Weighing the Week Ahead: What Does the Brexit Vote Mean for Financial Markets?

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This week’s economic calendar is a little light on data, but it packs plenty of important news. Last week I suggested that the Brexit build-up would become the dominant theme. Nothing has changed. Expect daily stories on three Brexit themes:

  1. What UK voters should do;
  2. Predictions about the result; and
  3. Consequences for financial markets.

While financial media will cover all, my attention will be on the third. What Will the Brexit Result Mean for Financial Markets?

Last Week

There was little economic news. The biggest change was the reaction to the FOMC meeting.

Theme Recap

In my last WTWA, I predicted a week divided between two themes—first the Fed, and then Brexit. It was indeed a two-story week, with an overlap in the middle. The Fed decision was greeted positively for a few minutes, and then the tide shifted.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. You can clearly see the slightly delayed reaction to the Fed announcement. Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

SPX-five-day

 

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. 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 Good

  • Sea container counts are showing some rebound from the recent soft patch, but we remain well off the highs. (Steven Hansen at GEI).
  • Earnings estimates are strengthening. Check out Brian Gilmartin’s analysis for a detailed look at which sectors and by how much.
  • Fund manager asset allocations to equities remain near an eight-year low. On a contrarian basis, this is bullish for stocks. (Urban Camel).

fund-managers-asset-allocations-percent-cash-june_baml

  • Retail Sales were strong, in both real terms and per capita (New Deal Democrat). More people are shopping online, which makes interpretation of sales more challenging. Doug Short has multiple charts and a “Big Four” update. Ed Yardeni has the online story.

Yardeni online shopping

  • Housing showed strength. The picture remains complicated and a bit mixed.
    • Housing starts met expectations, had revisions for prior months, and an increase of 9.5% over last year. (Calculated Risk)
    • Doug Short analyzes the secular trends in both building permits and housing starts.Housing-Permits-and-Starts-population-adjusted

     

    • NAHB builder confidence increased to 60, up from 58 and well above the expansion signal of 50. (Calculated Risk)

The Bad

  • Industrial production fell 0.4%. This remains the weak spot in the economic data.
  • Foreigners are selling U.S. equities. The pace is an all-time high according to Torsten Sløk, Ph.D., Deutsche Bank Securities via Barry Ritholtz. Check out the chart.
  • The rail contraction continues. Steven Hansen at GEI has his regular update on this story.
  • Jobless claims edged higher. But still reasonable at 277K.
  • Lowered Fed expectations recognize slower growth. Most market participants do not expect lower interest rates to solve this problem. Bloomberg has a good summary of the Yellen conference, including various viewpoints.

 

The Ugly

Continuing violence and terror. The mass shooting casualties have been getting worse.

 

massshoot_jun16a-1

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. No award this week. Nominations are always welcome.

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

We have a relatively light week for economic data, but a big one for news. I highlight only the most important items, helping us all to focus.

The “A” List

  • The Brexit vote (F). The vote is Thursday, but results will not be available until Friday trading.
  • New home sales (Th). Can recent strength continue?
  • Michigan sentiment (F). Good indicator for employment and spending – remains near highs.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Existing home sales (W). Less direct impact than new home sales, but a good read on the housing market.
  • Durable goods (Th). A decline is expected in this volatile series, but how big?
  • Bank stress test results (Th). Mostly important to a few banks, but also a measure of overall financial health.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

Chair Yellen will provide her semi-annual Congressional testimony to the Senate on Tuesday and the House on Wednesday. The question periods will be closely watched. You might think there is nothing left to learn after last week’s FOMC decision and press conference, but any fresh hints will get attention. We also have a resumption of appearances by other Fed participants.

 

Next Week’s Theme

 

Anyone whose breath can fog a mirror is being asked about his or her opinion of what the Brits should do. That is a lively topic, but not one for us.

The outcome of the vote is important, but the prospects seem to change daily. Again, not a good topic for us.

While the financial media theme for the week ahead will be broader, the key point will be:

What does the Brexit vote mean for financial markets?

I have read scores of articles on this topic, watched webinars from experts, and listened to (some of) the punditry. While it is part of my job, most investors do not want to do this. I will try to provide a few key points as background. Read some of these links, draw your own conclusions, and compare them with mine at the end of this post.

  1. How does Brexit compare to other perceived crises? Josh Brown notes the $140 billion of net equity outflows and compares the VIX level to prior incidents. Concerns are higher than for interest rate hikes or the Presidential election. (Bloomberg)
  2. Some suggest that we should expect chaos – and then damage control. (Bloomberg)

Bloomberg Damage Control

  1. The impact on U.S. markets should be modest. (CNBC and also David Merkel)
  2. Brexit would hurt trade, the global economy and stocks, and especially revenues from certain sectors.

FactSet UK Revenue Exposure by Sector

  1. Last but certainly not least, a chart-based background guide to Brexit (The Economist) Here is a sample:

20160227_woc220

And a tabular summary of the issues:

20151024_WOC501_2

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 

The Featured Sources:

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he expresses more confidence about growth in earnings.

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). Monthly reports including both an economic overview of the economy and employment.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting approaches to asset allocation.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. His latest update features his unemployment rate recession indicator. A recession is unlikely “any time soon.”

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

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interest can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

How to Use WTWA

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. For most readers, they 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 six 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?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 could be the Year for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions or suggestions for new topics.)

 

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 also the best advice from sources we follow.

Felix and Holmes

We continue our neutral market forecast. Felix is fully invested, but the sector balance has become more aggressive. Many sectors remain in the penalty box. The (usually) more cautious Holmes is once again fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now. It is not a resounding endorsement of the overall market, but a vote for opportunistic trading.

Top Trading Advice

Dr. Brett explains why your trading psychology is reflected in your daily life, and vice-versa. Learn how this can be important to achieving your trading goals. As an example he writes as follows:

I was recently driving on a highway and the road split into two sections, each going the same way.  The left fork was a single lane labeled express; the right fork was a double lane labeled local.  My trip was several hours in duration but I immediately took….

Which one would he choose, and why?

Adam H. Grimes provides insight on strategy vs. tactics. He defines the difference, but also provides some specific techniques.

In this case, we need to be very precise: tactics refer to how, where, (and maybe why) we execute at the specific prices we choose. Strategy, on the other hand is the big picture perspective. First, get the strategic view right.

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, it would be “Davidson’s” take on Brexit (via Todd Sullivan). Here is the key point:

High fear of financial collapse! Major investors saying “Get out!”, ‘Brexit’ forecasts dire for European economy! In the US, top investors say Fed has lost control and the economy or something will spiral out of control. These are only a few of the current basket of concerns. And then there is our current Presidential election fare and the terrorist attack in Orlando.

In reality, this week’s concerns have not been much different than what we have seen since the current economic recovery began in 2009.

He then produces charts on a series of key economic measures: employment, real personal income, retail sales, job openings, and the housing rebound. Please check out the charts, supporting the thesis that data trumps sentiment.

The conclusion?

While the world frets and then frets some more, economic activity has continued to expand. Eventually, investors have never failed to turn more optimistic and remain so for several years. It is this period of optimism from which excess economic activity derives. It should be readily apparent that while economic activity continues to expand, optimism and economic excess is not part of the current equation. It could said that “Excess pessimism does not produce excess economic activity!” There is no economic correction on the horizon. This does not mean that we could not have a dip in market prices at any point in time for other reasons. Dips should not matter for long-term investors. I anticipate taking action only once economic fundamentals indicate a correction is likely.

 

Stock Ideas

David Fish updates the list of Dividend Challengers. There are many specific ideas, so check it out.

Chuck Carnevale emphasizes the importance of valuation on your entry point, even when buying a great dividend stock. He has a great example of how waiting for the right entry point (even though a dividend was missed) actually added to total dividends in the long run.

 

Energy Perspectives

We have some interesting themes this week. Figuring out the stock implications will require some more thought. I am working on it, and I welcome comments.

  • Peak Fossil Fuels for Electricity, by Tom Randall at Bloomberg. Watch out for both coal and natural gas. Eight key points, including the upcoming domination of solar.

-1x-1

  • Billions in proven shale oil reserves suddenly become “unproven.” (Bloomberg) Hint: Improved accounting rules.
  • Don’t count on nuclear power. (EIA) The first new reactor just came online after more than 40 years of planning and construction. It is the first new one in twenty years. This chart shows the typical length of time

chart2

 

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading, but my favorite this week is Andrew Comstock’s What is the most important financial advice you would pass to your children. The advice garnered from a number of experts is somewhat inconsistent, but thought-provoking. In general, young people need to balance passion and earnings, current consumption versus the future, and borrowing versus saving. My own thought? You need to look forward to your work if you expect to do well.

For both young and old: 51 Things You Shouldn’t Do from John Clements.

For millennials: You need more realistic expectations about future returns.

Watch out for….

Chasing last year’s winners via annual sector rotation. Josh Brown has a nice post showing the prevalence of this performance chasing. He emphasizes, “The data is unambiguous.” His analysis and charts show why this does not work. (Felix objects that sector rotation works, but a shorter time frame is needed).

Yield stocks, the crowded trade. William Smead covers this point, while also noting the declining significance of Fed Stress tests and the potential for banks and the housing market.

9a85d9ad1d9f032c9fe14cfc3e5e5e5fe7d12d1d

 

Final Thoughts

 

Brexit is not another “Y2K” as Barron’s suggested this week, but the uncertainty has had an exaggerated effect. Here are my own conclusions:

  1. The outcome is approximately a coin-flip, making any planning difficult. Either resolution will reduce volatility.
  2. The referendum is advisory, which will be emphasized more next week. Members of Parliament will be informed by voter frustration, but may not accede to the specific plan.
  3. A Brexit would take years of negotiation to accomplish, with many of the agreements most important to the European and world economies re-established.
  4. The actual stakes are smaller than most think. I get some information from confidential sources, and I respect their restrictions. A strong and popular (but unquotable) source did some polling of experts. Likely immediate S&P 500 range is 2 ½% downside and 2% upside. The extremes might be slightly larger. This range fits my own expectations. It is all guesswork, of course, but probably better than the vague notions about dominoes dropping and world trade ceasing.
  5. There may be a surprise outcome from a positive vote. British leaders may use it to negotiate some EU rule changes.

And finally, as you navigate the week ahead remember this:

The most newsworthy stories are frequently not the most important for your investments!

Weighing the Week Ahead: The Fed, Brexit, and the Markets

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This week’s economic calendar is back to normal, with Wednesday’s FOMC announcement the highlight. Last Friday’s trading put the Brexit effects on the front burner, so I expect two themes for the week ahead. The first few days will be all about the Fed and any hints about the pace of rate increases. After the Fed meeting the emphasis will shift to the Brexit build-up, culminating next week.

Expect some punditry magic. The regular Fed experts will morph into Brexit gurus by Thursday morning!

Last Week

There was little economic news. What we had was encouraging. Once again, markets were pretty firm—until Friday!

Theme Recap

In my last WTWA, I predicted plenty of attention to the weak employment report and the implications for stocks. That was a pretty good guess for the early part of the week. There were some who joined me in noting the problems with this report and also plenty who created those “rolling over” curves that are so popular. Every day there was another story from a big-name trader or manager expressing concern about the weak global economy. (More on that topic in the Investor section below).

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. You can clearly see the quiet market, at least until Friday! Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

SPX-five-day

 

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. 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 Good

Households Balance Sheet

 

  • Consumer sentiment from the Michigan survey remains solid. The Doug Short chart (via associate Jill Mislinski) has a great combination of history, the GDP relationship, and past recessions.

 

Michigan-consumer-sentiment-index

 

The Bad

  • The rail contraction is getting worse. Steven Hansen (GEI) has the update.
  • Brexit odds increased. A poll showed a big shift, with a ten percent lead for the “Leave” faction. The immediate reaction was the this (questionable) chain: lower pound à lower Euro à stronger dollar à lower commodity prices à implication of slower growth à RISK OFF!!
  • Downbeat economy makes June action by the Fed unlikely. Our go-to Fed expert, Tim Duy, looks at the data in the wake of the employment report. He also provides a Fed preview, highlighting labor conditions.

-1x-1

 

The Ugly

The candidate reaction. I have seen many elections where people were unhappy with the choices, but nothing quite like this. 10% of homebuyers say they will consider moving if their candidate loses. It is probably an exaggeration, but still an interesting reflection on the times.

 

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 New Deal Democrat at the Bonddad Blog. Not only did he take on an extremely popular and deceptive chart, he put the research together and reacted in a timely fashion. Here is the bogus chart:

blogger-image--1828015261

 

The chart quickly spread as the “Doomer graph du jour.” I saw it on several sites. There is widespread lust for “evidence” of a new recession. Charts like this are frustrating – so many misleading stories, so little time.

The Silver Bullet winners should get appropriate and timely recognition.

As is often the case with these bad charts, the original author does not provide either data or sources! Everyone who wants attention and confirmation bias republishes the chart. NDD demonstrates that the timing of the recession calls is completely wrong if one accounts for the actual availability of the data. This is a common amateur blunder.

I encourage you to read the painstaking efforts to reconstruct and explain the data at Bonddad and also Matt Trivisonno’s blog.

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

We have a fairly big week for economic data and news. I highlight only the most important items, helping us all to focus.

The “A” List

  • FOMC rate decision (W). The Yellen press conference will get close attention.
  • Housing starts and building permits (F). Will the rebound continue?
  • Retail sales (T). Of special interest in the wake of weak earnings from some retailers.
  • Industrial production (W). A highly volatile series, but important.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • CPI (Th). Inflation is not getting much attention. It will take a few hot reports before this regains significance.
  • PPI (W). See CPI above.
  • Business inventories (T). April data, but relevant for Q2 GDP.
  • Philly Fed (Th). One of the two regional surveys that has some market impact.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

Beyond the FOMC meeting itself, there is no FedSpeak.

Next Week’s Theme

 

It is a rather normal week for economic data, with the FOMC announcement on Wednesday at the highlight. I expect the Fed to be the focus for the first part of the week, with attention shifting to Brexit on Thursday. Next week will feature an even larger Brexit focus. We therefore have a twin theme:

Will the Fed signal any change in the pace of rate increases?

Will the Brexit odds change, and what are the implications?

There is little to add on the Fed issue, which is probably the most over-analyzed in history.

Concerning Brexit, we have three questions (at least):

  1. What are the odds of the June 23rd vote? The most recent poll shows a 10% bulge for Leave, but the bookies do not really endorse this.
  2. What are the issues? It is helpful to understand both the facts and what people believe to be at stake – things like immigration, membership costs, trade relationships, impact on health care, and availability of employment. Does any of this have a familiar sound? Putting aside whatever opinion you might have, what are the implications?
  3. What are the Brexit consequences? For Britain, for Europe, and for the rest of the world?

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

Indicator Snapshot 061016

 

The Featured Sources:

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he expresses more confidence about growth in earnings.

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). Monthly reports including both an economic overview of the economy and employment.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting approaches to asset allocation.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. His latest update features his unemployment rate recession indicator. A recession is unlikely “any time soon.”

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

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

 

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. You can still follow them via Doug Short and Jill Mislinski. Their commentary remains bearish despite the upturn in their own index. While no one really knows what is in the black box, I suggested years ago that they incorrectly emphasized too many commodity series, falling victim to multi-colinearity. Commodity prices fooled them in 2011. Now they seem to be ignoring the rebound.

Big-Four-Indicators-Since-2009-Trough

How to Use WTWA

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. For most readers, they 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 six 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?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 – The Year of the Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (Please send any questions or suggestions for new topics.)

 

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 also the best advice from sources we follow.

Felix and Holmes

We continue our neutral market forecast. Felix is fully invested, but the sector balance has become more conservative. Most sectors remain in the penalty box. The (usually) more cautious Holmes is almost fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now. It is not a resounding endorsement of the overall market, but a vote for opportunistic trading.

Top Trading Advice

 

Anora Mahmudova (MarketWatch) exposes a deceptive chart pattern – the head-and-shoulders. I am interested in hearing from traders about this, but these complex charts seem open to misinterpretation. We rarely hear about failing setups.

Pradeep Bonde has some good advice for improving on a daily basis. He notes that it takes five years for traders to develop the needed skill.

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, it would be a split decision. There is plenty of dangerous and deceptive information about the alleged warnings of big fund managers. Some of these were incorrect, while others were just misleading. In one case the always-bearish prognosticator, Mr. Dow 5000, cannot decide if the Fed has engineered deflation or hyper-inflation. (A supernova can either implode or explodes, he explains). It is all going to blow up somehow, so you should own his bond fund instead. OK….

Here are some helpful articles. If you read them, you will have some inoculation against hype.

  • Ichan is out of Apple while Buffett is in. Valuation guru Aswath Damodaran looks at time frames, methods of analysis, and the perspective of traders versus investors. It is tough work for most readers, but if you want to make good decisions as an individual investor, you need to understand this.

AppleIcahnBuffetteffect

 

As well as the entire process —

Price vs value simple picture

 

  • Soros reports related to his family office. We don’t know why or when viewpoints might change. (Josh Brown)
  • Soros has (supposedly) been wrong on many prior “turning point” occasions. (Cullen Roche)
  • And last, but I hope not least, I have demonstrated that government filings are completely worthless. Because they do not report short positions, you only see a part of each trade. This is especially bad on option positions, where the media report long positions in puts (a short instrument) without description of the entire spread. The notion that being short a put is actually a long position in the underlying befuddles nearly everyone. Even the most prominent media sources provide absolutely no help on this subject. Instead the reporters are assigned a story about the Soros put holdings. My multiple articles on this have not gotten much attention, despite the careful research and examples.

Stock Ideas

We have some diverse suggestions this week.

Think outside the box with James Altucher. He brainstorms on how we can profit now from something we know is coming: the driverless car. This fits my definition of something you will not read about in tomorrow’s paper.

I tried to provide another example (Finding the Best Contrarian Stocks), answering some reader questions from last week about why I preferred banks to utilities.

Sometimes you know the theme from current events, but you might not know the best stock play. I am not a big fan of anonymous authors, but sometimes follow them until I am convinced of the quality. Valuentum explains why Palo Alto Networks is more attractive than one might originally think. Hint: free cash flow. We reached the same conclusion a few weeks ago.

Sector Ideas

Energy prices have been less wild, which is probably good for investors. Some experts are even picking up my recent theme that $50 oil may be something of a barrier, with current prices representing a “sweet spot” for the economy. Oil Insider asks, Have Oil Prices Hit the Sweet Spot? (subscription required, but here is a key chart).

92d34a40-10f3-45ea-b190-fbd2753d56d3

 

Anyone interested in energy eagerly awaits the annual Statistical Review of World Energy from BP. Here is a key summary chart:

BP Oil Consumption and Production

Housing has been one of my favorite themes this year, and it got plenty of attention this week.

  • Housing is “eating the economy” says Conor Sen. Here is a key part of his case for further expansion:

    One way to show how much more growth housing, and construction more generally, has in front of us is to look at construction’s share of total employment. It’s currently 4.6%, and in every cycle ever it’s gotten to at least 5%. Given 1) the size and hence housing needs of the Millennial generation in years to come, 2) the lack of construction, of single family especially, since the financial crisis, 3) the potential for infrastructure spending from the next president, whether it’s the Hillary/Dem version or the Trump “build a wall” version, 5% seems like a reasonable conservative target for how high this will go over the next 3-5 years.

    tumblr_inline_o8axtpc21f1rufy3f_500

     

  • Ben Carlson asks, Has There Even Been a Better Time to be a Homebuyer? After describing interesting data showing the difference between today’s houses and those built in 1973, he summarizes:

    Houses today also have wireless Internet connectivity, better appliances, and are generally more energy efficient. They aren’t making enough of them in my estimation — and I may be stating the obvious here — but new homes today look better, have more features and are higher quality than those built in the past.

    To summarize — houses today have fewer people living in them with more space, more bedrooms, more bathrooms and more comfortable living conditions.

    But wait…there’s more.

    Mortgage rates are at record lows:

    Screen-Shot-2016-06-06-at-11.16.55-AM

  • Ivy Zelman, a leading housing expert noted for frank and accurate analysis, did an interview with Barron’s. Here is a key quotation:

    Barron’s: April new home sales soared 17%. Where are we in the housing recovery?

    Zelman: Four years in. The first increase was in 2012. There are multiple years ahead. We are still 35% below a normalized level of starts, and that’s for a single-family. Every cycle is different. This cycle will be elongated, and the slope of the recovery is flatter than what we thought the trajectory would look like when we called the bottom in 2012. Builders have been slower to see the growth. There’s a shortage of shelter. We’re pretty indifferent whether shelter should be owned or rented. We’re just saying there isn’t enough. The U.S. is at a 30-year low of inventory available for sale. We are predicting double-digit housing-starts growth this year, next year, and in 2018.

    The interview includes a number of stock ideas, including two which we own (LEN and CAA).

  • Robert Shiller (via Mark Thoma) says that fears of being priced out of housing are “overinflated.” In analyzing fears based upon quite different factors, Prof. Shiller wonders, “(W)hy do people still worry that home prices are getting out of reach? The answer can’t be found in the housing data”.

Biotech is worth a look.

  • Charles Pennington notes the long-term success of biotech, using the Fidelity biotech fund as evidence. A better buy than in 1988?
  • Chuck Carnevale has five candidates for consideration. As always, he carefully notes which stocks might be better for a given investment objective. And of course you get a master class in using the F.A.S.T Graphs method. Here is one chart for one example. You need to read the entire post to appreciate the depth of the analysis.

     

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Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading, but my favorite this week is an article from Morningstar’s Russ Kinnel, 20 Common Investing Mistakes. It is a nice analysis of how emotions interfere with decision making and the need for planning. Here are two of my favorites, both very common:

Mistake 2 | Basing sell decision on cost basis.
You bought fund A at $10 and now its net asset value is at $5. You bought fund B at $10 and now it’s at $20. Which should you hold, and which should you sell? I have no idea. The amount you paid is relevant only to tax planning. What matters is which will have better returns over your investment horizon. If the answer is fund B, then sell fund A (you’ll have a tax benefit if it’s in a taxable account) and put the proceeds in fund B. The problem is that people have an emotional attachment to the price. Some are afraid to book losses, and others are too anxious to sell a winner for fear that they’ll miss out on gains. What matters is whether the funds have strong fundamentals.

Mistake 17 | Misreading your own abilities.
People who treat gambling addicts say that it’s the big winning bet that hooks gamblers. They get high and want to repeat that high. Fund investors can be a little like that. They remember that one time they accurately called the direction of the market or picked a sector fund, and they forget all the times their calls were off. Go back over your past investments. See what you do well, and figure out a solution for the areas where you didn’t do well. Maybe your individual stock picks aren’t that great overseas, so you should buy a foreign fund. Maybe your bond fund blew up, so you should change the way you pick bond funds and tone down the risk.

I try to include good advice for young investors, but there is a real shortage of material. MarketWatch has seven good tips for those in their 30’s. Many boomers wish they had known these when they were younger!

Watch out for….

Hedge funds (and similar opportunities). Rachael Levy explains, The secret to investing in hedge funds.

Cambridge Associates is one of the biggest investment consultants advising pensions and others on which funds to choose.

Their secret to picking hedge funds: avoid almost all of them.

“We think about 5% of the entire universe could be on a list of potential funds to look at,” Joe Marenda, a managing director at Cambridge, told Business Insider.

 

Final Thoughts

 

There could be a lot of volatility this week – important for traders, but pretty meaningless for investors. At least for those who keep their heads.

I expect nothing meaningful from the Fed meeting, but that will not stop the punditry. There will be massive efforts to infer something.

The Brexit story will include updated odds and I expect it to be the theme next week. I have no special insight about how this will turn out. I am watching my sources closely, especially concerning the possible economic impacts. I was accurate last week in noting this has something to watch, but no one really has a good handle on the implications.

Traders can try to guess the outcome and the reaction. Investors should approach the week ahead with a shopping list. Get ready to take advantage of opportunities. In this WTWA I tried to provide special emphasis on stock ideas. I hope it will provide some ideas for your own research.

Finding the Best Contrarian Stocks

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Why does everyone want to be contrarian? It is the best way for long-term investors to beat the market. You can be a trader of popular momentum stocks, but you need to be agile in your timing.

Contrarian investing is rewarding for investors with discipline and the right temperament. Here are four rules:

  1. Forget about what you read in the newspaper or see on financial television. This is what we call “old news.” People who appear are attempting to sound smart by telling you things that reinforce what you already know.
  2. Find a theme that is difficult to see. Contrast it with something that is easy to see.
  3. Look for the best (or worst) ETF choices for these themes. Single out the best (or worst) stocks in the sector.
  4. Verify your analysis with data!

A Current Example

Often, the best way to explain an idea is to provide examples. Let’s repeat the four points above with our examples in mind.

  1. There is a daily media assault on banks. Government regulation is reducing profits. The yield curve is too flat. Energy companies might go bankrupt, and reserves might be too small. It is going to be 2008 all over again. [Old news – and also inaccurate].
  2. The long-running quest for yield has induced investors to focus on dividend yield rather than the strength of the underlying investment. The yield is easy to see. The risk is not.
  3. The financial sector is attractive; utilities are not. Focusing on regional banks permits you to avoid some of the government attention to big banks and also minimize energy exposure. The regional bank ETF (KRE) is a good choice. By contrast, very bad sectors should be on your “sell” list. Utilities have rallied strongly in the reach for yield. The XLU ETF is the popular choice in this category, having risen to over-valued territory.
  4. We can now pick some attractive trading candidates. Due diligence starts (but does not end) with a trip to F.A.S.T. Graphs. Depending upon the stock and sector, you may need to dig deep. F.A.S.T. Graphs has plenty of additional information, but check out other sources as well.

Since economic growth is under-rated and interest rates are likely (finally) to move higher, my long and short candidates both reflect this.  Most people do not realize how far the quest for yield has stretched the valuations for utilities.  Meanwhile, banks are hated.

We investigated regional banks, looking at factors like tangible book (important for banks and hard to find) and identified several for our basic stock program. (I was not surprised when a leading investor was interviewed on CNBC, mention six banks out of hundreds. Our three choices were on his list). One pick is KeyCorp. Earnings growth is 16% and the multiple is below 12. Meanwhile, you collect a dividend of 2.7%

KEY

While we do not do short selling of individual stocks or ETFs in our programs, investors should be worried about utilities, including XLU. Check out the stock that represents almost 9% of the ETF —   NextEra Energy (NEE) The stock has an earnings growth rate of about 6% and a P/E of 20. The yield is 2.9%, only slightly higher than our regional bank example.  It is like owning a 100-year bond.  Owners will get crushed by a modest increase in interest rates, as the stock price falls to maintain a yield differential over Treasury notes.

NEE

 

Conclusion

Contrarian investing is not easy. You will not hear the TV pundits praising your stocks – at least not at first. You also would like to have a catalyst that will change the public perception. In this case, a small increase in interest rates will start the ball rolling.

Only the greatest succeed in spotting where the puck is going. That is the challenge. If you aspire to beat the market, you need to think ahead!

Weighing the Week Ahead: Is Small Employment Growth Big News for Stocks?

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This week’s economic calendar is the lightest in recent memory. After Monday, FedSpeak fans will be disappointed, since we are entering the quiet period before the next FOMC meeting.

Like nature, pundits abhor a vacuum. To fill it they will be asking:

Is the weak employment report big news for stocks?

Last Week

Most of the economic news was fine – until Friday morning! The weak employment report, widely viewed as the most significant economic data of the month, clearly changed the market perspective. Astute market observer Eddy Elfenbein described the instant market sector rotation from financials (which I like) to utilities (which I hate). This is going to change, but what it will take is a key question.

big06032016g

 

Theme Recap

In my last WTWA, I predicted that the big discussion would be about the risk/reward for stocks and possible breaking of the recent trading range. That did get some attention – at least as much as anything else other than politics – until Friday morning. New highs now seem to be on hold.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. He has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

SPX-five-day

Special News

Abnormal Returns is one of our regular sources and references, helping all of us on many occasions. This week Tadas is supporting a great cause, charity: water. Check out the description at Abnormal Returns, where you can either purchase T-shirts with the new logo, or join me in making a direct contribution.

Please also be sure to check out the special offer at the end of today’s post – a reader opportunity that I have sought for many months.

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. 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 Good

  • ADP private employment report showed a solid gain of 173K, and the prior month was revised higher.

Change-in-Nonfarm-Private-Employment-May-2016

NAPM vs GDP

  • The Fed’s Beige Book showed overall economic improvement. Steven Hansen reports (but does not show much enthusiasm for the news).
  • Wage growth is improving. The Atlanta Fed report came before Friday’s news, but presumably it will get even better.

6a00d8341c834f53ef01b8d1f0ee1f970c-500wi

  • Sentiment remains negative, and that is a positive for stocks. The Bespoke Premium service (check it out!) provides this chart:

Bespoke sentiment

 

The Bad

  • Consumer confidence (via the Conference Board) declined from the prior month (92.6 vs 94.7) and also missed expectations. I regard consumer confidence as important, so declines are worrisome.
  • Auto sales disappointed. Trucks and SUVs were strong, but passenger cars very weak. The WSJ has a good report.

BT-AJ025_CARSAL_16U_20160601174539

  • The yield curve is flattening. Dr. Ed asks if this is a “global yellow light.”
  • Employment growth weakened. By all measures, and despite the deceptive decline in unemployment, the May employment situation report disappointed. The WSJ has a collection of reactions from economists. Conclusion: A dud! Business Insider has a similar compendium. Some highly respected sources suggested that the results were even weaker – perhaps a negative number – if the seasonal adjustments were accurate. The following chart is from the BLS report:

CES0000000001_933544_1465097389712

The Ugly

Defective air bags. Bloomberg’s feature story, Sixty Million Car Bombs: Inside Takata’s Air Bag Crisis, describes the story behind the development and sale of a product that proved to be dangerous. Warnings from some within Takata were not heeded. The company denies that “data integrity problems” revealed in documents from the U.S. Senate investigation were directly related to air bag ruptures. This is a fascinating article that shows the temptation to cut corners when big profits are at stake. It will take three years to replace all of the defective air bags.

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. Think of The Lone Ranger. No award this week. Nominations are always welcome!

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

We have an extremely thin week for economic data. I highlight only the most important items, helping us all to focus.

The “A” List

  • Michigan sentiment (F). Information about consumption and job creation you can’t get elsewhere.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • JOLTS Report (W). Mostly misinterpreted. Not an indicator for job growth, but rather the labor market.
  • Wholesale inventories (Th). Has impact on Q2 GDP.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

A Monday appearance by Chair Yellen will have an impact before noon, setting the context for the rest of the week. There is a little other FedSpeak, but we are entering the quiet period before the next meeting.

Brexit news will also grab attention.

Next Week’s Theme

It is a very light calendar. Like nature, pundits abhor a vacuum! There are pages to paint with pixels and airtime to fill with opinion. The space available is always about the same, even if the need is reduced. CNBC has gone to reality TV and features at night, and it is creeping into the daily schedule. My solution of TIVO and mute is a good way to avoid the reports on the stress in the nine-figure real-estate market and whether the latest blip in some indicator should change my market attitude.

You will learn more watching those good ol’ boys from West Texas!

My exasperation… [Mrs. OldProf noted my jaw setting and reminded me to restrict my opinions to the conclusion. Thanks to her and please check there.)

Friday’s employment report seemed sharply different from other recent economic news. The key question for the week will be:

Is the weak employment report big news for stocks?

There are four promising themes for speculation:

  1. Is the employment data the best read on economic growth?
  2. Will the weak report influence Fed policy?
  3. Does Fed policy really matter?
  4. Will market perceptions be more important than any of the factual questions?

The super-bearish opinions will emphasize the weak economy, the Fed in a box (corner, rock and hard place or whatever) and the need to hike rates regardless of conditions.

The mainstream is expecting Chair Yellen to dial back, if only because of market perceptions. We will get our first clue about the Fed on Monday.

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

Indicator Snapshot 060416

 

The Featured Sources:

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he expresses more confidence about growth in earnings.

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). Monthly reports including both an economic overview the economy and employment. After each employment report Bob Dieli provides a complete, balanced, “no-spin” analysis. Here is a typical chart from this week’s report:

Dieli Employment Change

(Find out more in today’s conclusion).

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting approaches to asset allocation.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. His latest update features his unemployment rate recession indicator. A recession is unlikely “any time soon.”

Fig-8.-6-3-2016

 

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

How to Use WTWA

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. For most readers, they 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 and no cookie-cutter approach. Each client is different, so I have six 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?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 – The Year of the Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (Please send any questions or suggestions for new topics.)

 

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 also the best advice from sources we follow.

Felix and Holmes

We continue our neutral market forecast. Felix is fully invested, and continues with fairly aggressive sectors. Most sectors remain in the penalty box. The (usually) more cautious Holmes is almost fully invested, with fifteen positions. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now. It is not a resounding endorsement of the overall market, but a vote for opportunistic trading.

Top Trading Advice

 

Adam H. Grimes has some great advice on trading a quiet market. So many traders go wrong in such times. Of his five points, I especially like the last:

Quiet markets are boring, but focus is rewarded. No one wants to talk about some market that is sitting in a 2% range for weeks, and the media quickly loses interest when markets go into consolidation. You, as a trader or investor, cannot. No one is going to do this work for you. It’s hard work to maintain focus when that focus is not rewarded today, tomorrow, or even next week, but you must do so. Know where the opportunities are, and monitor market conditions for shifts that might mark significant inflections. For some traders, a daily look at a handful of markets is enough, but other traders might consider setting alerts or using other screening tools.

Dr. Brett has another great contribution that most traders have never considered. The language we embrace to describe markets colors are thinking and prevents flexibility. He writes:

The traders I see making money are employing language differently to make sense of frequently-changing markets.  For example, several traders I know are trading shorter-term strategies and longer-term strategies and adjusting the weighting of those based upon how markets are moving.  A good example was yesterday’s trade in the ES futures.  We had early selling off the weak jobs number, but many sectors of the market displayed buying interest.  The advance-decline line was unusually strong, given the decline in the average, and we never hit a selling extreme of -800 or less in the NYSE TICK measure.  This was a useful tell that the selling was part of sector rotation, not part of a general bear/risk-off move.  Recognizing this made it much easier to take profits on short positions early in the day and not get whipsawed by the afternoon strength.

In a topic that has broad interest, Bloomberg’s Sheelah Kolhatkar asks why Phil Mickelson did not get busted for insider trading. When I was teaching new traders at the Chicago options exchange, one of my first classes was to bring in a legal expert on this topic. Information flowed wildly – in the rest rooms and elevators, but most of it was wrong or unhelpful. Meanwhile, if something worked, what was the risk?

Needless to say my companies and students never used such information and they all understood why. Traders need to know about this. Did you hear about the plumber who got a tip from a top executive? Free bathroom remodeling? Sheesh!

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, it would be Chuck Carnevale’s warning about buying over-valued stocks. He carefully points out how even good companies can be poor stock purchases if the price is too high. I cannot agree more. As part of our stock screening we always use Chuck’s tools, and you should, too! Here are some examples of good companies at bad prices.

426415-1464884091632117_origin

426415-14648840545287015_origin

 

The full article has more examples as well as some current “buy” ideas.

 

Stock Ideas

Here is an update on Morningstar’s ultimate stock pickers. These reflect “conviction buys” which are new or large positions from top managers. The information lags a little, but no one is “talking his book.”

4128

 

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading, but my favorite this week is from Larry Siegel, the Gary P. Brinson Director of Research for the CFA Research Foundation. He takes on a difficult but important topic – the expected return from various asset classes. A recent study by the McKinsey Global Institute has attracted plenty of attention, mostly because of the downbeat forecasts. The range of factors is apparent from this fascinating deconstruction of all that goes into determining equity returns. It is taken from the original study and repeated by Siegel to assist in the analysis.

MGI decomposition

 

You need to read the entire article to understand this, but it is worth the effort. Here is his conclusion:

Investors who expect a miracle from the markets – who think that 3% or 5% savings rates will get them close to their goals or that 10% savings rates will assure them a luxurious future – will be disappointed. Those conditions never existed. One would have had to have perfect foresight – and a lot of money early in life – to buy at the bottom in 1982 and then never sell until the top in 2000 or 2007 or 2015, availing oneself of the full glory of the largest bull market in history.

But investors who save diligently, buy and hold diversified portfolios of stocks and bonds and focus on their very long-term goals will do fine. A bias toward equities is justified, given the exceedingly low expected returns on bonds. Even with growth as low as we’ve experienced over the disappointing period since the end of the global financial crisis, the equity risk premium implied by McKinsey’s forecasts is 4%, enough to justify an above-average allocation to equities. With higher growth rates, the equity risk premium implied by McKinsey’s forecasts is even higher: 4.5%.

 

Dividend Stocks

Is it time for a stress test?

Energy Stocks

Our best source on the economics of the energy markets is Prof. James Hamilton. His update this week is worth careful reading by anyone interested in oil prices or energy stocks. Since there has been such a high correlation between oil prices and U.S. stocks (the bogus economic proxy), we are all forced to be interested. This chart from his excellent article is worth special attention:

china_oil_imports_May_16

Watch out for….

The Brexit threat. Polls put the vote (June 23rd) at 50-50. The bookies make it 30% in favor. This is a threat worth watching, since good studies suggest a major hit to exports if it passes. (Econbrowser). Two questions remain:

  • How much of this is already anticipated?
  • How much will extend to the rest of the world?

Marc Chandler cites three political events before the vote.

Expect more on this topic next week.

Some net-lease REITs. Brad Thomas explains what to look for as well as three to avoid.

 

Final Thoughts

 

How much did Friday’s employment news change the fundamental picture of economic growth? Or the prospects for stocks?

Not very much.

There are three key points:

  1. Any single report is of marginal significance – even employment.

A single employment report is but one flawed indicator of what is happening. It carries such significance not because it is especially accurate, but because we would really like to know the answer!

[picking up from above] My exasperation hit a peak Friday morning when the pundit-in-chief complained about revisions in the employment report. I was astounded to realize how little he knew about how the information was collected and compiled. As Cramer himself would put it: “HE KNOWS NOTHING.” Why does he think Fed economists would have fewer revisions? Sure we can track a package across the county. Should we all wear a bar code? We have excellent data with an eight-month lag. Getting data monthly is difficult and costly. (Should have kept the mute on!)

There is a huge margin of error on the net job growth (+/- over 100K) as well as the various subcategories. This is sampling error — after all revisions. Some companies never respond to the survey. Historically the growth of new businesses replaces those that drop out – plus a little more. I have explained this many times, most recently here, but you never see it mentioned by the punditry. The temptation to discuss pseudo-facts is just too juicy.

There are several estimates of employment growth, including the ADP, that are just as good and perhaps even more accurate than the BLS approach.]

  1. The Fed understands point #1. They have 350 expert economists who do not need to pontificate on TV. They understand surveys, sampling, birth/death models, and alternative methodologies. They place much less emphasis on a single number than the market.
  2. Nevertheless, the Fed does not want to surprise markets. Many recent Fed decisions have reflected not the best information, but the Fed guess about the market perception of information.

Everyone expects that a June rate increase is off the table, and probably July as well. The exact timing does not really matter, but I still expect two hikes before the end of 2016.

The Biggest Investor Challenge

I am often asked what is the biggest challenge for investors. If you think about it, the answer is obvious. Staying invested despite the barrage of negative hype has been a daunting challenge for most. Staying the course requires confidence in your approach and your sources. There is no information more valuable than knowing where we are in the business cycle.

Everyone seems to be itching to make a “big” call about the market or a recession. This will make them famous and rich.

It is better to rely upon someone with a genuine, long-term record. Bob Dieli’s regular reports provide the explanations and data that will give you the confidence to stay invested while that is right – as well as plenty of warning when it is time to change course. It is a very valuable resource. After many months of cajoling Bob has agreed to offer my readers a one-month free trial and a discount on subscriptions. Please give it a try. The reports are witty as well as informative. You will swiftly learn why I am such a fan.

Weighing the Week Ahead: What is the Risk/Reward for Stocks?

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This week’s economic calendar is loaded, and packed into a holiday-shortened week. There will also be plenty of FedSpeak, encouraging the favorite game of not just reporting data, but wondering how the Fed will see it.

When it comes time to put it all together, pundits will be asking:

What is the risk/reward tradeoff for stocks?

Last Week

The news was very good, and the market responded.

Theme Recap

In my last WTWA, I predicted that the pundits would be focused on the oil price rally and what it meant for investors in stocks. That was a good call, with the theme continuing through week’s end. Several sources even cited both the recent strength and the apparent ceiling at $50/barrel. As a bonus, the strong housing data revived the “springtime for housing” theme from two weeks ago. Despite the competition from election news, these were important stories. If you prepared in advance, you were better able to handle the news.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. He has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

SPX-five-day

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. 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 most important economic and market news was quite good.

The Good

  • Q1 GDP was revised higher, up 0.8% instead of 0.5. This is old news, but it does provide a slightly stronger base for the year. More importantly, the current data suggests that Q2 will be much stronger – some estimates now reaching 3 %.
  • Jobless claims declined again, to 268K. People are not losing jobs, especially when considering the higher working population. We also need job creation. Bespoke has the story, and a great chart.

     

052616-Initial-Claims-SA

  • Industrial production jumped 5.8%, the most in eighteen months. Utilities were behind much of the gain.
  • The Michigan sentiment index showed a surprising increase of 5.7 points, for the highest reading in nearly a year. Jill Mislinski provides a complete analysis and Doug Short’s chart. You can readily see that the index is back at healthy levels, topped only by the Y2K era.

Michigan-consumer-sentiment-index

 

  • Housing data showed real strength.
    • Pending home sales popped 5.1%. (Calculated Risk)
    • New homes sales had the best showing since 2008. Inventory is now down to 4.7 months. (Calculated Risk)

NHSApr2016

The Bad

  • April durable goods fell 0.8%, worse than expectations of a 0.3% decline. (BI).
  • Transportation “stunk in April” according to New Deal Democrat. It has certainly been the worst part of the economic story. Check out the full post for details. Steven Hansen at GEI has a thoughtful analysis suggesting that this was a “huge recession which never came.” Think about coal.
  • Puerto Rico debt measure is stalled in the Senate after progress in the House. This represents more than the specific issue. It is something of a litmus test for Speaker Ryan’s ability to negotiate. That is the real market significance.

     

The Ugly

The vulnerability of government technology. The multi-year pressure on government spending has had a definite effect on equipment. Upgrades that would be routine in business simply do not happen in government. It is a vicious cycle. The older the equipment and software get, the higher the maintenance costs. Barbara Kollmeyer has a good analysis of the problem, including this chart.

MW-EN838_gao226_20160526041302_NS

This problem is deeper than general obsolescence. The determined hackers are looking for vulnerable systems. There is a likely collision course, already seen in prior attacks.

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. Think of The Lone Ranger. This week’s award goes to Narayana Kocherlakota, former President of the Minneapolis Fed. Many of those who have moved on from a roles as official participants in Fed meetings are speaking out. This valuable information gives us an inside look. Sometimes the message is that we are making too many unjustified inferences. Kocherlakota writes:

Timing alone, though, hardly merits so much attention. To understand why, consider two possible scenarios. In one, the Fed starts raising rates in June and then adds another quarter percentage point at every second policy-making meeting (once every three months) for the next three years. In the other, the Fed waits until the second half of 2017 and then adds a quarter percentage point at each of the next 12 meetings. The second path represents slightly easier monetary policy, but most economic models would suggest that there would be almost no difference in the effect on employment or inflation.

It is possible that no information will be more important for investors over the next two years or so.

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

We have a very big four-day week for economic data. (Dare I say YUGE?) I highlight the most important items, helping us all to focus.

The “A” List

  • The employment report (F). Remains the biggest news of all.
  • ISM index (W). Great read on an important sector. Concurrent with some leading qualities.
  • Personal Income and spending (T). April data, but a continuing rebound here is important for economic expansion to continue.
  • Auto sales (W). A strong indicator of economic growth. F150 sales? Many believe this is linked to construction and small business.
  • Consumer confidence (T). This is the Conference Board version. It provides information on job creation and spending plans that you will not get elsewhere.
  • ADP private employment (Th). This independent read on private employment growth, using contemporaneous data, deserves more attention.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Fed Beige Book (W). The anecdotal report that will inform participants at the upcoming Fed meeting will not tell us much, but pundits will find something!
  • PCE prices (T). The Fed’s favorite inflation measure. Not much change expected.
  • Construction spending (T). Volatile April data is still relevant because of the importance of this sector.
  • ISM services (F). Not quite as important as manufacturing, but only because the data series is shorter. Will recent strength continue?
  • Trade balance (F). April data relevant for Q2 GDP calculation.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

Not much will be happening at the start of the week, with many slow to return from a long weekend. Expect volume to pick up.

There is also a full slate of Fed speakers, including Chair Yellen.

Next Week’s Theme

 

It is a big economic calendar and a holiday-shortened week. There will be a trifecta of questions:

  1. Economics. Will the recent data rebound continue?
  2. The Fed. Will strong data increase the pace and timing of rate increases?
  3. Stocks. How will stocks react? Will good news be good?

The pundits will circle around these topics. Even the pundit-in-chief seems to be shifting with the winds. They will analyze the data, emphasize how important Friday will be for the Fed, and wind up asking:

What is the risk/reward tradeoff for stocks?

 

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 

Indicator Snapshot 052816

The Featured Sources:

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he observes that more people are using forward earnings, and many are thinking about 2017.

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). Monthly reports including both an economic overview the economy and employment.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting approaches to asset allocation.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods.

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

Noteworthy this week:

How to Use WTWA

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. For most readers, they 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 and no cookie-cutter approach. Each client is different, so I have six 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?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 – The Year of the Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (Please send any questions or suggestions for new topics.)

 

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 also the best advice from sources we follow.

Felix and Holmes

We continue our neutral market forecast. Felix is fully invested, and with more aggressive sectors. Most sectors remain in the penalty box. The (usually) more cautious Holmes is once again fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now.

Top Trading Advice

Dr. Brett Steenbarger emphasizes emotion-free trading. He writes:

The emotionally intelligent trader can prepare for frustration, fear, greed, and other seemingly disruptive states.  By anticipating them, rehearsing our response to them, and channeling their energy constructively, we turn our experience into a powerful trading asset.

Holmes is barking enthusiastic agreement, and Felix is nodding wisely!

12 good points from Paul Tudor Jones (via New Trader U). They are all worth considering, but my favorite is #9:

“Always think of your entry point as last night’s close.”

 

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, it would be the overall market outlook from David Templeton at HORAN Capital Advisors. He covers many of the themes I regard as most important, but readers will enjoy getting the message from different sources.

In particular, he deals with the common argument about good news: The Fed will raise rates. He writes as follows:

Historically though, the initial moves in rate increases by the Fed is pursued to get rates back to a more normal level. As a result, when interest rates are increased from a level below 5% stocks tend to rise. In short, below the 5% level there is a positive correlation between interest rates and stocks.

correlation rates market

Stock Ideas

Chuck Carnevale has a terrific follow-up to his prior article on Emerson Electric (EMR). Individual investors who do their own stock picking should read this carefully. Not only does he provide great analysis and advice about entry points, it illustrates what your research should cover.

Time to buy Europe? Jason Zweig (WSJ) recounts all of the bad news, as well as the depressed stock levels. Is it time to “buy low?”

And for income investors – always consider the dividend kings. Here are eighteen companies that have increased dividends for at least 50 years. If that level of income is enough, this kind of stock may be the answer. Philip Van Doorn (MarketWatch)

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading, but my favorite this week is from Ben Carlson for his discussion of Social Security Benefits. Here are but two points from a great post. You should read it all.

  • Social Security is a more important part of retirement than many realize, covering more than half of the needs for most people.

Screen-Shot-2016-05-09-at-9.35.14-AM

  • Waiting longer for benefits generally helps, if you are able to do it.

Screen-Shot-2016-05-20-at-4.19.39-PM

The article also has some links to good sources. Your financial advisor should be considering the Social Security contribution when figuring out your retirement needs and asset allocation.

Older investors pick their biggest mistake – not starting early enough in saving for retirement.

Value Stocks

How about AbbVie as a retirement holding? Looking at the numbers shows value, but perhaps no immediate catalyst. Where others see “value trap” I see an opportunity for enhancing good dividend yield by selling near term calls. Take what the market is giving you!

Energy Stocks

There is not a specific recommendation here, but the information is important. I am watching it, and so should you. What companies begin to profit at various levels of oil prices? (The Daily Shot)

5731ace1-a511-4e58-90cf-70fe183dad33

Watch out for….

Safety stocks. Seth Masters asks, Are “Safety Stocks” Truly Safe? Many of the relevant sectors have been part of the recent quest for yield. With investors fearful about a weak economy – or even recession – something with a dividend yield looks great. If the economy improves, it is a different story, as this chart shows:

 

w1056

Bonds. In the “man bites dog” department, even Bill Gross is going negative on bonds. Mr. Dow 5000 is still not recommending stocks.

 

Final Thoughts

 

The risk/reward debate includes many viewpoints, but the worries usually dominate.

  • These stories are more newsworthy, so they get higher ratings. Barry Ritholtz has a good article on “click bait.” One of his examples is the repeated story about George Soros buying puts. I have two different posts (here and here) showing the error of this approach, but the scary stories get the readership.

1200x-1

 

  • The negative predictions call for extreme outcomes (market 50% over-valued – various sources, we are already in a recession – Peter Schiff’s claim this week, Europe and the rest of the world will crumble, or maybe it will be China. There is just enough plausibility in the arguments that many people are “scared witless” (TM OldProf euphemism) If you think the downside is 50% and the upside only 2%, what would you do?
  • The positive arguments are generally modest and restrained. Ed Yardeni (who also accurate downplayed the recession worries in January) sees a 10% upside for stocks in the next year. The Fast Money gang acted like he was crazy. “What needs to happen for that?” was the question. Not much, he explained. A little earnings growth, no recession, and a little inflation. It was a modest claim.
  • Politicians of all stripes find it useful to highlight dissatisfaction. This political approach is effective when running for election, but it is dangerous for investors. It is easy to think about societal ills rather than improving your investments. You cannot improve public policy by making poor investment decisions and losing your money!

For a change, why don’t we ask what could go right? (The Barron’s cover story this week is on the right track, repeating some of our main themes — but perhaps not analyzed as thoroughly. It is always helpful to have more voices helping investors).

  • The economy is not headed for recession, and actually shows promise on the big-purchase items like autos and homes.
  • Employment is good and improving.
  • Earnings may have troughed with the energy crash (apparently) behind us. Meanwhile, energy prices remain relatively low.
  • Interest rates remain low – this makes companies more profitable and stocks more attractive.
  • The dollar strength seems to have leveled off, helping the earnings of multi-national companies.
  • Economic and market cycles do not die of old age. A “mature” cycle has the same survival potential as a new one, despite the appealing metaphor of the doddering old person.

The market could easily gain 10% next year, and the year after that. Picking value stocks could increase your potential, since the economic skepticism has created recession pricing.

Most do not understand this key point: We could be having the same debate two years from now! Or even three.

And stocks could be 50% higher.

Weighing the Week Ahead: How Should Investors React to the Oil Price Rally?

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This week’s economic calendar is pretty light. Market participants will be looking to an early getaway for the long weekend. While there will be plenty of entertaining FedSpeak, I expect a different topic to be at the fore. Pundits will be asking:

Should investors react to the oil price rally?

Last Week

The news was pretty good, but the stock market was not.

Theme Recap

In my last WTWA, I predicted that the punditry would be asking whether it was “springtime for housing”. That was the recurring topic as housing news was reported on several different days and garnered plenty of discussion. Competition came from the Fed Minutes, some dramatic earnings reports, and the election race.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. He has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

SPX-five-day

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. 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 and market news, on balance, was pretty good.

The Good

  • Housing starts increased to a 1.172 annual rate, beating expectations. Calculated Risk has a complete analysis. I am especially interested in single-family building permits, a good leading indicator. Bob Dieli’s monthly economic report always updates this chart:

Dieli Building Permits

 

  • Existing home sales were up 5.45 million (SAAR), the top of the Calculated Risk range for a solid report. Bill writes:

    Note that January and February are usually the slowest months of the year and March and April are the beginning of the “selling season”.  This is a solid start to the year.

    EHSNSAApr2016

  • Jobless claims down ticked to 278K, in line with estimates and below the 300K level that some have been citing. (The four-week moving average was up slightly).
  • Industrial production rose by 0.7%. Eddy Elfenbein has a good report, noting that this interrupts the downtrend since November, 2014. He also points out the effect on the Atlanta Fed’s GDP forecast for Q2, now up to 2.8%
  • Sentiment remains very negative. Urban Carmel summarizes asset allocations and economic skepticism. Ben Eisen of the WSJ cites four stats, including the fund flows in the chart below. Schwab’s Liz Ann Sonders agrees. She notes only negative questions from both investors and advisors, “all almost bordering on Armageddon.”

w1056

The Bad

  • The Philly Fed indexremained negative and essentially unchanged, -1.8 on the diffusion index. Employment improved dramatically, but remained marginally negative. The outlook fell a bit but remained strongly positive. There was little market reaction.
  • Fed minutes showed more chance for a June rate increase. Our go-to Fed expert, Tim Duy, sees a June hike as a bit less than 50-50 but July as quite possible. The Fed remains more confident about the economy than most market participants.
  • LA port traffic declined. Calculated Risk uses a rolling twelve-month average to control for seasonality. The decline was 0.7% for inbound traffic and 0.8% for outbound. Steven Hansen opines that this raises recession concerns.
  • Rail traffic “moves deeper into contraction”. Steven Hansen looks at a variety of rolling averages, including some analysis that adjusts for the declining coal shipments.

The Ugly

State and local pension funds. Chicago provides an example. A decision of the Illinois Supreme Court struck down an “overhaul” of the system, adding $11.5 billion to the deficit, now $18.6 billion. The fund covers 70,000 workers and in the absence of any changes, will run out of money in ten years. (Crain’s Chicago Business)

Noteworthy

Try this financial literacy quiz designed by economists from Wharton and George Washington. (via Shawn Langlois) I am confident that WTWA readers will do well. Keep in mind that less than 1/3 of the population could get all three questions right!

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. Think of The Lone Ranger. This week’s award goes jointly to Gene Epstein of Barron’s and New Deal Democrat of the Bonddad Blog and xe.com. Both take on the frequent current scary articles about the “flattening” yield curve, citing the yield difference between the ten-year and two year notes. That spread is currently 0.94 percentage points. Those on a mission often cherry-pick the part of the curve to analyze, and cry alarm whenever it gets a little smaller.

Epstein points out that until the curve actually inverts (a spread of less than zero) there is not a reliable recession indicator.

2016_05_23_cmyk_NL_

NDD has a great article with plenty of charts. He calls out the “doomers” with this commentary and chart:

In the last week or so there have been a spate of articles – from the usual Doomer sources but also from some semi-respectable sites like Business Insider vans an investment adviser or two ,see here ( https://lplresearch.com/2016/05/19/is-the-yield-curve-signaling-trouble-… ) – to the effect that the yield curve is flattening and OMG RECESSION!!! Here’s a typical Doomer graph – that draws a trend line that ignores the 1970s and neglects to mention that 2 of the 4 inversions even within the time specified don’t fit:

image_686

I wish that more publications would recognize the Silver Bullet winners and writers like them. It is difficult to call out weak and biased posts. There is little reward for good and courageous analysis.

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

We have a modest week for economic data. I highlight the most important items, helping us all to focus.

The “A” List

  • New home sales (T). Continuing strength in housing?
  • Durable goods (Th). Important April data. Continuing recent strength?
  • Initial claims (Th). The best concurrent indicator for employment trends.
  • Michigan sentiment (F). Best for job growth and prospective spending. Strength continuing?

The “B” List

  • Pending home sales (Th). Unlikely to match last month. Not as important as new sales, but a read on the market.
  • GDP second estimate for Q1 (F). This will get attention, but it is old news by now with Q2 more than half over.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

There is plenty of FedSpeak, including a Friday appearance by Chair Yellen. Things will be slowing down by Friday as some slip away early for a long weekend marking the unofficial start of summer.

Next Week’s Theme

 

It is a pretty light economic calendar. In addition to the daily dose of analysis by pseudo-experts on the Fed, I expect to see some serious discussion about energy prices. Will the oil rally continue? What does that imply for investors and traders?

Voting a tentative “No” is Dana Lyons, who cites technical resistance and concludes as follows:

Will the oil rally stop here? We have no idea – but we wouldn’t be surprised to see the rally get clogged up, at least temporarily.

tumblr_inline_o750onwm8P1sq14jh_500

Oil & Energy Insider is also cautious but more bullish, mostly citing fundamentals. Their free edition includes this analysis:

Oil prices bounced around this week, flirting with $50 per barrel but stopping short of that key threshold. The major supply outages in Nigeria (now at 900,000 barrels per day) and Canada (more than 1 million barrels per day) continue to put upward pressure on oil prices as they are erasing the supply overhang. Still, much of that will be temporary. The EIA poured a bit of cold water on the rally this week, reporting a surprise uptick in oil stocks. At the same time, U.S. production continues to slowly erode. The markets are more confident than at any point in recent weeks that prices won’t crash back into the $30s, but more movement to the upside is not a given.

Their premium edition (which requires a subscription) is headlined Fundamentals Starting to Underpin Oil Price Rally. They cover a wide range of considerations, but include key questions: When might we expect Nigerian supply to rebound? Most investors would find their analysis quite helpful:

–    The Niger Delta Avengers have attacked pipelines and platforms in Nigeria, knocking 800,000 barrels per day offline.
–    Between 2006 and 2009 Nigeria suffered a similar level of attacks and outages, and a sweeping amnesty policy helped bring an end to the violence. The new President Muhammadu Buhari has taken a tougher line, ending patronage that existed in security contracts for many militia members, a move that has contributed to the resurgence in pipeline attacks.
–    Nigeria’s cash reserves are running low as its economy slows. Reserves have plunged from $49 billion in 2013 to $27 billion recently.
–    Eni (NYSE: E) suffered the latest attack this week. Fellow oil majors Royal Dutch Shell (NYSE: RDS.A) and Chevron (NYSE: CVX) have also seen their infrastructure taken out from explosions.
–    Nigeria’s oil production is at its lowest level since the 1980s. The attacks show no sign of letting up, and as of now the Nigerian government is unwilling to back down.

 

 

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

Indicator Snapshot 052016

The Featured Sources:

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he observes that more people are using forward earnings, and many are thinking about 2017.

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). Monthly reports including both an economic overview the economy and employment.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting approaches to asset allocation. This week Dwaine opened to the public one of his subscriber-only research reports. He notes that one of his recession indicators has moved up to 60%. He goes on to explain that he uses a group of six different methods as his preferred approach. He writes as follows:

Another way to look at the RFE is to average the current recession probability showing on each of its six model components, which is currently showing a 14.6% probability of recession. This model appears to have served well in the past, with zero false positives above readings of 0.20.

2016-04-26_1743

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods.

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

Noteworthy this week:

Hedge funds are using artificial intelligence to analyze the Fed minutes. Guess who can do it faster – you or them?

Peter F. Way reports on the hedging techniques of “big money” traders, identifying candidates with the best risk/reward balance. Apple?

501110-14632831049172328

 

How to Use WTWA

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. For most readers, they 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 and no cookie-cutter approach. Each client is different, so I have six 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?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 – The Year of the Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (Suggestions and questions welcome!)

 

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 also the best advice from sources we follow.

Felix and Holmes

We continue our neutral market forecast. Felix is about 75% invested, and with less aggressive sectors. REITs and utilities have moved near the top of the list. The (usually) more cautious Holmes remains almost fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates.

Top Trading Advice

Dr. Brett Steenbarger has important advice about Seeing Beneath the Market Surface. He writes:

Markets move higher, markets move lower.  The question worth continually posing is, “Is the market getting stronger or weaker?”  This is a meaningful question because a market that moves higher can be getting weaker and a market that moves lower can be getting stronger.

Read the entire post as he explains how to apply this approach.

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, it would be this Forbes article by Brett Steenbarger (and not just because he has some kind words about WTWA, but thanks!) As a psychologist and trading coach he sees things missed by others and explains them very well. I share many of his themes, but often cannot communicate them as well. People need to be open to new ideas and unemotional in executing the plan.

Few can meet these tests.

Stock Ideas

Chuck Carnevale has a timely post on cyclical stocks. He shows how to use his tools to analyze valuation in this difficult sector. When can these stocks be right for dividend-oriented, conservative investors? Emerson Electric (EMR) is his illustration. If you agree with our experts that a recession is not imminent, cyclical stocks are a good place to shop.

How about Kroger? Hale Stewart makes this a good example of how to search for a good stock – find an interesting sector, a cheap stock, and a catalyst.

Retailers that might profit from the “Amazon effect.” (Philip Van Doorn) Hint: they need to change their business model.

Marc Gerstein has some interesting contrarian retail plays. Marc always uses some science in his method. Here he identifies desired characteristics, develops a screen, and looks for a catalyst. It is another article that goes beyond simply delivering stock ideas (although it does that). Stock screening meets Peter Lynch.

How about solar? If energy prices improve, solar stocks do as well. Travis Hoium has an interesting argument favoring First Solar (FSLR) over some alternatives.

Outlook

Why is it so attractive to be negative on your investments? One good answer lies in Morgan Housel’s explanation of volatility and how it can take investors off course. It is so easy to think about an account in terms of how far we are from the past high. In fact, that is the condition over 87% of the time. Each year includes a lot of big moves that seem small when you later look at the long-term stock chart. He uses 1998 as a year of major gains, but only if you were able to ride out the major swings. I like this chart showing time spend below the prior high:

sp6_large

 

 

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. There are always several great choices worth reading, but my favorite this week is from Carl Richards at Investment News. He suggests that a good financial advisor helps clients by turning off the news spigot. (If you do not use a financial advisor, I recommend that you turn it off anyway! You might make an exception for WTWA).

There’s a valuable role for us to play as real financial advisers, that of the human curator. Do our clients really need to spend hours sorting through their feeds and trying to decode the headlines or could we be doing that for them? What should they be paying attention to?

For instance, one friend shared with me that when he turned off the financial news spigot, he calculated that he saved two to three hours every night. Do the math and it ends up being a savings of 40 or so days each year.

Value Stocks

Time to buy again? They are cheaper than the broad market and that seemed to be the story last week.

Watch out for….

Boeing (BA). Barron’s warns that demand for fuel-efficient aircraft has declined.

Bonds and fund redemptions. If the ten-year note increases one percentage point, to something like 2.8%, you will immediately lose 9% on your investment. It would take a few years to make that up, even if rates moved no higher.

Investment big-shots using a platform to talk their book. Are they really there to help you? This is an interesting summary of recommendations at the recent SALT conference, which was breathlessly covered in the media. Most of the topics would require a lot of research, but the Sherwin-Williams (SHW) recommendation (You can’t buy paint online) caught my attention. It took about five seconds to discover the error of this assertion.

13F filings. Here is one example that highlights stocks from David Einhorn. This, and nearly everything written about 13F reports is misleading. This WSJ article headlining George Soros is especially misleading. I explained this carefully (for the second time) but no one cares. We can think of it as our secret!

Final Thoughts

Knowing economics helps to understand energy pricing, but the payoff for that knowledge has been delayed. In my most popular article ever on Seeking Alpha, I noted a few basic facts about energy including the relatively small gap between supply and demand. We are now observing the closing of that gap. It could (and will) continue in one of three ways:

  1. Reductions in supply through economic forces. U.S. producers responded, but most others have not – so far at least.
  2. Increases in demand through a growing economy. This is happening with record miles driven in the U.S. and many new consumers worldwide.
  3. External shocks, through weather, disasters, or war.

The same economic effects may well push against a price increase. The reduction in rig counts, for example, seems to have paused for the first time in eight weeks. Bespoke has one of their great charts using data from the primary source on drilling activity, the Baker-Hughes weekly report.

052016-Baker-Hughes

 

Even if $50/barrel represents an intermediate high for oil prices there are important favorable consequences:

  1. The savings to the consumer, compared to recent years, remains large;
  2. The fears about failing companies and job losses, exaggerated and localized, will be less of a story.;
  3. The concern about banks failing due to oil company bankruptcies will be reduced.

Current oil prices may represent a sweet spot both for the energy sector and the overall stock market.

Government Reports from Big-Money Investors: Three Things You Need to Know (but don’t)

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Four times a year big-time money managers are required to file form 13F with the SEC.  This always sparks news stories naming the most important investors, people like George Soros and Warren Buffett, and drawing conclusions about what they are doing.  The implication is that you might benefit from looking over their shoulders.

You won’t!  The information is worse than worthless — it is misleading.  Here is why, the three things you should know:

  1. The reports are old news.  The law provides 45 days to file after the end of the quarter and there is no incentive to be early.  The process for filing has been streamlined for the modern age, but the requirements have not.  This delay is an eternity in the modern investing world.  The consumer of the information has no idea whether the positions are still valid.  Has recent news been important?  Could the firm reporting be selling into the strength generated by the report?  They have no obligation beyond the legal reporting.  They are free (and should be) to trade in the best interest of their investors as they get new information and opportunities.
  2. The reports cover only long positions.  There is no requirement to report “shorts.”  The implications of this gap invalidate the reports.  Bill Ackman, for example, is widely known for his short position in Herbalife (HLF) and his very public attacks on the company and its business model.

If you relied upon the government to inform you about Mr. Ackman’s short positions, the 13F would tell you absolutely nothing!

Ackman Longs

Here is another example.  George Soros reported long positions in Barrick Gold and a call (a bullish position) in a gold ETF.  What do we know from this?  Nothing at all.  He might actually have a neutral gold position like a pairs trade, long Barrick and short another gold stock that he believes to be weaker.  We don’t know, because shorts are not reported.

His long call position in the gold ETF might be paired with a short call.  Whether the overall position is long or short depends on which strike and expiration date was bought and sold.  Once again, we know nothing about the overall position.  I do not know from the filing whether Mr. Soros is really bullish on gold, and neither do you.

3. The report on options positions is  — can’t think of a kind word — clueless.  Since the government will not approve a method of analyzing an options position, they require something that is really stupid.  The filer reports long options only.  This means that there are no spreads, including both long and short options, even though that is the most common method of trading for big-time investors.  Worse yet, the long options are not described in terms of their actual value.  The value of each option is assigned the nominal value of the underlying stock!!  Professional traders, and the Nobel-Prize winning options modelers, know that an option has a value based upon a variety of factors, including the stock price, the strike price, the time to expiration, interest rates, expected volatility, and expected dividends.  The option has a theoretical value based upon these factors and a “delta” (the expected change in option value for each dollar move in the underlying).

I understand the government problem in assigning a “theoretical value” and assuming some level of expected volatility.  That does not excuse these blunders:

  • Ignoring short positions in the spread
  • Assigning the underlying stock value to options, even those that are far out-of-the money

Here is a great example from Mike Saltzman, my top researcher, associate portfolio manager, and a veteran options trader.

The reported SPY put position (a bearish bet) is 2.1 million.  The government filings multiply that times the value of the underlying spy, reaching a total value of $430 million or so.  Since the total number of puts is greater than last quarter, this is seized upon in the popular media.

In reality, we have no idea of the strike or the time to expiration for these puts.  The implication is that we have no idea of the value or the deltas for each put.  If far out of the money, they might be cheap protection.  More likely they represent a spread, the sort that a professional trader might buy as cheap downside protection.

Suppose, for example, that you did this spread.

Buy 1.05 million Jun’16 180P for .21

Sell 2.1 million Jun’16 175P for  .12

Buy 1.05 million Jun’16 170P for .09

This is a put butterfly, an extremely common  limited risk position. We own the same number of long and short option positions, so risk is limited. This particular butterfly would cost about $.06 in option, and $6 in commissions. It has a lot of potential. If the SPY goes down to 175 it would make  $9.94 per spread or almost  This spread has a very small short delta component.  It will only make money if the SPY were to fall  more than 10% in just a few weeks. It costs eighteen cents (or about 180K) and might make almost $10 million.

This is not really a short bet on the market.  It is downside protection purchased on a risk/reward basis.

Meanwhile, on the 13F this would show up as being long 2.1 million puts, with a value of (think short value) of $430 million — completely unrelated to the actual position value or properties.  There are many other examples of spreads that would fit the 13F filing,  including some that actually are bullish plays on SPY.

From the filing itself we cannot even conclude that Mr. Soros has a short position in SPY.  It is extremely unlikely that he simply bought 2 million puts without any offsetting short puts.  Professional traders usually work with spreads.

Conclusion

The 13F report is an unhelpful and costly exercise.  Those who take it seriously may well do the wrong thing.

I wrote about this two years ago but the media coverage has not improved.  The best investment advice is to ignore these stories.

 

Weighing the Week Ahead: Springtime for Housing?

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This week’s economic calendar includes some key data on the housing market and few other major reports. The debate about the strength of the U.S. economy continues. The housing market is an important contributor to the economy. As we enter the key season for real estate many will be asking:

Is it Springtime for housing?

Prior Theme Recap

In my last WTWA, I predicted that there would be special attention to the mixed message of economic reports, contrasting the relative strength of employment with other data. That was a major theme. Some insisted that the employment was overstated. Others said it was a lagging indicator. A few mentioned that GDP was probably understated. Friday’s relatively strong data continued the mixed message. I also suggested that the political sideshow would grab attention, but that was obvious.

Once again the early strength faded at the end of the week. Doug Short captures the story of the decline, the third straight) with his excellent weekly chart. (With the ever-increasing effects from foreign markets, you should also add Doug’s World Markets Weekend Update to your reading list).

SPX-five-day

The entire post adds more analysis on the major themes as well as a multi-year context.

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.

This Week’s Theme

The economic calendar has mostly secondary reports again this week. Friday’s stronger economic data only intensified the debate, as the market reacted negatively. This week features three important housing reports and two of lesser significance. Since springtime brings higher expectations for this sector, I expect more attention than usual. The punditry will be asking:

Is it Springtime for Housing?

Background

Attention focuses on housing with some frequency since it is important to the economy. Wells Fargo notes that residential investment rose 14.8% in the past year, contributing 0.5% to the Q1 GDP growth (which coincidentally was 0.5%). Last year the National Association of Homebuilders calculated that housing was over 15% of GDP. The impact is not just home sales, but also remodeling.

housing-share-of-GDP-1024x768

Viewpoints

The basic themes, moving from bearish to bullish on stocks are as follows:

  • The real estate market is about to crash (Ron Insana);
  • 0% down has returned. Didn’t we learn anything?
  • Increasing housing prices strain the affordability for new buyers (prices are too high);
  • Millennials do not have adequate credit;
  • Homes held in foreclosure proceedings or by speculators provide low-priced competition; (Whoops. That one changed).
  • Home sales are low because there is insufficient supply (the new version).
  • Interest rates remain at historically low levels, helping affordability;
  • We can expect increasing purchases from young people;
  • Increased home prices enable more people to sell – trading up or even sideways to take new jobs.

It is easy to find disciples for each viewpoint.

As always, I have my own opinion in the conclusion. Make your own choice, and feel free to make your case in the comments.

But first, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. My working definition of “good” has two components:

  1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially – no politics.
  2. It is better than expectations.

The Good

There was some good news.

  • “Framing” lumber prices are higher. One of the many reasons to follow Calculated Risk is finding data no one else mentions.
  • The “shallow industrial recession” seems to be over. New Deal Democrat provides both data and analysis.
  • Retail sales were much stronger than expected, up 1.3% versus expectations of 0.9%. The retail earnings reports varied widely, with high-end names doing poorly. Online sales were excellent and gas station sales moved higher. (Remember that gas prices have been part of the recent retail weakness). Auto sales remain strong.
  • Life expectancy is higher – and health inequality is lower. Alex Tabarrok of the Foundation For Economic Education presents the data, including the chart below. There is still a downward slope in the data, but the entire line has shifted.

Life-Expectancy-2

  • The Michigan sentiment index beat both last month and also expectations by a wide margin – 95.8 versus about 90. This survey gets timely information about job creation and spending that we do not see elsewhere. As always, I recommend looking at the best chart (and also great discussion) from Doug Short. This month I also recommend checking out the Michigan site. You can find long-term charts and a great explanation of the method. Here is the summary of the key forward-looking data:

Michigan Sentiment mid-May

  • The job market improved, as indicated by the JOLTs report. I often describe this as the most misunderstood data release. Too many people try to use it to analyze net job growth, something better done with various other sources. The ECRI has a new indicator (something about purple animals) subtracting actual hires from job openings, and somehow inferring weakness if this difference increases. They seem to be on a mission to find something negative in the data. Here is their key chart:

 

160510_JOLTS_web_W495Let’s keep this simple.

  • Job openings are good – the more the better.
  • The quit rate shows voluntary departures from jobs, a strong signal of confidence about finding an alternative.

The Atlantic has an article that is geared toward non-economists, but explains the key points. The article notes that quits are highest in low-paying jobs and lowest among financial services workers and government employees.

Doug Short illustrates the strength of the voluntary quit rate versus layoffs.

JOLTS-quits-versus-layoffs

 

The Bad

Some of the news was negative.

  • Energy bankruptcies increased, despite rising oil prices. Terry Wade at Reuters suggests that recent oil price increase might be too little, too late for many companies.
  • Rail traffic continues to worsen. Steven Hansen reports the 10.6% y-o-y decline, adding a variety of interesting comparisons.
  • Earnings season continued with mixed data. FactSet has a nice weekly analysis with interesting charts and also a focused discussion on key sectors. Here are some of the main themes:
    • The 71% earnings “beat rate” is higher than usual, but everyone knows the expectations have been lowered.
    • Earnings declined for the fourth consecutive quarter.
    • The sales beat rate was below normal.
    • Many companies cited the strong dollar as a source of weakness, so they expect better future results.
    • Autos and internet sales showed the most strength.
    • A forgiving market did not punish “misses” as much as usual – at least on average!

FactSet Revenue Growth by Sector

  • Jobless claims edged higher. 294,000 was the highest reading in more than a year. (Jeffry Bartash, MarketWatch) Employment is important and we should watch in closely – both job creation (which this does not measure) and job loss (which it does).
  • Business inventories rose more than expected. The inventory data is easy to spin and difficult to interpret accurately. Does it reflect unsold goods or business confidence in future sales? Steven Hansen (GEI) sees the bullish side.
  • Puerto Rico defaulted on a $400 million debt payment. The Council on Foreign Relations explains the significance.

The Ugly

The TSA. Airport security lines have grown much longer. People are missing planes and some airlines are even delaying flights. Baggage is sitting outside because of inspection delays. There are no immediate plans for more TSA resources, so it is a matter allocating what is available. Here is a good story in The Guardian (via a tweet from Real Clear Markets). A video of the lines at Chicago’s Midway airport now has over two million views.

The comments from Guardian readers suggest that the situation is having an impact on potential international travelers.

1800

 

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.  Think of The Lone Ranger. No award this week. Nominations are welcome. I see plenty of opportunities!

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. I recently made some changes in our regular table, separating three different ways of considering risk. For valuation I report the equity risk premium. This is the difference between what we expect stocks to earn in the next twelve months and the return from the ten-year Treasury note. I have found this approach to be an effective method for measuring market perception of stock risk. This is now easier to monitor because of the excellent work of Brian Gilmartin, whose analysis of the Thomson-Reuters data is our principal source for forward earnings.

Our economic risk indicators have not changed.

In our monitoring of market technical risk, I am now using our new model, “Holmes”. Holmes is a friendly watchdog in the same tradition as Oscar and Felix, but with a stronger emphasis on asset protection. We have found that the overall market indication is very helpful for those investing or trading individual stocks. The score ranges from 1 to 5, with 5 representing a high warning level. The 2-4 range is acceptable for stock trading, with various levels of caution.

The new approach improves trading results by taking some profits during good times and getting out of the market when technical risk is high. This is not market timing as we normally think of it. It is not an effort to pick tops and bottoms and it does not go short.

Interested readers can get the program description as part of our new package of free reports, including information on risk control and value investing. (Send requests to info at newarc dot com).

In my continuing effort to provide an effective investor summary of the most important economic data I have added Georg Vrba’s Business Cycle Index, which we have frequently cited in this space. In contrast to the ECRI “black box” approach, Georg provides a full description of the model and the components.

For more information on each source, check here.

indicator snapshot 051416

Recent Expert Commentary on Recession Odds and Market Trends

Doug Short: Provides an array of important economic updates including the best charts around. One of these is monitoring the ECRI’s business cycle analysis, as his associate Jill Mislinski does in this week’s update. She respectfully cites their most recent article. In my view it uses tortured logic to reach a negative conclusion of the JOLTs report (discussed further above). The Doug Short analysis of this report is much, much stronger. The ongoing review of the ECRI is comprehensive and provides an interesting comparison with Recession Alert, one of our featured sources. Chart lovers will love this regularly updated article.

Doug’s Big Four update is the single best visual review of the indicators used in official recession dating. You can see each element and the aggregate, along with a table of the data. Doug’s updates cover both the individual elements and a chart-packed summary helping to see what it all means.

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured “C Score.” His view of where we are in the business cycle differs sharply from that of the ECRI. His approach has been more accurate over a long period and especially in the last decade. I am overdue for an update comparing the recession methods. (So many great topics to consider, so little time).

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting systems. These include approaches helpful in both economic and market timing. He has been very accurate in helping people to stay on the right side of the market.

Georg Vrba: provides an array of interesting systems. Check out his site for the full story. We especially like his Business Cycle Indicator, updated weekly and now featured in our table. Georg also has an unemployment rate recession indicator. This has long confirmed that there is no recession signal. What would it take to change the prognosis? In this interesting post he suggests that an increase of 0.3% in unemployment would warn of a recession.

The Week Ahead

We have a modest week for economic data. While I highlight the most important items, you can get an excellent comprehensive listing at Investing.com. You can filter for country, type of report, and other factors.

The “A List” includes the following:

  • Housing starts and building permits (T). Most are looking for a rebound.
  • Existing home sales (F). Less GDP impact than new construction, but a good read on the market.
  • FOMC minutes (W). Expect pundit efforts to make something out of nothing!
  • Leading indicators (Th). A controversial but popular measure of economic trends.
  • Industrial production (T). An important but volatile series. Signs of improvement in a lagging sector?
  • Initial claims (Th). The best concurrent indicator for employment trends.

 

The “B List” includes the following:

  • Philly Fed index (Th). I have promoted this indicator in importance after an academic study of it. First May data.
  • Business inventories (F). March data, but relevant for Q1 GDP.
  • CPI (T). Inflation by any measure remains of secondary importance until we get a few hot months. Then the story will change significantly.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

     

There is a little FedSpeak. The Supreme Court will announce some decisions, perhaps including Obama actions on immigration and Puerto Rico. Political news will continue, and some are indeed attributing market weakness to the probable candidates. There are still a few important earnings reports.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a “one size fits all” approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

WTWA often suggests a different course of action depending upon your objectives and time frames.

Insight for Traders

We continue our neutral market forecast. Felix is still 100% invested, but with less aggressive sectors. REITs and utilities have moved near the top of the list. The more cautious Holmes is also fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. Holmes holds a maximum of 16 positions at one time. For more information about Felix, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix and Oscar’s weekly ratings updates via email to etf at newarc dot com. They appear almost every day at Scutify (follow here). I am trying to figure out a method to share some additional updates from Holmes, our new portfolio watchdog. (You learn more about Holmes by writing to info at newarc dot com.

Dr. Brett offers innovative ideas for traders, and he does it week after week. Are you a perfectionist? Then prepare to be frustrated in your trading.

So what is our trader’s need?  It’s the need to trade, the need to make money.  If the market isn’t making sense, there’s no trade to put on and no money to be made.  If the setup isn’t there, the trade isn’t there and neither are the profits.  If a bad trade is placed, the fruits of a good trade are erased and there go profits.  That same dynamic can also make it difficult to step away from screens, even though the trader recognizes in real time the signs of frustration.  It’s not OK to miss opportunity.

Holmes is barking agreement. Felix would also agree if he were here instead of at a blackjack table in Vegas (emailing daily results). I hope Felix doesn’t get caught count counting cards like some of those other models.

Todd Sullivan provides us with another valuable insight from “Davidson.” This quotation shows what traders should really be watching, if they want to catch short-term moves:

Today’s pools of capital are seeking gains within the day-by-day trading frenzy. The least little shift is taken as the possibility of a new trend and capital shifts in anticipation.

And later…

Most of the discussion today centers on whether it is oil or the US$ which is driving the correlation. This is like a discussion of which comes first, the ‘Chicken’ or the ‘Egg’. My perception is that the main driver in changing global trade balances. Even if one could unravel all the inputs we have on global trade, the data itself is incomplete with a number of nations treating global trade figures as state secrets. Global trade balances impact prices and currencies long term to produce the correlations seen in the chart from Jan 1973.

Davidson on oil prices

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. Major market declines occur after business cycle peaks, sparked by severely declining earnings. Our methods are focused on limiting this risk. Start with our Tips for Individual Investors and follow the links.

We also have a page summarizing many of the current investor fears. If you read something scary, this is a good place to do some fact checking. Pick a topic and give it a try. Feel free to suggest new topics if your own “fear” is not on the list.

Some readers expressed concern about the overall market valuation. I discussed this last week. If you are worried about all of those valuation indicators (which supposed worked for centuries, but not in the last couple of decades) I urge you to read, Is the Market Cheap? Three things you need to know about valuation, but don’t.

Many individual investors will also appreciate our two new free reports on Managing Risk and Value Investing. (Write to info at newarc dot com).

Other Advice

Here is our collection of great investor advice for this week. If I had to pick a single most important source for investors to read, it would be David Merkel’s post, You Can Get Too Pessimistic. He notes the low probability of real disaster scenarios. In the context of a thoughtful analysis, he provides the following advice:

If you give into fears like these, you can become prey to a variety of investment “experts” who counsel radical strategies that will only succeed with very low probability.  Examples:

  • Strategies that neglect investing in risk assets at all, or pursue shorting them.  (Even with hedge funds you have to be careful, we passed the limits to arbitrage back in the late ’90s, and since then aggregate returns have been poor.  A few niche hedge funds make sense, but they limit their size.)
  • Gold, odd commodities — trend following CTAs can sometimes make sense as a diversifier, but finding one with skill is tough.
  • Anything that smacks of being part of a “secret club.”  There are no secrets in investing.  THERE ARE NO SECRETS IN INVESTING!!!  If you think that con men in investing is not a problem, read On Avoiding Con Men.  I spend lots of time trying to take apart investment pitches that are bogus, and yet I feel that I am barely scraping the surface.

Stock Ideas

Chuck Carnevale has an interesting recommendation for retired investors – Cisco Systems (CSCO). As usual he does a thorough analysis, using his first-rate methods. See the whole story for illustrative charts and the key points.

Barron’s has a cover story on Regeneron (REGN), which it calls the best of the biotechs. I see many attractive names in this beaten-down sector. The article does a good job of explaining why Regeneron is special.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. There are several great choices worth reading, but my favorite is from Josh Brown. He explains that many investors have a “toxic combination” of reducing financial literacy and increasing confidence. It is nothing personal, but a general consequence of aging.

Outlook on China

There has been a lot of very negative commentary about China in recent weeks. Some of this comes from outspoken hedge fund managers who have significant short positions. To balance this, investors need information from those who study and invest in China. One such source is KraneShares, which provided an excellent briefing for financial advisors last week. While there were many key points, her are two worth extra emphasis:

KraneShares China Growth

And also, most observers focus on manufacturing, ignoring the planned shift to a service-driven consumer economy.

KraneShares Service economy

My conclusion is that investing in China is not a matter of if, but when and how. The financial press emphasizes data points like the “flash PMI” which have little relevance to the key issues. (Full disclosure: KraneShares offers KWEB. We own it in our aggressive program, and I am considering expanding it to more investors who need more international exposure).

Market Fairness

Some individual investors are missing opportunities because of the perceived unfairness of the system. If you are trading in modest size, high frequency trading may actually have slashed your trading costs and increased your potential gains.

 

Watch out for….

Onecoin. This cryptocurrency seems to include elements of multi-level marketing, Ponzi schemes, and a lack of liquidity. There is always a great temptation to make money fast, but recent economic conditions may have increased the appetite. Before “investing” I urge you to do some careful research. Here is an opinion from a crypto currency site and also one from a CPA who has a great quotation from the Association of Certified Fraud Examiners:

  • The investment opportunity promises “guaranteed” returns.
  • The opportunity is described as “once-in-a-lifetime,” or pressures you to buy immediately “before it is too late.”
  • The deal sounds too good to be true. Compare any promised return with the returns on well-known stock indexes.
  • The investment offer was unsolicited.
  • You are unable to find any public information about the investment opportunity. Often, this is explained away as the investment being “by invitation only” and a “secret that is best kept, lest too many people get involved.”
  • The opportunities or people touting them are located outside of the United States. This particular point gives the scam an exotic feel and includes the idea (real or implied) that profits can be squirreled away offshore and away from the taxing authorities.
  • You do not know the person who is contacting you, or they are just an acquaintance.

Check out the full post to see the comparison to the Onecoin marketing materials.

Final Thoughts

Last week I offered a strong opinion about resolving the tension between various economic data sources. I make most of WTWA a balanced summary of what is happening, with an emphasis on a current theme. It is in the conclusion where I do my editorializing. As I noted last week, when I do not have a solid answer to the weekly theme question, I am not afraid to say so. If only more observers would do the same! Readers sometimes complain that I do not give a specific answer to my own question. That misses the point. The weekly question is my prediction for the market theme – what you will see in the media. I cannot control that, and it would be dishonest to claim an answer that I do not really have.

With respect to housing, I expect growing strength. It might not show up this month, since we are still following Bill McBride’s “long bottom.” I plan to watch Calculated Risk stories this week for the best interpretation of the data. He writes this week:

Housing starts are up 13% from March 2014 to March 2016.

New home sales are up 25% over the two years.

Existing home sales are up 13%.

House prices are up 9.7% (Case-Shiller National Index February 2014 to February 2016).

Some day I’ll be bearish again on housing.  But not in 2014 – and not now.

My own reasons for longer-term optimism include the following:

  • Supply. Not that long ago many were predicting a “shadow supply” of foreclosed homes. That was gradually absorbed. Now the same sources are discussing a lack of inventory!
  • Demand. When I first wrote about “shadow demand” it generated a lot of skepticism from readers (something that I embrace). We still have plenty of people living with parents when they would prefer their own home. Many magazine feature writers try to make this into a new preference of Millennials. I doubt it. Mostly this is the result of the lag in employment growth.
  • Demographic and social trends. These are also demand factors, of course, but as people enter the labor force, we get more household formation. Immigration policy has been a negative in recent years, and it remains a wild card.
  • Improving home prices. Many homeowners were making their payments, but were underwater on their mortgages. Higher prices have resolved some of that. They are now abler to move more readily, either to follow the jobs or to upgrade.

Trading and Investment Implications

Traders must continue to work the trading range, guessing daily reaction to Fed speculation, the moves in the dollar, and the shifts in oil prices. On Friday, stronger economic data sent the market lower. For the short term the message is that “good news is bad news”.

Investors should take the opposite perspective. The worry about the economic message from oil prices and interest rates is overdone. A good investor looks for good value. There is a method for this:

Find sectors and stocks that are currently unloved.

While I have been cautious about adding to our underweight energy positions (not just unloved, but hated) I do like and own homebuilders and regional banks.

Is the Market Cheap? Three things you need to know about valuation, but don’t

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There is a general consensus that valuation indicators are not very useful for market timing. Despite this, the financial media and the blogosphere feature an avalanche of articles warning that the market is seriously overvalued. Your retirement account might drop 50% at any moment. There are countless worries in the world.

Many investors have been “scared witless” (TM OldProf) by this, missing out on a great opportunity. Is it now too late? What is the current potential for market gains?

Here are three things you do not know about valuation:

  1. The oft quoted indicators are not currently endorsed by their developers, only by those of the bearish persuasion.
    1. Warren Buffett described his “favorite valuation indicator,” the stock market cap to GDP ratio, in 2001. The current high readings are gleefully cited by many. Warren Buffett himself, while not specifically repudiating the indicator, has often noted that it does not work when interest rates are so low. He has repeatedly said that investors should prefer stocks to bonds in the current market climate. Charlie Munger has said the same thing. There have been many stories about this, but they are mostly ignored.
    2. Prof. Shiller’s CAPE ratio shows an overvalued market and is frequently cited. No one ever mentions that Prof. Shiller himself is more than fully invested in stocks for someone of his age. He cut exposure a bit last fall, but does not recommend the “all-in, all-out” approach of many who quote him. Whenever he is asked in an interview he explains that young people should certainly own and hold stocks. He never advocates using CAPE for market timing. He has endorsed CAPE for sector selection. Barclay’s seems to have pulled the page with the Shiller endorsement, although the CAPE Fund is still trading. My article explains the methodology.
    3. Tobin’s Q was invented in the 50’s by a great economist. It emphasized the replacement cost of major companies. If he were alive today, this brilliant man would be revising his methods to explain modern technology companies, as well as stocks like Amazon, Google, and Facebook. It is not fair to apply methods designed for a world with more manufacturing to one so different. No one uses this method for individual stock analysis. Only a few people profit from writing about this aged and obsolete indicator.
  2. There are many experts whose methods show that stocks are attractive. Whenever these people – Laszlo Birinyi, Brian Wesbury, Jeremy Siegel, Jim Cramer, and me, to mention a few – suggest that stocks are undervalued, someone plays the “perma-bull” card. I don’t know for sure about the others, but I am perfectly willing to shift positions as the evidence changes. No one should be embarrassed about being right. I find the name-calling unhelpful for both bullish and bearish viewpoints.
  3. There is a bias in valuation coverage. Because the bearish concept has such a grip, and predicts huge declines like 50% or so in stocks, it grabs headlines and page views. If you do not believe me, do a little personal poll or else a Google search on stock market valuation. Look at the headlines. Those who are comfortable with current stock values expect 10% gains or so. For the average investor, the risk-reward seems dangerous. The key is that the big declines are low probability, while the expected gains are pretty normal.

Conclusion

The bearish valuation theme has persisted for many years. It is usually invoked to claim that all indicators show an over-valued market. No other choices or ideas allowed! This is not a balanced analysis.

The consensus that valuation methods are not good for timing came years too late. It was only after the various bearish valuation indicators did not signal a buy in 2009. How many years will it take before investors catch up? Forget about changes in pundit opinion. They are all “locked in.”

The single greatest reason for the valuation error is the level of inflation and interest rates. And not the Fed-controlled rates, but the longer end that reflects market forces. Mr. Buffett, as usual, nailed it in his commentary, but few paid any attention. In an interview last August, he stated:

Buffett reiterated that he was a long-term investor, saying he expected prices to be “a lot higher” 10 years or 20 years from now.

He likened owning stocks to owning a home, saying that if homeowners expected prices to fall 5%, they wouldn’t sell their homes in hopes to buy it back for 5% less. They are locked in for the long haul.

He also stated, as he has on many other occasions:

What you can say now — [it’s] not very helpful – but the market against normal interest rates is on the high side of valuation. Not dangerously high, but on the high side of valuation. On the other hand, if these interest rates were to continue for 10 years, stocks would be extremely cheap now. The one thing you can say is that stocks are cheaper than bonds, very definitely. We’ve seen low interest rates now for six years or so, rates that we really wouldn’t have thought possible, particularly in Europe where they’ve gone negative. And that’s continued a long time, and of course we saw them continue for decades in Japan.

Do you think you should pay attention to What Mr. Buffett said fifteen years ago, or what he says now? Can’t he interpret his own indicator? Can you or I do better?

The same argument applies to Prof. Shiller, who is poorly served by the uber-bearish applications of his work.

My conclusion? Earnings prospects are important and remain my own principal focus for stock valuation. Stocks remain moderately attractive, despite the scary stories. Specific names are quite cheap, with low PEG ratios and great prospects. Develop a good shopping list!

Weighing the Week Ahead: Why the Surprising Strength in Employment?

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The economic calendar had most of the big news last week. Earnings season is winding down. It is a time to digest and analyze what we have learned. Many will be asking:

Why is employment growth still strong while other indicators show weakness?

Prior Theme Recap

In my last WTWA (two weeks ago), I predicted that the media buzz would focus on the challenge to the old highs in the stock market. This was indeed a popular topic as the market moved higher. After last Tuesday’s primaries, it was trumped by political news. (I have trumping on my mind (heh heh) only because many of my friends are currently competing in the Team Trials to determine the U.S. representative to the 2016 World Bridge Games).

The attempt at a new stock record missed again and the early strength last week also faded. Doug Short captures the story with his excellent weekly chart. (With the ever-increasing effects from foreign markets, you should also add Doug’s World Markets Weekend Update to your reading list).

SPX-five-day

The entire post adds more analysis on the major themes as well as a multi-year context. Since it has been two weeks since the last WTWA, I will include a second of Doug’s charts to catch up. You can see another failed rally, a triple top, a head-and-shoulders, and an upside down head-and-shoulders.

SPX-2

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.

 

This Week’s Theme

The economic calendar has mostly secondary reports this week. Friday’s employment data rekindled an ongoing debate about employment growth versus the other indicators showing economic weakness. We will have help (?) from plenty of FedSpeak, probably offering widely different conclusions. I expect attention to center on the following question:

Why is employment fairly strong while so many other indicators seem weak?

The Sideshow

My suggested theme is a bit too wonky for media sources seeking viewers and readers. I understand that many will be tempted instead to wax political, trying to infer what the election means for your investments. I wrote about the political theme two months ago, and the implications have not really changed. Just skip to the conclusion of that post. This week Barry Ritholtz does one of the better pieces on political implications for investors, reaching a conclusion similar to mine. He notes the biggest new idea, also debated by the Squawk on the Street gang: A Trump presidency might well involve refinancing debt and doing a lot of construction.

Here are some public policy differences between the leading candidates. It is a starting point for thinking about specific stocks.

Background

Pundit scrambling continues. After Monday’s modest market strength, a TV anchor glibly stated that the gains were not surprising given the start of the month and the expected news from BuffettFest. He had not suggested this on Friday, in time for your trading and the tune quickly changed on Tuesday. So typical.

Those charged with explaining each and every piece of economic news have had to deal with a mixed picture.

Question

How much time per day does the average Facebook user spend on the site? Answer at the end of today’s post.

Viewpoints

The basic themes, moving from bearish to bullish on stocks are as follows:

  • Global recession is upon us. There is something wrong with employment data. GDP is better.
  • Most recent U.S. indicators have missed expectations.
  • Leading indicators show a slower rate of expansion. Employment will soon catch up.
  • Earnings have been engineered. Just look at sales for the truth.
  • Job growth is the most reliable economic indicator, better than GDP. (NYT)
  • Wages show a consistent 2.5% year-over-year increase. Spending will follow.
  • Q1 will mark (yet another) soft spot to the start of the year. Expect a resumption of modest growth.
  • Growth is about to increase, stimulated by increased Federal deficits, policy changes in China, and low interest rates.

 

It is easy to find disciples for each viewpoint.

As always, I have my own opinion in the conclusion. Make your own choice, and feel free to make your case in the comments.

But first, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. My working definition of “good” has two components:

  1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially – no politics.
  2. It is better than expectations.

The Good

There was some good news.

  • Bullishness registers a major drop. Mark Hulbert explains why the market timer behavior is probably bullish for stocks.

w704 

  • ISM services increased and beat expectations. The reading of 55.7 also reflected some positive comments from respondents.
  • The lending environment has improved. Torsten Sløk of Deutsche Bank (via Barry Ritholtz) writes that banks are more willing to lend and consumers more willing to borrow. Using the Fed’s Senior Loan Officer Survey, he cites stronger consumer balance sheets and solid improvement growth as reasons for improvement from a sluggish start to the year.

lend 

  • Earnings reports were mixed. FactSet reports that the earnings beat rate is positive. The sales beat rate remains below the five-year average. A common story is a company beating on the bottom line, but missing on sales, also slightly worse than the five-year average. Outlooks are better than average. Utilities are weak. Auto companies are strong. Brian Gilmartin is a bit more optimistic (but cautious) as he cites the ex-energy numbers.
  • Employment growth remains positive. The monthly employment report is sufficiently complicated to permit spinning in any direction. I heard authoritative sources comment on the net jobs increase needed to avoid more unemployment, with a range from 85,000 to 130,000. My employment preview post explained why too much is made over small changes in a single month. The basic trend of reasonable growth continues, but without the major increase we normally see in an expansion. This economic recovery has been slower and stretched out. The question is how much further employment can improve. While everyone has an opinion, the WSJ always had a good chart pack on this subject. Here is one.

 

WSJ employment

 

A source with no horse in the race (Holmes instructed me not to use “dog in the hunt”) has an interesting take on seasonal adjustments. He believes that the adjustment background is too short and the weather recognition too limited. This is a good subject for a full post, but readers may want to consider it.

jobnumbers5616

 

The Bad

Some of the news was negative.

  • Productivity increased and beat expectations. But it remains unacceptably low. Scott Grannis calls it the “missing ingredient.”
  • ISM manufacturing dropped to 50.8 and slightly missed expectations.
  • Auto sales missed expectations by about 0.5%, but improved over the prior month.

The Ugly

Cheating on data announcements. A study by the ECB suggests the presence of “informed trading.” (This sounds like one of my euphemisms!) The results cover a wide range or reports including both public and private. This is an important topic for traders, especially those carrying positions overnight. Here is a key quote:

Abstract

We examine stock index and Treasury futures markets around releases of U.S. macroeconomic announcements. Seven out of 21 market-moving announcements

show evidence of substantial informed trading before the official release time. Prices begin to move in the “correct” direction about 30 minutes before the release time.

The pre-announcement price drift accounts on average for about half of the total price adjustment. These results imply that some traders have private information about macroeconomic fundamentals. The evidence suggests that the pre-announcement drift likely comes from a combination of information leakage and superior forecasting based on proprietary data collection and reprocessing of public information.

 

If you believe that the results are achieved from “superior forecasting” you are not a long-time reader of WTWA!

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.  Think of The Lone Ranger. This week’s award goes to Jeff Reeves who questions a Reuters column suggesting that Tesla was overvalued since its market cap represented a huge multiple of cars sold.

$620,000 for every car it delivered last year, or $63,000 for every car it hopes to produce in 2020.

By comparison, General Motors Co’s (GM.N) $48 billion market value is equivalent to about $4,800 for every vehicle it sold last year.

Reeves suggests (after the mandatory “with all due respect”) that you are an idiot if you take that approach. He provides a number of excellent examples from other companies illustrating that this is a completely irrelevant approach to valuation. Please read the article to see how Netflix, Facebook, Apple, Coke, the New York Times, and biotech might compare.

There are so many catchy headlines and so little refutation!

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. I recently made some changes in our regular table, separating three different ways of considering risk. For valuation I report the equity risk premium. This is the difference between what we expect stocks to earn in the next twelve months and the return from the ten-year Treasury note. I have found this approach to be an effective method for measuring market perception of stock risk. This is now easier to monitor because of the excellent work of Brian Gilmartin, whose analysis of the Thomson-Reuters data is our principal source for forward earnings.

Our economic risk indicators have not changed.

In our monitoring of market technical risk, I am now using our new model, “Holmes”. Holmes is a friendly watchdog in the same tradition as Oscar and Felix, but with a stronger emphasis on asset protection. We have found that the overall market indication is very helpful for those investing or trading individual stocks. The score ranges from 1 to 5, with 5 representing a high warning level. The 2-4 range is acceptable for stock trading, with various levels of caution.

The new approach improves trading results by taking some profits during good times and getting out of the market when technical risk is high. This is not market timing as we normally think of it. It is not an effort to pick tops and bottoms and it does not go short.

Interested readers can get the program description as part of our new package of free reports, including information on risk control and value investing. (Send requests to info at newarc dot com).

In my continuing effort to provide an effective investor summary of the most important economic data I have added Georg Vrba’s Business Cycle Index, which we have frequently cited in this space. In contrast to the ECRI “black box” approach, Georg provides a full description of the model and the components.

For more information on each source, check here.

Indicator Snapshot 050716

Recent Expert Commentary on Recession Odds and Market Trends

Doug Short: Provides an array of important economic updates including the best charts around. One of these is monitoring the ECRI’s business cycle analysis, as his associate Jill Mislinski does in this week’s update. She cites a recent presentation by ECRI co-founder Lakshman Acuthan suggests a period of “stagflation lite.” The review of the ECRI is comprehensive and provides an interesting comparison with Recession Alert, one of our featured sources. Chart lovers will love this regularly updated article.

Doug’s Big Four update is the single best visual review of the indicators used in official recession dating. You can see each element and the aggregate, along with a table of the data. Doug’s updates cover both the individual elements and a chart-packed summary helping to see what it all means. Here is the look after Friday’s employment report.

Big-Four-Indicators-Since-2009-Trough

 

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured “C Score.” His view of where we are in the business cycle differs sharply from that of the ECRI. His approach has been more accurate over a long period and especially in the last decade. I am overdue for an update comparing the recession methods. (So many great topics to consider, so little time).

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting systems. These include approaches helpful in both economic and market timing. He has been very accurate in helping people to stay on the right side of the market.

Georg Vrba: provides an array of interesting systems. Check out his site for the full story. We especially like his Business Cycle Indicator, updated weekly and now featured in our table. Georg also has an unemployment rate recession indicator. This has long confirmed that there is no recession signal. What would it take to change the prognosis? In this interesting post he suggests that an increase of 0.3% in unemployment would warn of a recession.

This week Georg added a new indicator, (DAGS) a variant of Bob Dieli’s Enhanced Aggregate Spread. His excellent article includes a discussion of what might cause a recession as well as an approach that historically would have improved the lead time for a recession signal. In a companion post he describes the Dieli method including similar charts for comparison. Concerning the prospects for a recession, Georg writes as follows:

Assuming that the current trajectory of the DAGS does not change, then it will reach zero in the fourth quarter of 2016, signaling the possibility of a recession start 40 weeks later, in the third quarter of 2017. However the DAGS could rise again, as it did after January 2012 when it was at a similar level to where it is now.

Under current economic conditions the DAGS would indicate a cycle peak much earlier than the EAS, and when such a signal occurs there would be ample time to consult a set of coincident indicators to make a recession call.

DAGS+-fig-1

 

 

The Week Ahead

We have a modest week for economic data. While I highlight the most important items, you can get an excellent comprehensive listing at Investing.com. You can filter for country, type of report, and other factors.

The “A List” includes the following:

  • Retail sales (F). Expectations are for a solid rebound.
  • Michigan sentiment (F). Some distrust survey data, but there is no better way to discover current spending and employment trends.
  • JOLTS Report (T). The report on job openings is still relatively new and widely misunderstood. Important indicator of structural changes in the job market.
  • Initial claims (Th). The best concurrent indicator for employment trends.

 

The “B List” includes the following:

  • Wholesale inventories (T). Volatile March data, relevant for Q1 GDP.
  • Business inventories (F). March data, but relevant for Q1 GDP.
  • PPI (F). Inflation by any measure remains of secondary importance until we get a few hot months. Then the story will change significantly.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

     

FedSpeak is back! Those thirsting to hear more from Fed Regional Presidents will have an opportunity almost every day next week.

Political news will continue, but a big market impact is unlikely – at least for now.

There are still some important earnings reports as the Q1 reporting season winds down.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a “one size fits all” approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

WTWA often suggests a different course of action depending upon your objectives and time frames.

Insight for Traders

We continue our neutral market forecast. Felix is still 100% invested, but there are fewer attractive sectors. The more cautious Holmes remains close to fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. Holmes holds a maximum of 16 positions at one time. For more information about Felix, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix and Oscar’s weekly ratings updates via email to etf at newarc dot com. They appear almost every day at Scutify (follow here). I am trying to figure out a method to share some additional updates from Holmes, our new portfolio watchdog. (You learn more about Holmes by writing to info at newarc dot com.

Dr. Brett continues to find ideas that no one else has discussed. This week he explains about the “path” to a good trade. Here is a stimulating excerpt:

Let’s do a thought experiment:  I might expect a stock index to move from 2000 to 2100, a 5% move.  Let’s say the index remained nearly unchanged in value for six months before shooting higher to 2100 in the seventh month.  How many traders would have stuck with this trade?

Let’s consider a different scenario:  The index moves from 2000 to 2100 in one month, but only after having dropped to 1940 in the first week.  How many traders would have stuck with this trade?

Mike Bellafiore warns not to jump the gun, anticipating before your setups are really in place.

(The cautious Holmes is barking approval at this idea).

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. Major market declines occur after business cycle peaks, sparked by severely declining earnings. Our methods are focused on limiting this risk. Start with our Tips for Individual Investors and follow the links.

We also have a page summarizing many of the current investor fears. If you read something scary, this is a good place to do some fact checking. Pick a topic and give it a try. Feel free to suggest new topics if your own “fear” is not on the list.

Many individual investors will also appreciate our two new free reports on Managing Risk and Value Investing. (Write to info at newarc dot com).

Other Advice

Here is our collection of great investor advice for this week. If I had to pick a single most important source for investors to read, it would be Morgan Housel’s post, Alternative Definitions of Risk. He explains that even significant market volatility (like 2011) does not signal real risk. He cites several types of risk that are often neglected. Here is a good example:

The risk of inadequate return

Cash is now the most desirable asset among savers age 18 to 29,  even if the money isn’t needed for 10 years, according to a survey by Bankrate.

Young investors do this to cut down on the risk of investing in stocks. But odds are they will come to see this as one of the riskiest investments they ever make. Cash for the long-term won’t fund future goals, while the market volatility they’re avoiding today posed little risk to those future goals.

 

Stock Ideas

Goldman Sachs recommends a dividend basket.

When should you sell a stock? George Athanassakos a Professor of Finance and the Ben Graham Chair in Value Investing suggests eight reasons. I like and use them all!

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. There are several great choices worth reading. We all like apps and we also like saving money, so you will enjoy my favorite from the group, 5 Apps That Will Actually Save You Money.

Outlook

Oppenheimer Funds sees the China prospects as encouraging. This is an interesting contrarian viewpoint.

Value Stocks

Has the tide turned? Morgan Stanley notes that in 2016 value has beaten growth. So far, so good for my prediction that 2016 will be the year of the value stock. (For those interested, get a free report from main at newarc dot com).

MS-5-2-USD-value

Watch out for….

Non-traded REITs. Before deciding that this is the right investment for you, be sure to read the fine print. Here some excerpts of listed risk factors from an actual offering. As a buyer, you sign off indicating that you have read all of this stuff!

the proceeds from a sale or redemption of shares may be less than the original amount invested;

there are substantial conflicts among the interests of the REIT’s advisor, sponsor, dealer manager and respective affiliates;

may incur substantial debt, which could adversely impact the value of an investment;

obligated to pay substantial fees to its advisor;

may pay distributions from any source, and there are no limits on distributions that may be paid from sources other than cash flow from operations;

…and a general observation that payments may come from assets rather than operations. So much for your expected 7% annual return.

Final Thoughts

When I do not have a solid answer to the weekly theme question, I am not afraid to say so. If only more observers would do the same! Readers sometimes complain that I do not give a specific answer to my own question. That misses the point. The weekly question is my prediction for the market theme – what you will see in the media. I cannot control that, and it would be dishonest to claim an answer that I do not really have.

This week is different. I have confidence in the recession indicators I cite – chosen after extensive study and analysis. I also have studied labor economics and the various tracking measures. Most of those commenting on the employment versus GDP question are talking their book. The bond folks disparage employment and the stock reps cite employment data. My mission is quite different. I need to guide clients into whatever is best for their personal circumstances and the current environment.

While I have looked at many indicators, here are two that are typical of the main theme.

  1. The global economic fears are overstated. Gavyn Davies (FT) has a thoughtful article, Fading Risks of Global Recession. He cautiously notes as follows:

    The latest nowcast shows a rebound in global activity growth to 3.4 per cent, which is just below trend. Growth in the advanced economies has rebounded from a low point of 1 per cent in February to 1.4 per cent now (ie still about 0.3 per cent below trend). Growth in the emerging economies has jumped from 3 per cent in February to 5.5 per cent now, which is at trend for the first time in three years. However, the rebound in the emerging economies is driven by improvements in China and Brazil, both of which are subject to large risks of renewed setbacks in coming months.

ftblog1073

  1. Employment, measured in many different ways, shows no sign of rollover. One advantage of subscribing to Bob Dieli’s service is a monthly deep dive into the employment data, published the day of the report. Whether you are interested in labor force participation, part time workers, wages, job quality or overall trends, one of the forty pages of charts will provide an answer. I am trying to persuade Bob to offer a lower-priced version for average investors. His big theme this week was that the economy was not rolling over. The expansion phase continues. The chart below is but one example:

Dieli April 2016 Employment

Getting the most out of your investments is not just a matter of buy-and-hold. It also does not require guessing the “normal” market volatility in an effort to be a genius. It certainly does not mean going all-in or all-out.

Long-term investors profit from a focus on data, not emotion.

Answer to the Facebook question: 50 minutes per day. My reaction is Wow! What is yours?