Weighing the Week Ahead: Will an Earnings Surge Revive the Stock Rally?

Are you ready for some real news? How about corporate earnings? While there is some economic data on tap, the Q1 earnings season starts in earnest this week. With questions about economic strength, the dollar and the Fed in mind, pundits will be looking for fresh data. They will be asking:

Can resurgent corporate earnings revive the stock rally?

Last Week

Last week the news was heavy but generally neutral. Strong economic data caused celebration. The Fed minutes and concerns about tax reform were the biggest negatives.

Theme Recap

In my last WTWA I predicted special attention to the Trump-Xi meeting. That was a good call, with plenty of discussion all week. The talks did not yield much news, but there might be a lesson from that as well.

The Story in One Chart

I always start my personal review by looking at a weekly chart. While there was not much of an overall change this week, Wednesday was the exception. Stocks moved sharply higher after the ADP number and sold off sharply in the afternoon, perhaps because of reaction to the Fed minutes, perhaps because of tax reform prospects.

 

The News

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

This week’s news was neutral.

The Good

  • Construction spending rose 0.8%. Steven Hansen (GEI) is not convinced.
  • Rail traffic in March increased 7.3% (AAR).
  • ISM manufacturing maintained recent strength at 57.2. Scott Grannis offers this chart.

  • ADP private employment registered a change of 263K, handily beating expectations.

  • Weekly jobless claims dropped to 234K

 

The Bad

  • Tax reform prospects seemed to get worse at least that was the market take on Speaker Ryan’s press conference.
  • The Fed may be reducing its balance sheet. (Reuters). Fed expert Tim Duy thinks that balance sheet reduction will be gradual.
  • Auto sales were surprisingly weak. Calculated Risk concludes:

    This isn’t a huge concern – most likely vehicle sales will move sideways at near record levels. But the economic boost from increasing auto sales is probably over.

  • ISM services dropped to 55.2. This is still a strong level, of course, but any dip from a peak is drawing attention.
  • Non-farm payrolls registered a net increase of 98K, well below expectations. Doug Short has a nice chart pack, including this rolling average interpretation of non-farm payrolls.

 

The Ugly

Rising global threats including Syrian gas attacks, North Korean challenges, and more terrorist 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. No award this week, but nominations are always welcome. There are many bogus claims and charts out there!

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 normal week for economic data, including releases on Friday when financial markets are closed.

The “A” List

  • Michigan Sentiment (T). Continued high readings and debate over “soft” data.
  • Retail sales (F). Will negative consumer news be confirmed?
  • Initial jobless claims (Th). Is the series edging up from record low levels?

The “B” List

  • JOLTS (T). February data. This is about labor market structure, not job growth!
  • PPI (Th). Still tame, with more of the same expected.
  • CPI (F). See PPI. The core increase is starting to approach the Fed’s target level.
  • Business inventories (F). Not much expected from this February data.
  • Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

The schedule is light on FedSpeak and many markets around the world are closed on Friday.

Next Week’s Theme

In a normal week for economic data the start of the Q1 earnings season will command attention. Geopolitics will grab some headlines, but market participants are eager to see if the recent stock market strength is supported by corporate earnings. The key question?

Will resurgent earnings revive the rally in stocks?

Each earnings season sees a revival of a familiar theme: Companies guide expectations lower. The final report is a “beat” compared to this lowered bar.

More objectively, observers can compare earnings to the prior year. The weak energy sector has been a drag on these comparisons, leading to an “earnings recession.” This name was attached to two consecutive quarters of decline. This quarter seems more promising. Earnings expert Brian Gilmartin does a sector-by-sector analysis, concluding that this quarter might see S&P 500 growth of 12-14%.

John Butters of FactSet notes that current expectations are an increase of 8.9%, but that “double-digit” growth is more likely. He looks at the history of “beat rates.”

 

What does this all mean for investors? As usual, I’ll have a few ideas of my own in today’s “Final Thought”.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

 

The Featured Sources:

 

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

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

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

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

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. His most recent post notes that the expected growth rate in S&P earnings is now 8.41% — the highest level since October, 2014.

Doug Short: The World Markets Weekend Update (and much more). His Big Four chart is the single best method to monitor the key indicators used by the National Bureau of Economic Research in recession dating. The latest update now includes the employment data.

 

 

How to Use WTWA (especially important for new readers)

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix, Holmes, and Friends

We continue with a strongly bullish market forecast. All our models are now fully invested. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our five technical experts, and some rebuttal from a fundamental analyst (usually me, but sometimes a guest expert). We try to have fun, but there are always fresh ideas. Last week the group discussed how to find trading ideas in a quiet market. We were delighted to have expert commentary from Chuck Carnevale, founder of F.A.S.T. Graphs and a frequent source for WTWA. Check out the five stock ideas from our regular group, and especially Chuck’s reactions.

Top Trading Advice

 

Brett Steenbarger continues his stream of great posts. My favorite this week is his explanation of the real reason traders lose money. That should certainly attract universal interest! Here is a key takeaway:

There is only one source of making money in markets, and that is identifying recurring patterns in market behavior and exploiting those in a manner that provides solid reward relative to risk.  We marshal and attenuate various personality traits to identify and exploit those patterns.  Success comes, not from indulging our personalities, but from knowing which traits to draw upon and which to work around.  That is called wisdom.

Peter Coy has great advice for system traders: Beware of excessive back fitting of your data. If this seems too nerdy, you are probably making serious errors in developing your trading system.

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Gary Belsky’s, Why We Think We’re Better Investors Than We Are. Here is a sample, comparing an unhappy lawyer with a disappointed investor:

Both people are highly likely to obsess over their sunk cost — law school tuition and time served for the lawyer, the original investment amount for the stock picker — in a nonconscious desire to justify their earlier decisions. Both are also very likely to fall prey to “loss aversion,” a key tenet of Prospect Theory, which tells us that humans typically respond to the loss of resources — be it time, effort, emotion, material goods or their proxy, i.e., money — more strongly than they react to a similar gain.

What differentiates the typical lawyer and average investor, however, is their justification for engaging in their activity. Lawyers are trained to do what they do, while the majority of investors are not. Ask a random player in a law firm’s basketball league whether he or she could compete with LeBron James, and the most common response will be laughter. Yet many of those lawyers would willingly compete with the billionaire investor Warren E. Buffett.

 

Stock Ideas

 

Barron’s has some undervalued energy stocks for consideration.

Our Stock Exchange always has some fresh ideas. There are ideas from five different approaches. Felix, who is most aligned with long-term traders, likes Sprint (S). You will enjoy the careful response of our guest expert, Chuck Carnevale, to that idea! The entire post has a good discussion.

Blue Harbinger has ten attractive ideas with 10% yields. It is a thorough analysis, and read the cautions carefully.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, this is a must-read. Even the more casual long-term investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. As usual, investors will find value in several of them, but my favorite is Jane Hwangbo’s 6 Things You Don’t Know About Money. The six points are interesting, as is this conclusion:

The point of money is to magnify you.

If you care about something, you get the opportunity to make more impact. If you love someone, you can give them more of what they need. You can share more. You can contribute more. You can invest in your future more.

You get more options.

In his regular column, Seeking Alpha Editor Gil Weinreich takes up an intriguing question – whether boomer retirements will cause a market crash. There is also a good discussion as well as links to other sources.

Value versus Growth

It is always interesting to see whether market sentiment is favoring value or growth. Blue Harbinger provides this interesting table.

Watch out for…

 

Kinder Morgan (KMI) and other pipelines. The operations are amazingly extensive.

The “toll road” analogy is also seductive for the pipeline companies. But that is only part of the story. Simply Safe Dividends has an excellent and thorough examination of the underlying finances, cost of capital, safety of the dividend, and the effect of changing energy prices.

 

Final Thoughts

 

There are several developing themes that require more elaboration than I can provide in WTWA. In such cases I often state my conclusions in advance – with more to come. Here are a few such ideas.

  • There are some lessons from the Trump-Xi meeting. Nothing bad happened. That may not seem newsworthy, but it is useful intelligence.
  • President Trump had his first test as Commander-in-Chief. He consulted experts and took their advice. Whether or not you agree with the decision, the process is better than we might have expected a few weeks ago.
  • The hard data, soft data meme is the latest way to find a source of market worry. The definition of the categories is not objective, nor is the analysis of the sources carefully done. This is definitely an agenda item.
  • The employment report is a single important example. The headline payroll report change was only about 100K. Despite repeated warnings that sampling error alone is +/- over 100K jobs, discussing smaller changes is great sport. The ADP report is a good independent source. Jobless claims are excellent. Wages are rising. The unemployment rate is declining. There is no reason to look for excuses (like the weather) for a weak number. But pundits must earn their pay!

Each earnings season I offer a challenge. I am still waiting for an answer. Those who do not trust earnings say that the estimates are too optimistic. They also say that (at the time of the report) they are too low. If both are true, there must be some point in time when the estimates are pretty accurate. John Butters provides this interesting table, looking only at the last-quarter effect.

 

If earnings growth continues this pattern it can do the following:

  1. Increase confidence in earnings estimates;
  2. Increase confidence in an improving economy;
  3. Provide the basis higher forward earnings;
  4. Support the idea of a higher PE multiple.

Eventually, whatever the other worries, it is all about earnings.

Weighing the Week Ahead: Is Market Optimism Justified?

We have a rather light week for economic data. The biggest reports came last week. Earnings season continues. Everyone is keeping a close eye on President Trump, wondering what might happen next. Meanwhile, stocks are at all-time highs and interest rates have stabilized. This combination creates more questions than answers, which will lead the punditry to wonder:

Is the market optimism justified?

Last Week

Last week the economic news was strong, but (once again) with little reaction from stocks.

Theme Recap

In my last WTWA two weeks ago I predicted a focus on volatility, wondering whether policy uncertainty would have a reaction in stocks. That was a good call, although overshadowed by the policy moves themselves. There were several articles on volatility, mostly noting the lack of reaction in the VIX.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. She notes that the week’s gain was all from early action on Friday. Some attributed this to the employment report, but the timing is more consistent with a reaction to Trump actions on Dodd-Frank.

Let us also update another chart from this useful weekly article — a graphic picture of drawdowns. You can readily see both the frequency and magnitude.

Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read his entire post for several more charts providing long-term perspective.

Some Super Bowl Fun with Two Hidden Lessons

Most readers will be watching the Super Bowl today. Did you know how important this is for market performance in 2017? The old AFC/NFC forecast is passé. We now must “dig deeper” into the data. By email I received an analysis that looked at Manning’s, Broncos, and other factors. I’ll focus on this year’s table.

And here is the recommended interpretation:

Looking at the averages, one might think that having New England or Bill Belichick in the big game is no big deal. A look at the year by year results shows that this could be a huge deal since the averages mask big swings in both directions.

For New England, just being in the big game could be a bearish sign as the market has dropped 6% on average in years where the Patriots have played in the Super Bowl since the turn of the century. During the Tom Brady dynasty years, the Patriots have won four of six times so far while the market is tied 3-3. Two of the years the Patriots have made the big game, 2002 and 2008 have coincided with major bear markets, an ominous sign.

Markets have also been volatile in years where Bill Belichick has coached in the big game both with New England and the New York Giants. Following his coaching appearances, the market has finished up 30% once, down 30% once, up 20% once and down 20% once.

Conclusion: What Super Bowl matchups could mean for the market in 2017

Based on the volatile reaction by markets to seeing New England and Bill Belichick in the Super Bowl, combined with the short-term positive, long- term negative reaction to last year’s win by Peyton Manning and the Denver Broncos, it looks like we could be in for a highly volatile for the markets this year. The bull market of recent years could be due for a setback. While signs are mixed over what direction the market may finish the year, there is a strong possibility of a 20% plus move this year.

Jane Wells asked some questions (What milestone did the Dow recently pass? Who is Janet Yellen?) to the high-income Super Bowl Participants. You will enjoy their answers.

Oscar likes the Falcons, but Vince insists that football picks are not part of his programming! Mrs. OldProf likes the Falcons as well, but that is just because they beat her Packers. I’ll stick with the Michigan man.

Use the comments to suggest the “hidden” lessons. WTWA readers should not need me for this oneJ

The News

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

This week’s news was again quite good—almost all positive. I make objective calls, which means not stretching to achieve a false balance. If I missed something for the “bad” list, please feel free to suggest it in the comments.

The Good

  • Consumer spending rose 0.5% in December, beating November’s increase of 0.2% and expectations of 0.4%.
  • Pending home sales rose 1.6%, beating expectations for a 0.6% gain.
  • Consumer confidence remained high at 111.8, although slightly slower than the December reading.
  • Initial jobless claims remained low, at 246K. (Calculated Risk).
  • Factory orders increased 1.3% beating expectations and much better than the 2.3% loss from November.
  • ISM manufacturing registered 56, beating expectations and reaching a level not seen for more than two years. (Scott Grannis). This chart shows why it is important.

  • Auto sales remained at record levels. (Phil LeBeau, CNBC). There is also a shift to the more profitable vehicles.
  • Nonfarm payrolls showed a net gain of 227K. The headline solidly beat expectations, so I am scoring this as “good.” The details were a bit more mixed, with some slight negatives. This is my own summary after reading many sources.
    • Positive
      • Headline job gain.
      • Increase in labor force participation.
      • Benchmark revisions confirming that prior data was something of an under-estimate– also showing healthy growth of jobs from new businesses. (This parallels the Business Dynamics report, which I wrote about here).
    • Negative
      • Small negative revisions to prior months.
      • No gain in the “household survey” employment.
      • Slight uptick in unemployment.
      • Sluggish increase (O.1%) in wage gains.

     

The Bad

  • Personal income increased by 0.3% in December, slightly missing expectations for a gain of 0.4%, but much stronger than the prior month’s 0.1% gain.
  • Construction spending for December declined 0.2%, missing expectations for a slight gain and dramatically lower than the prior month’s 0.9% pop.
  • Earnings beats are slightly below recent averages. (Factset).

 

The Ugly

A possible Chinese stress test for Trump. Jennifer M. Harris, Senior Fellow at the Council on Foreign Relations has an Op-Ed piece, with the full article at CNN. Here is the key quote:

Major geopolitical crises have a way of greeting US presidents soon after taking office. Nazi Germany’s withdrawal from the League of Nations in 1933, the Soviet-led construction of the Berlin Wall in 1961, the Gulf of Tonkin incident in 1964 — all were among the most daunting tests of US foreign policy in the past century, and all came less than a year into the tenures of new US administrations.

This is no accident. Foreign governments often like to test a new White House early on.

Russia, Iran, and North Korea are other obvious candidates.

 

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. Jacob Wolinsky has a terrific review of Harry Dent predictions. Here is one of the most dramatic, from just a year ago.

Time to redraw that one. The power of graphs with red lines and arrows is amazing. Jacob’s article also includes the results of a Google search for Dent’s predictions. You must see it to believe it!

I especially appreciate that Jacob was inspired by his Silver Bullet award in 2013. I only wish that more would join me in highlighting people doing this kind of valuable work.

Meanwhile, Mr. Dent’s business model is working just fine. Check out the speaking fees.


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

It is back to normal for the volume of economic data, but the most important reports came last week.

The “A” List

  • Michigan Sentiment (F). Continued strength anticipated. Special interest in future expectations.
  • Trade balance (T). December data with impact on Q4 GDP adjustments. Will be watched more closely as Trump policy is clarified.
  • Initial jobless claims (Th). How long can the amazing strength continue?

The “B” List

  • JOLTS report (T). Misunderstood and misused. This is about labor market structure, not job growth.
  • Wholesale inventories (Th). December data can have some effect on GDP adjustment. Favorite spinning target.
  • Crude inventories (Th). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

Fed speakers are back on the trail. Questions will probe the new political environment and hints about future rate hikes.

Earnings reports will remain important. Early actions from the Trump Administration have captured the spotlight and will continue to do so.

Next Week’s Theme

 

There is plenty of good economic news. A nice chart-packed review from Steven Hansen (GEI). And also from Urban Camel. Here is just one example comparing full-time and part-time jobs. There are plenty of great charts in both posts.

The earnings recession is over and future growth looks good. (Brian Gilmartin).

And yet everyone is nervous. (Great piece from Josh Brown).

While President Trump will continue to grab the spotlight this week, I will continue my focus on the stock market fundamentals. In today’s Final Thought I will offer some suggestions about how to implement this approach. Meanwhile, expect the key question for this week to be:

Is market optimism justified?

The basic positions cover a wide range. Even if one or more of them seem incredible to you, be assured that someone passionately maintains that viewpoint.

  • You must be kidding! Market valuations are in nosebleed territory. Investors are like Wile E. Coyote.
  • It is only a matter of time before the new Administration does something to spark a crisis.
  • Technical indicators have moved to neutral. (Charles Kirk and Guy Ortmann of Scarsdale Equities. Both are excellent, but require a relationship).
  • Markets can expect solid earnings growth with upside of 10% or so. (Ed Yardeni, Barron’s).
  • Companies are getting more comfortable with Trump and more confident about the future. (Avondale digest of conference calls – a great resource).
  • Tax cuts, repatriation of corporate profits, and lower regulations will create an explosion in economic growth.

What does this mean for investors? As usual, I’ll have a few ideas of my own in today’s “Final Thought”.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

Although dropping last week, the yield on the ten-year note has increased significantly since the election. This has lowered the risk premium a bit. I suspect much more to come. By this I mean that the relative attractiveness of stocks and bonds will continue to narrow.

The C-Score has also dropped. The relationship is not linear, and it remains in the “safe” zone.

The Featured Sources:

 

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

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

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

Doug Short: The World Markets Weekend Update (and much more).

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

This illustrates Dwaine’s take on leading indicators, asking about time above the current value.

Georg Vrba: The Business Cycle Indicator and much more.Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli’s enhanced aggregate spread, considering when it might first give a recession signal.

Scott Grannis: The market is not very optimistic. This shows the importance of our weekly coverage of the equity risk premium, showing the relative attractiveness of investors’ two major choices – stocks and bonds.

 

How to Use WTWA (especially important for new readers)

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. All our models are now fully invested. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our four technical experts, and some rebuttal from a fundamental analyst (usually me). We try to have fun, but there are always fresh ideas. Last week Holmes made a timely call on Macy’s (M). Many of the stocks cited are worth your consideration.

Top Trading Advice

 

As I suspected a few weeks ago, Dr. Brett Steenbarger is taking a sabbatical to work on his next book. Most traders have probably not matched me in reading all his posts. Many of them have enduring value, so you should take some time to review his archives. My favorite this week helps you to explore you best trading strengths and virtues.

Ralph Vince has a warning about Trump Effects:

While everyone is in a lathered-up blather about executive orders and screeching, we gotta keep our eyes on the ball. I for one can’t get sucked up into political noise when there’s money to be made.

Nearly everyone I speak to is looking for three things:

1. A pullback in equities.
2. Interest rates have bottomed and will now approach more historically normal levels.
3. Volatility is bound to increase in the coming months and perhaps years.

And the degree of which I am hearing this makes me quite certain none of these are in the cards.

A colorful YOLO story – possibly fake – about a trader going “all-in” on poor earnings from Apple (AAPL). His collection of puts and short call spreads would make $5 million if it worked, recovering the $2.5 million inheritance he lost in two years. With the strong report, he was completely blown out, as witnessed on a live stream. There are many lessons here whether it was true or not. Handling wealth. Position size, whatever your confidence. Suspicion about those making dramatic calls to sell their services.

 

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Davidson (via Todd Sullivan), who pulls together economic data and conclusions in his explanation of why stronger Employment Reports Indicate Higher Equity Markets.He includes several important indicators, emphasizing the need to look at several. This illustrates the right way to do financial research. He writes:

One must continuously test indicators against each other to be intellectually honest.

 

Stock Ideas

 

Barron’s likes Chili’s (Brinker International – EAT) but not Chipotle (CMG).

Our trading model, Holmes, has joined our other models in a weekly market discussion. Each one has a different “personality” and I get to be the human doing fundamental analysis. We have an enjoyable discussion every week, including four or five specific ideas that we are buying. This week the dip-buying Holmes (who has been very hot) liked Macy’s (M). That worked well for those who did their own research and agreed.

Seeking yield?

How about health care REITs? Blue Harbinger analyzes twenty candidates, two of which we own.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, this is a must-read. Even the more casual long-term investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. My personal favorites this week are two entries I see as related. Josh Brown points out the opportunity for young people to start saving and investing, enjoying compound interest. Tony Isola shows the flip side – the cost of an impulsive purchase paid off on a credit card. This is a great lesson!

Seeking Alpha Editor Gil Weinreich’s Financial Advisors’ Daily Digest has quickly become a must-read for financial professionals. Somewhat to my surprise, the topics are also especially relevant for active individual investors. They frequently join in the comments, adding to the value of the posts for both groups. Gil has several good topics, but I especially liked this discussion of the fiduciary rule. Most people do not understand what this means, and what is at stake. I strongly support Gil’s argument.

Watch out for…

Binary options. Another product that seems simple but few understand or trade successfully. (FT).

BDC’s. BDC Buzz has the story.

VIX trading. Bill Luby provides data on the poor results of VIX ETPs. Many are tempted to buy the VIX as a hedge without even knowing how it is calculated or whether it is a leading indicator.

Final Thoughts

 

Like Josh Brown, I am hearing a lot of worry about what might happen in the Trump Administration. Over the last several months I have highlighted all of the following:

  • An expectation that the Market would rally no matter who won the election – just removing one element of uncertainty.
  • The earnings recession ended in Q316.
  • Forward earnings are the most effective way to forecast the market, and 8-10% higher is quite plausible.
  • P/E multiples are strong when people have confidence in earnings.
  • This could be conservative if repatriation, better growth, or reduced regulation come to pass.
  • The best sectors are financials, tech, home builders, and some biotech.
  • The biggest market worry is a battle over trade, especially with China.

To my surprise I opened Barron’s and found Dr. Ed Yardeni making exactly the same points. Anyone reading WTWA for the last few months could have done the interview. I generate my own ideas and reach my own conclusions, but I always like it when astute analysts look at the same evidence and agree.

In a similar vein, my Seeking Alpha colleague Bill Kort has a great analysis of the danger of mixing your opinions about news with your investments. I am delighted that some of my work and my highlighting of Morgan Housel encouraged him to pursue this valuable topic.

Policy uncertainty remains the most important investor worry. We can mitigate this in two ways:

  1. De-emphasize the social issues. Yes, they are important. Feel them passionately if you wish. As an investor, you must ask whether they affect your portfolio.
  2. Consider timing. We cannot know about and react to a military attack. We can monitor the progress of trade negotiations. The most important investor threats still leave us time to react. I am watching closely, and so should you.

Why You Never See the Best Employment Data

On the first Friday of each month the Bureau of Labor Statistics releases the Employment Situation Report. The data – especially the payroll employment change – is the subject of much speculation, forecasting, and spinning once it is announced. Most sophisticated analysts (like me) regularly report that the sampling error is +/- 120K jobs or so. And that is after the second revision. Few realize that the revisions mostly “top off” the sample responses. There is also non-sampling error, of course, if the current universe of employers is not representative.

The BLS method involves attempting a “count” of the total number of jobs, via a survey, in one month and subtracting it from the prior month. It is not a direct count of change in the number of jobs. ADP attempts a similar estimate using payroll data from their private clients. Today they reported a gain of 246K private jobs. Both are estimates – and only estimates!

The most accurate employment report comes from a source you never hear about, the quarterly Business Dynamics Report. It is based upon the Quarterly Census of Employment and Wages (QCEW), the authoritative final count of all things labor. The QCEW is the basis for the final benchmarking of all the major BLS reports. Why? The data is drawn from local employment offices, not surveys. Businesses are legally required to report all workers. It is the basis for employment insurance, and there is obviously no incentive to overstate employment.

Why Don’t We Hear About This?

No one reports the results of the Business Dynamics Report or the QCEW because we do not have this great and accurate data until eight months later. From the Wall Street perspective, it is “old news.” Here is an important table from the last report.

For our current purposes, the key number is the net employment change of 307,000. I am going to compare that to the estimates made at the time of the original releases.

We should also observe that overall job creation in the quarter was almost 7.5 million jobs. This is very important, but no one seems to know it. Jobs destroyed were over seven million, leaving the net of 307 thousand. This is around 100K per month, and that is all you will hear about.

Please also note that the new jobs come from both additions at current establishments and opening establishments. New jobs from new businesses were 1.4 million for the quarter. The data from this series proves that those complaining about the BLS birth/death adjustment are wrong now, and always have been.

The Estimates

If we fire up the Wayback machine, we can look at the reported employment data from this period. To understand the data, we must realize that the BLS, ADP, (and others) are all making an estimate of the “true job growth.” Their estimates represent different methods, all with pluses and minuses. Let’s see how the two estimates did against what we now know to be “the truth.”

We do not have monthly data for the BED series, but we can see how the two sources did for the entire three-month period. “Truth” was a gain of 307K. Both estimating sources were a bit too high, with the BLS doing better for this round. I have occasionally done this comparison, concluding that the ADP method should also be considered. It would be useful to do this analysis over a longer period. It takes a lot of careful work. (Perhaps if I get a good summer intern, this will be one of the projects. Applications welcome).

Implications for Investors

I understand that investors generally tune out educational posts, especially when a “deep dive” is involved. This is discouraging, since one of my missions is to help people “navigate the noise.” In the case of employment data, it is nearly all noise!

Here are conclusions I have reached, and which you might consider:

  • BLS and ADP both provide useful estimates of employment change. It is a mistake to regard (as most do) the BLS as the “official” result.
  • We should expect variation in the monthly BLS numbers. The survey has a confidence interval of 120K! If the data are real, then the reports should fluctuate around truth.
  • Traders focus on the BLS. They must, since that will be the trading flow. If you are a trader and want to game that announcement, you are on your own. If you are an investor, you should include both reports in your thinking.
  • Do not be bamboozled by those who claim that seasonal adjustments or estimates of new jobs are misleading. I have studied dozens of these claims. None of the writers show any real expertise in data analysis or a proven track record. They are all men on a mission or women on the warpath.
  • The overall path of employment growth remains solid. That will be true even if we get a “weak” payroll employment number on Friday.

And Finally

This topic is (yet another) example of how difficult it is to find real experts. It takes real skill and knowledge. You cannot just read the newspaper.

Other Reading

Your Employment Report IQ – No one knows even 25% of these answers, despite the importance. My favorite prof and greatest teacher introduced me to labor economics. He “approved this message” and said that everyone should read it. While I appreciate the encouragement from a great mentor, the viewership was about 10% of my WTWA pieces – and far less than other pseudo-experts. Trying to help people is an uphill battle!

My best single piece on the monthly employment report. Guessing beans in a jar?