter-term individual stock rallies despite fearful market sentiment, there continues to be opportunities to profit as the market (and individual stocks) continue to climb the wall of worry. And depending on your style (whether it’s mean reversion like Holmes, buying smaller dips within larger rising channels like RoadRunner, or simply using momentum strategies to climb the wall of worry like Oscar) there continues to be plenty of attractive opportunities in this market.

Stock Exchange Character Guide

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 http://dashofinsight.com/background-stock-exchange/  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: Will a More Aggressive Fed Spark the Long-Awaited Correction?

We have a light calendar for economic data. The week’s focus will be the FOMC policy announcement on Wednesday. Given the resilience of the market rally in the face of various natural and human threats, the punditry will turn to a favored topic. Expect people to be asking:

Will the Fed be the catalyst for a market correction?

Last Week Recap

My expectation for last week was only partly correct. There was plenty of competing news and not much optimism about a market-friendly legislative agenda.

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. Monday’s big rally was sparked by the weakening of Irma and lowered damage estimates. After some follow through on Tuesday, the market was flat for the rest of the week.

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 off next Saturday, so there might not be a WTWA post. If I can, I will do an abbreviated version, but it might be a day late.

The Silver Bullet

As I indicated recently I am moving the Silver Bullet award to a standalone feature, rather than an item in WTWA. I hope that readers and past winners, listed here, will help me in giving special recognition to those who help to keep data honest. As always, nominations are welcome!

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!

There was little economic news, but it was generally positive. The negatives were not very significant.

The Good

  • U.S. median income increases for the second year in a row. Christopher Matthews (Axios) has details.

  • Corporate executives remain optimistic about the economy. Avondale conference call summaries provide great context for the data we follow.
  • Initial jobless claims moved lower, despite the Harvey and Irma effects. Bespoke charts the data and New Deal Democrat shows how a hurricane adjustment makes the picture even better, 239,000. Eddy Elfenbein also weighs in.

  • JOLTs showed a solid and improving picture. The Beveridge curve and the voluntary quit rate are the key elements. Contra – New Deal Democrat questions the data.

The Bad

  • Industrial production fell 0.9%, a decline from last month’s gain of 0.4%, and missing expectations of a gain of 0.2 to 0.3%. Steven Hansen (GEI) notes the headline loss. His expected deep dive into year-over-year comparisons and unadjusted data is less discouraging.
  • Retail sales declined 0.3% compared to a prior month gain of 0.3%, which was revised down from 0.6%. Expectations were for a modest increase. Reuters attributes the decline to hurricane effects. Perhaps so, but we will have some noisy data for the next couple of months (at least).

The Ugly

Irma aftereffects. Especially the death of senior citizens in facilities that lost power.

Noteworthy

What is your financial health? Check out the data from MarketWatch showing ten indicators, updated in real time. While 70% of Americans say they are living comfortably or doing OK, nearly half could not cope with a $400 emergency. Here is one example.


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

We have a light economic calendar. The housing data are important, but Wednesday’s FOMC decision and Chair Yellen’s press conference will take the spotlight. Other Fed participants will also hit the speaking trail after the meeting.

Briefing.com has a good U.S. economic calendar for the week (and many other good features which I monitor each day). Here are the main U.S. releases.


Next Week’s Theme

There is widespread agreement (perhaps mistaken) about the role of Fed policy in current asset prices. We also have an over-supply of armchair experts on what the Fed should be doing. This comes at a time when significant market drawdowns have been few and modest. Jill Mislinski illustrates this key element of background—only two drawdowns of more than 10% in the last six years. Even North Korean missile launches have little effect in the current market.


Is this a dangerous combination, waiting for a catalyst? Expect many to be asking:

Will a more aggressive Fed spark the long-awaited correction?

The Fed is always a topic for discussion, but it reaches some higher level every six months or so. I always take a fresh look at the week ahead, but it sometimes helps to remember the history of a specific issue. Here is my summary of a discussion of Fed tightening from one year ago.

An abbreviated sequence of the week’s events:

Stock futures were set up for a flat opening, just as we had seen all week.

Boston Fed President Eric Rosengren, repeating a speech made in August, stated that gradually removing accommodation was the best way to extend the duration of the recovery. The Boston Globe states that this pushed the Dow 400 points lower.

Stock futures moved lower by about ½ of one percent when the speech was reported.

Since markets are not expecting a September rate increase, and only a 60% chance of one before the end of the year, the original move attracted a lot of discussion.

When the Dow declined a little more, CNBC started running the headline that Fed fears were slamming stocks.

Several commentators cited the possible end of the Fed support for asset prices. Art Cashin fed the fire, noting in mid-afternoon that if stocks were down 300 on just the hint, an actual increase might take them down 1000.

We might well ask what has changed. Here are the key viewpoints:

  1. At last! If the Fed quits propping up the market, maybe stocks will get to the “normal” valuation. Contra – Dr. Ed Yardeni.


2. The Fed has been consistently wrong on policy. It has waited too long to raise rates, missing the best opportunity. There is no dry powder for the next recession, which may happen at any time.

3. The Fed has been consistently wrong on policy. The threatened deflation from a weak global economy is not ready for more aggressive Central banks. (Tim Duy).

4. Fed policy is changing, but only very gradually. The impact will be modest.

5. Market-timers are anticipating a decline, implying a limited effect. (Mark Hulbert).

6. No one knows the consequence of this policy shift. (Greg Robb, MarketWatch).


7. The importance of Fed policy changes is not very important in the current low-rate environment.

As usual, I’ll have more in the Final Thought, where I emphasize my own conclusions.

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


Notes on changes:

We have added a distinction between the technical appeal of the market on a short-term (two months or so) and a long-term basis. The mildly bearish interpretation for last week did not imply a full exit from trading. It was a warning that conditions are not as attractive. As you will see, this indicator can move fairly rapidly.

The nine-month recession probabilty from the C-Score remains at <15%. This is a curvilinear relationship. The odds move only gradually in the current range.

The Featured Sources:

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

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

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

Georg Vrba: Business cycle indicator and market timing tools. It is a good time to show the chart with the business cycle indicator.

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

Featured Guest Source

CXO Advisory does top-notch, professional research on the topics important to investors. I often find myself wondering about some piece of conventional wisdom that lacks proper evidence. I find myself wishing that I had a bigger research staff. Then I consult the CXO Advisory archive and discover a thorough analysis. Here is an example.

Nearly every week I see a post citing the increase in margin debt. The assertion is that danger is signaled because people are borrowing money to buy stocks. Those providing a chart as evidence do not analyze effectively whether this is a leading, coincident, or lagging indicator. This is not something you can readily see by inspection. In February, I cited Paul Hickey of Bespoke for the Silver Bullet. His analysis showed the market results after a period of margin debt declines of 10% or more, finding no difference.

CXO has an excellent analysis. This is members-only research, but I am asking them to make this article public as an example. Meanwhile, (with permission) here are some key conclusions:

The Pearson correlation for the two series is 0.39 and the R-squared statistic is 0.15, indicating that monthly change in margin debt explains 15% of the same-month movement in the S&P 500 Index. This result confirms a tendency of the two series to move together.

However, the correlation between next-month S&P 500 Index return and monthly change in NYSE margin debt is 0.00 and the R-squared statistic therefore also 0.00, indicating that the latter has no ability to predict the former at a one-month horizon.

There are several interesting and convincing charts, showing the effects over several time frames. This one summarizes the key point: Margin debt lags changes in markets.

Reading through the CXO archives lets you check out the record of various “guru’s” and the facts behind many popular market truisms. Any thoughtful consumer of investment information will find this subscription worthwhile.

Insight for Traders

We have not quit our discussion of trading ideas. The weekly Stock Exchange column is bigger and better than ever. We combine links to trading articles, topical themes, and ideas from our trading models. This week’s post covered the need to find trades that fit your personal style. Blue Harbinger has taken the lead role on this post, using information from me and from the models. He is doing a great job.

Insight for Investors

Investors should have a long-term 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 Adam F. Grossman’s interesting discussion of Warren Buffett’s decision NOT to buy Microsoft (MSFT). I won’t spoil the story, but the lesson about defining and sticking to your competence is a good one. Here are some of the key points:

This will look different for each individual, but here’s the overall approach I recommend. It’s five steps: (1) Articulate your goals; (2) Quantify each goal; (3) Attach a time frame to each goal; (4) Develop and implement an investment plan for each goal; (5) Review your plan at least once a year and modify it as your circumstances change.

Stock Ideas

Our ideas this week have a focus on yield, although the methodology differs.

Chuck Carnevale analyzes his long position in Visa (V). Knowing when to exit is important. Valuation helps with this decision.

Brown-Forman (BF.A) is a fast-growing dividend aristocrat, and part of Warren Buffett’s portfolio. The same source, Simply Safe Dividends, cites Walgreen Boots Alliance (WBA) as part of the Bill Gates portfolio. Both stocks are worth consideration on the merits, but not because of who owns them. People are competent in different spheres. Both Mr. B and Mr. G are worthy of admiration for their accomplishments and social commitment. It does not mean that Mr. G is a great stock picker or that Mr. B’s portfolio is suitable for you. Mr. B can beat me at investment analysis and baseball trivia. Mr. G has me on business vision, software, and world health. Less importantly, I can beat them at bridge!

And here are ten reasons that Berkshire Hathaway is a “screaming buy.”

Brian Gilmartin has a careful analysis of Coke’s (KO) strengths and challenges.

Blue Harbinger analyzes the top health care REITs, most of which we own.

Market Folly has a nice summary of ideas from the Delivering Alpha conference.

Personal Finance

Seeking Alpha Senior Editor Gil Weinreich has an interesting topic every day. His own commentary adds insight and ties together key current articles. This week, among several good posts, he has one that shows special value both for advisors and investors. Once again, he reviews and discusses reader comments, a valuable part of the series. One of his links is today’s “best investment advice” (see above). This is a good daily read for both investors and advisors.

Abnormal Returns has a different topic each day. I read them all, but individual investors might find the Wednesday focus most relevant. There are always many great links. My favorite this week is Michael Kitces’ analysis of the challenges in using a funded ratio for retirement planning. Here is a key quote from the summary:

An increasingly popular strategy to give context to the progress of saving towards a (retirement) goal is the funded ratio – where the current account value is presented as a percentage of the total savings necessary to achieve the goal (or at least, be on track for the goal with an assumed growth rate).

The virtue of the funded ratio is that it takes an abstract account balance and relates it directly to a goal or outcome, and can give savers a sense of accomplishment as the percentage slowly and steadily climbs towards 100%. The bad news, though, is that once account balances grow large, the funded ratio itself can become highly volatile as markets move up and down, and the discount rate used to calculate the funded ratio can unwittingly turn into an indirect absolute return benchmark that is difficult to keep up with.

Watch out for….

Eddy Elfenbein notes that the Dow would be down for the year if priced in Euros. Currency effects can be important when making foreign investments.

Exxon Mobil (XOM). Is the company overly optimistic about oil prices?

Verizon (VZ). Competition not letting up.

Final Thoughts

Is it now time to fear the Fed?

  • The change in the Fed balance sheet is modest given the size of the overall market. (here and here)
  • The policy change has been well-advertised. (Leading Fed expert Tim Duy).
  • The balance sheet was never the main driver of market strength.

Is a correction imminent?

  • I don’t know. Neither does anyone else.
  • While the change in Fed policy has little substantive meaning, expect plenty of spin.
  • There is always a chance for a self-fulfilling prophecy.
  • Anticipating corrections is not a profitable investment strategy. (Historical analysis based on Shiller data and CAPE. Victor Haghani and James White)

What worries me…

  • Wasting the opportunity to shake up existing Washington alliances. Most of the needed policies require bipartisan cooperation between moderates. Last week saw little progress beyond the initial actions.

…and what doesn’t

  • Market valuation. Some day there will be a reconsideration of the methods that have frightened so many for so long. A continuing focus on growth in earnings expectations has worked well.
  • The Fed.