Weighing the Week Ahead: Is Good News Now Bad for Investors?

What happens when the economic calendar is light and the market volatile? Pundit Paradise! Last week set the table. This week is the pre-game. Next week the FOMC will decide and explain. For those who think it is all about the Fed, this week’s question is obvious:

Is Good Economic News Bad for Investors?

Prior Theme Recap

In last week’s WTWA I predicted that each morsel of economic data would be parsed through the lens of potential changes in Fed policy. This may be the most accurate theme prediction I have ever made. Weak economic data during the week had little effect. The jobs report alone, despite some weak spots, was strong enough to spark rate hike speculation.

It even happened as I hypothesized – HFTs responding to computer parsing of the data (8:31 AM), delayed in the announcement (8:32 AM) by “weather.” Traders joined in (8:33 AM). Then bloggers. Then pundits.

Doug Short’s pictures are always worth a thousand words, but you should join me in reading his weekly market snapshot where the words are also great. This week he notes: “But good economic news freaked out the market, with pundits jabbering about the increased odds of a Fed rate hike.”

SPX-150306

 

Feel free to join in my exercise in thinking about the upcoming theme. 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.

This Week’s Theme

The upcoming week is very light on data, but rich in pundit potential. Since airtime and news space must be filled with “explanations” of any market move, there is a job to be done! Since we have exactly one day of (probably) positive economic data and the market declined, we had better jam those two facts together and start drawing conclusions. There is an open week for a favored sport — Fed speculation. The key question will be:

Is Good Economic News Now Bad for Investors?

Yes, you can think of it as last week’s theme, Part II, but that is the reality. It may well extend another week for Part III.

The Viewpoints

Let me split the viewpoints for this week into what the Fed should do and what difference it makes.

Recommended/Likely Policy

  • Time for a rate increase. There is growing sentiment that extraordinary policy involves unknown risks with little gain. Former Dallas Fed President Bob McTeer says, Let ‘Er Rip, Janet; Let’s Get It Over With
  • Robust Jobs Report increases odds for rate increase. (Jon Hilsenrath).
  • Increase more likely, but pace will be slow. Tim Duy notes the significance of wage gains.

Effect

  • Market reflects strong jobs report (Reuters).
  • Rate hikes will be a disaster for investors. Economic data have been very weak. Pension Partners has the list of “misses” and the Citigroup Surprise Index. Their conclusion is that the “bad news is good news” crowd might be silenced if rate increases occur in the face of economic weakness.
  • Good news will push markets higher (“Davidson” via Todd Sullivan).

    I continue my mantra, “Buy stocks! Buy Stocks! Buy Stocks!” A rising economy lifts all ships. Yes, we will want to get out before the tide goes out, but the tide continues to come in. Based on economic indicators which no one seems to pay attention to these days, we should have up to 24mos of warning of a pending market top.

    Current data provides confidence in the view that there is no economic peak visible for at least 12mos-24mos and subsequently no market top in that time frame.

  • Stocks usually rise both immediately before and immediately after rate hikes. (MarketWatch).
  • It makes no difference. Scott Grannis did not find the jobs report to be that strong, but also sees the policy significance to be minor.

    February jobs growth was stronger than expected, confirming that labor market conditions have improved. But not by much. The economic outlook has not improved dramatically, it’s simply gotten a bit better. Whether the Fed tightens one month earlier than expected as a result of this number is almost a trivial matter. Short-term rates are not going to be problematic for the economy for a long time, no matter what. I see no reason the economy couldn’t continue to (very slowly) improve even as the Fed raises short-term rates a couple of hundred basis points over the next two years or so (that’s a forecast drawn directly from the bond market’s current expectations).

As always, I have some additional ideas in today’s conclusion. 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 “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 last week.

  • ISM services index was 57.1 slightly better than expectations and a marginal positive.
  • China’s non-manufacturing PMI showed a slight rebound. There is a lot of attention on Chinese growth, now targeted at 7% instead of 7.5%. We all want to find helpful data. (GEI).
  • Employment improved. This is a test of my rules about good equaling “market friendly.” The current theme is how to interpret good economic news. For now, let us take the improved employment picture at face value. The consensus of economists was “A Strong Report.” The WSJ has ten good charts capturing the improvement. Here is a good one:

BN-HG904_0306jo_G_20150306091046

 

There is a tendency in the commentary to fear automation. Remember the Luddites? (Walter Isaacson in the FT).

The Bad

There was plenty of mildly discouraging economic news.

  • Personal income and spending were both slightly weaker than expected.
  • The ISM manufacturing index fell to 52.9. This was also slightly below expectations, but consistent with current GDP estimates.
  • Auto sales were somewhat disappointing, especially from Ford. Some are noting exceptionally bad weather.
  • Earnings expectations further softened. FactSet reports likely year-over-year declines for the first half of 2015. On the plus side, the forward earnings growth of the NASDAQ remain in line with historical averages. The energy effect has been important as Brian Gilmartin emphasizes in his excellent weekly analysis.
  • Short-term leading indicators weaken. New Deal Democrat’s excellent weekly column includes plenty of data on indicators you might otherwise miss. This week he notes a convergence of some coincident and short leading indicators, including shipping, steel production, retail, commodity prices, credit spreads, and housing.
  • Jobless claims rose again to 320K. The four-week moving average is now almost 25K over the recent low, so the increase is not just noise. Doug Short captures the long and short term trends in this chart:

DShort Initial Claims

 

The Ugly

Utilities. The XLU was down 3% on Friday alone and over 10% in the last few weeks. With a PEG ratio of over 2.7, there is plenty of risk remaining in a group sought out for safety. If the ten-year yield goes to 3%, where it started last year, expect utilities to drop another 20%.

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 nomination this week, although the field is fertile. Try this one on margin debt:

It is threatening if it goes up –

8-18-2013 12-28-47 PM

 

And also if it goes down….

 

MW-DG846_bear_m_20150303124837_ZH

 

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. For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

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.”

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 market indicators. This week he notes an increase in his combined measure of economic stress, although the levels are still not yet worrisome.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (three years after their recession call), you should be reading this carefully. Doug has the latest interviews as well as discussion. Also see Doug’s Big Four summary of key indicators.

Georg Vrba: has developed an array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal. He gets a similar result from the Business Cycle Indicator (chart below). Georg continues to develop new tools for market analysis and timing, including a combination of models to do gradual shifting to and from the S&P 500. I am following his results and methods with great interest. You should, too.

BCI-Fig-1-3-5-2015

 

Worried about CAPE and other valuation model warnings? Dorsey Wright explains that even the extreme readings on these measures have not been helpful:

Pretty shocking results.  If you can’t even successfully identify overvalued markets when a market is in the 99th valuation percentile, then why even pay any attention to valuation measures at all?  If someone wants to be bearish, there is always some seemingly plausible reason and CAPE valuation measures are an often-cited reason.  However, Gray’s study is a solid takedown of the idea that CAPE can be effectively used as a way to get out of the market at the right time.

What about bullish sentiment? I regularly cite sentiment in the standard way, since we respect the general market opinion for weekly news. Meanwhile, the longer time frame often differs. Chris Kimble explains that bullish sentiment might not be contrarian. Quelle surprise! Active managers might know something after all.

spxperformancewhennaaimover90march3-675x365

 

Reader Question

I get lots of questions both in the comments and via email. I answer as many as possible and always wish I could do better. Sometimes I get something that seems both timely and relevant to many. This week there is special interest in whether there is currently an “earnings recession” and what that might mean for the market.

Part of the attention comes from James Kostohryz, who writes about the earnings recession and asks, “Is the Stock Market in Danger?

I have favorably cited his work in the past and I am a regular reader. I agree with certain key points, including the following:

  • The importance of forward earnings estimates;
  • The recent decline in these estimates; and
  • The evidence that markets and forward earnings generally move in a similar direction, especially if you are flexible about timing

With that in mind —

I need to do an update about causal modeling. Consider the following facts, probably true but carefully invented for today’s post. There is a very strong correlation between Illinois road salt consumption and the number of toll way accidents. The relationship persists over many years. This leads some in the legislature to suggest that our financially troubled state slash spending on road salt to cut accidents. (Don’t laugh! The Wisconsin Legislature featured a Senate debate on the 55 MPH speed limit. One side contended that hitting a deer at a high speed would be much worse. The other pointed out that if you had been driving faster you would be gone before the deer got there).

In many situations correlations are explained by a third variable. Winter snowfalls create both treacherous conditions and the need for salt.

In financial analysis there are hundreds of variables that move with general economic conditions. It is more important to focus on recession risks (the equivalent of winter in the example) as I do each week. If forward earnings do not grow, it will generally weigh upon future stock prices. The information in well-known and reflected in current prices. (See also Ben Levisohn in Barron’s).

The Week Ahead

It will be a light week for economic data.

The “A List” includes the following:

  • Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.
  • Retail sales (Th). Any February boost from lower gas prices?
  • Michigan sentiment (F). A good concurrent read on employment and spending, with some leading qualities.

The “B List” includes the following:

  • JOLTS report (T). Important for interpreting structural unemployment – important to the Fed, but poorly understood by markets.
  • PPI (F). Inflation data is of lesser significance until we see several months at higher levels.
  • Crude oil inventories (W). Maintains recent interest and importance.

The Fed will report the second round of stress test results showing which banks may declare dividends and do buybacks. There is a little FedSpeak on Monday, but then we have a quiet period in front of the March 17 FOMC meeting.

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 five 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?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has continued a “bullish” posture for the three-week market forecast, but it is a close call. The data have worsened a bit. There is modest uncertainty, reflected by the percentage of sectors in the penalty box. Our current position is still fully invested in three leading sectors, and we remain aggressive. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

Those who want to test their skills should check out the hedge fund manager contest at Scutify.com and compete for over $20,000 in cash and prizes. It is plenty of fun and the risk/reward is excellent!

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 new page summarizing many of the current investor fears. If you read something scary, this is a good place to do some fact checking.

My bold and contrarian prediction for 2015 – that the leading sectors would lose and the laggards would win – still looks promising. I also see plenty of time left in this economic and stock cycle.

Other Advice

Here is our collection of great investor advice for this week:

Personal Finance

Last week I posted some highlights from the annual Berkshire Hathaway letter. This week there were some excellent “reviews.” I especially like the quotes and quips and these interactive annotations of the report. Have fun!

Personal finance Wednesday at Abnormal Returns. Great ideas and links.

Stock and Sector Ideas

Millennial investors own the wrong stocks. Patrick O’Shaughnessy explains, comparing holdings of this age group with that of older investors. Here is the first portfolio:

static1.squarespace.com

 

Watch out when buying dividend funds. (Barron’s).

Transportation stock ideas.

Chuck Carnevale uses his excellent tools for an analysis of the dangers in many utility stocks. Check out his many examples as well as the overall analysis.

 

Market Outlook

Sell now if you need your money from stocks within the next eight years. (Hussman).

 

Energy

Look for oil prices in the $65-70 range. (UBS via MarketWatch)

Bargain ideas from Oakmark funds.

Final Thought

Sometimes my final thought is worth a repeat. Last week’s was especially accurate.

One of my regular themes is the difference in time frames between traders and investors.

Traders parse everything through the lens of Fed policy. HFT algorithms look for key words and front-run the humans. Human traders do the same thing – but more slowly. The blog posts hit, “explaining” why the Fed will change course.

If you are a trader, you have a tough job competing in this game.

Investors are free to ignore the immediate psychological reaction and to consider the fundamentals. Here are the most important two points:

The exact timing of the first Fed rate increase does not matter. There is a difference between tight monetary policy and slightly less accommodative policy. Markets do quite well in the early stages of rising rates, especially when starting from a low initial point. This will be ignored by many who will invoke “Don’t fight the Fed.” This will be the fundamental battleground between traders and investors, bears and bulls, and various political types – perhaps lasting for years.

The end of the business or stock market cycle is not imminent. Bull markets do not die of old age. Investors should understand that this one might run for many years. There are many famous and successful investors who have explained this, but I especially like this year-old analysis from Leon Cooperman. It happened just as a famous technical analyst noted that markets were at “an inflection point” not unlike the 1929 crash. See also David Rosenberg. It is easy to find many others top analysts explaining this.

This week I will add why I am not very impressed by the combination of weak economic data and Fed policy.

The data are not really that weak. I do not cite the Citi surprise index for a reason, documented each week in this series.

  1. A surprise depends upon the level of current expectations. If it is really high, I do not worry about a small miss. The same is true in the other direction of course.
  2. The list includes many indicators that are unimportant. If you look at the list in the post, it is all about quantity. The major indicators that we feature tell a different story.

In the richness of time – probably not very long – the market will recognize the best values. The continuing gradual economic growth favors mid to late-cycle stocks. The biggest risk is (ironically) in the sectors where many have sought safety.

One More Idea

Columbo was a favorite of mine, so let’s consider one last idea. It would be a big timesaver for us all. We now have many years of full transcripts for Fed meetings. We know that hundreds of people have this information and there is no potential for deception. We can see exactly what was discussed five years ago, often including the current participants. (Yellen’s 2009 participation looks pretty good, BTW). For serious research, you can check out five key takeaways from 2009. For fun, you can check out the “laugh track” of humor from the FOMC meetings from the grim background of 2009. I am having trouble selecting from these knee-slappers, although I did send the Oxford T-Shirt joke to some friends of that persuasion. Enjoy on your own.

But here is the time-saving idea: Anyone who wants to speculate on what the Fed is thinking must include some actual evidence from past transcripts. If, for example, you want to suggest that the Fed “wants a market correction” (you can’t make this stuff up) then you have to find at least one historical example where some participant raised that idea. Otherwise, shut up!

Weighing the Week Ahead: Will the Economic News Alter Fed Policy?

The economic calendar includes an avalanche of important data. The daily economic news, culminating in the jobs report on Friday, will dominate the market discussion this week. The popularity of parsing everything through the lens of Fed policy creates a special situation. Pundits will ask:

Will the economic data alter Fed policy?

Prior Theme Recap

In last week’s WTWA I predicted that the punditry would focus on housing data and economic impacts with a brief diversion for the Yellen testimony. That was as good call, since the housing debate bracketed the testimony and still followed our themes at week’s end, especially on CNBC programming. Josh Brown’s excellent article, 10 reasons the housing market could go ballistic this spring, captures the spirit of the discussion. Regular readers know that I have long recommended viewing pent-up demand (reason #2) along with shadow inventory. All ten reasons are interesting.

Feel free to join in my exercise in thinking about the upcoming theme. 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.

This Week’s Theme

The upcoming week is loaded with interesting data, more than we often see in two weeks and including the most important reports. With Fed Chair Yellen’s testimony fresh in our minds, it will be natural to combine questions about the Fed with interpretation of the data.

Will the Economic Data Alter the Fed’s plan?

The Viewpoints

Here are the key viewpoints on the economy and Fed policy:

  • The Fed is on course to raise interest rates this year. Vice-Chair Fischer suggests that the current balance sheet effect, without any more buying, is 110 bps on the ten-year yield. This leaves room to normalize rates.
  • The Fed will remain data dependent, with a possible delay until next year (Bloomberg).
  • The Fed will be forced to initiate more QE. (Critics fearing deflation).
  • The Fed has undermined all data. It is hopelessly “behind the curve” from a failure to raise rates earlier. (Critics fearing hyperinflation).

Critics of all flavors were represented during Chair Yellen’s Congressional testimony. The same economic data will be viewed quite differently depending upon the viewing lens. Bob Dieli emphasizes the inflation test as especially important and provides an interesting chart to consider the timing of the first rate hike:

Dieli on Fed

 

As always, I have some additional ideas in today’s conclusion. 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 “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 last week.

  • Progress in Greece. The four-month delay was agreed upon.
  • Inflation is still subdued. And no, it is not a deflationary threat, explains Brian Wesbury.
  • Weekly jobless claims dipped. Back below 300K. Calculated Risk analyzes and charts the significance.
  • Q4 GDP was revised lower, but beat expectations at 2.2%. While the market sold off later in the day, this did not seem to be a major factor. Some were encouraged at the reasons for the revisions, including a lower inventory effect. Doug Short has the best summary of the effect of each component:

dshort gdp

 

  • Durable goods orders beat expectations. Steven Hansen at GEI has a complete analysis, including a longer trend and some caveats.
  • Earnings reports strengthened. The blended growth rate is 3.7%. Companies beating estimates are seeing solid stock price increases. (FactSet). Brian Gilmartin is pretty optimistic about the picture for 2015 focusing on increases in the bottom-up estimates.
  • The chemical activity index. We always appreciate updates from “Davidson” via Todd Sullivan. The correlation suggests “a rise in equity prices for the next 12 months or so.”

Screen-Shot-2015-02-24-at-10.11.45-PM-622x420

  • Michigan sentiment rebounded to 95.4. This is slightly off the recent high, but still very strong.
  • Pending home sales hit 18 month highs. (Calculated Risk) This is a forward looking indicator, but Bill remains concerned about NAR sales estimates. He has an update noting major revisions in seasonal adjustments for the West region.

The Bad

There was also some discouraging economic news.

  • Fund managers are bullish. This is negative on a contrarian basis (The Short Side of Long). Contra from The Fat Pitch, tracking financial bloggers. Both sources have interesting charts, so make up your own mind. I am scoring this with the standard contrarian interpretation.
  • Jobless claims rose dramatically to 313K, the most since December, 2013. This is an important series, but difficult to track with moving holidays like President’s Day. (Bloomberg)
  • Ukraine cease fire is in jeopardy, hanging by a “hair trigger.” (CNN) This is a continuing human tragedy and a major drag on the world economy.
  • Existing home sales disappointed, the lowest level since May, 2014. Mesirow Financial observes that the best investment properties have traded and the baton must now be passed to first-time buyers – a crucial shift. Other observers blame low inventory (WSJ).

The Ugly

Congress is back in action! Or inaction. With minutes to spare before funding would end for the Department of Homeland Security, Congress managed a one-week funding extension. This means that we get to watch the entire story again next week. Groundhog Day was a month ago. Even Greece and the Germans managed a four-month extension.

And following up from a prior “Ugly” the Chicago financial situation gets worse.

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 Nicholas Cola and Jessica Rabe of Convergex. Cola takes on the oft-cited Jeff Gundlach slide deck on the 2015 outlook. Gundlach states that equities have never risen for seven years in a row since 1871. The Convergex analysis, while quite deferential, demonstrates that Gundlach is inaccurate in several respects. The points are all nicely documented and charted in a supplement. The conclusion is that several more years of rally would not be a surprise.

(Note more discussion of bull markets and old age in today’s final thought).

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. For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

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 market indicators. This week he notes an increase in his combined measure of economic stress, although the levels are still not yet worrisome.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (three years after their recession call), you should be reading this carefully. Doug has the latest interviews as well as discussion. Also see Doug’s Big Four summary of key indicators.

Georg Vrba: has developed an array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal. Georg continues to develop new tools for market analysis and timing, including a combination of models to do gradual shifting to and from the S&P 500. I am following his results and methods with great interest. You should, too.

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.”

This week’s report is chock full of insights and ideas. Here is Bob’s take on last week’s theme, housing:

James Picerno, a leading business cycle expert, warns against relying on too few “cherry-picked” indicators. He cites a statement that the housing recovery is faltering. His thoughtful article has several great examples, leading him to conclude as follows:

On that note, recession risk is still quite low, based on a broad review of the published numbers. Yes, the housing market may be an early sign of trouble; ditto the weak trend in commodity prices. But there are many positives one could point to as well. But it’s ridiculous to get into a tit-for-tat debate–my indicators are better than yours! The emphasis should be on developing superior multi-factor business cycle benchmarks. Fortunately, there’s no shortage of efforts on this crucial work. The bad news is that you’re not likely to read about it unless you’re looking beyond the usual suspects.

Sad, but true. The story that “all is well” does not get much attention.

The Week Ahead

It will be a big week for economic data.

The “A List” includes the following:

  • Employment report (F). The most watched economic indicator, despite the wide error band and revisions.
  • ISM Index (M). Important concurrent economic read with some leading qualities.
  • Personal income and spending (M). Will the bonus from lower gas prices show up?
  • PCE prices (M). Favorite Fed inflation indicator.
  • Auto sales (T). Good non-government verification of spending. Weather effects last month?
  • Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.
  • ADP private employment (W). Deserved recognition as a solid independent measurement of job growth.

The “B List” includes the following:

  • ISM services index (W). Less history than the manufacturing index, but now covering more of the economy.
  • Beige book (W). Anecdotal economic evidence that the FOMC will use at the next meeting. If you are a veteran of the Art Cashin era you may call this the “tan book.”
  • Trade balance (F). Impact of oil prices should be evident.
  • Construction spending (M). January data, but an important growth measure.
  • Factory orders (Th). January data for this volatile series.
  • Crude oil inventories (W). Maintains recent interest and importance.

There is not much FedSpeak, but plenty on the international affairs front.

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 five 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?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has continued a “bullish” posture for the three-week market forecast. The data have improved a bit, but are only slight better than the recent neutral readings. There is reduced uncertainty, reflected by the falling percentage of sectors in the penalty box. Our current position is still fully invested in three leading sectors, and we remain aggressive. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

This week’s special advice for traders comes from two of my favorite sources: Brett Steenbarger citing Charles Kirk. The basic idea is the importance of not overfitting your trading models. The important technique is to resist temptation to add many variables for slight theoretical improvements in performance. My partner Vince calls this “pruning.” It is the key to what he calls a “robust” model. When you are looking at a new trading system it is one of the key things to consider. Less is more.

As I have noted for seven weeks, Felix continues to feature selected energy holdings. The focus has shifted from refiners, to producers, to natural gas during this time. Solar stocks have also earned a high rating.

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 new page summarizing many of the current investor fears. If you read something scary, this is a good place to do some fact checking.

My bold and contrarian prediction for 2015 – that the leading sectors would lose and the laggards would win – still looks promising. I also see plenty of time left in this economic and stock cycle.

Other Advice

Here is our collection of great investor advice for this week:

Personal Finance

The annual Berkshire Hathaway letter is a must-read for investors. If you cannot spare the time to read all 42 pages, see pp. 18-19 for an explanation about why to prefer stocks to bonds in the long run. The risk often comes from our own behavior:

Investors, of course, can,by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy. Indeed, borrowed money has

No place in the investor’s tool kit: Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.

And also see page 34-35. Mr. Buffett advises at least a five-year time horizon for those buying his stock. He also explains the reason for keeping adequate cash reserves (counting Treasuries):

The reason for our conservatism, which may impress some people as extreme, is that it is entirely predictable that people will occasionally panic, but not at all predictable when this will happen. Though practically all days are relatively uneventful, tomorrow is always uncertain. (I felt no special apprehension on December 6, 1941 or September 10, 2001.) And if you can’t predict what tomorrow will bring, you must be prepared for whatever it does.

A CEO who is 64 and plans to retire at 65 may have his own special calculus in evaluating risks that have only a tiny chance of happening in a given year. He may, in fact, be “right” 99% of the time. Those odds, however, hold no appeal for us. We will never play financial Russian roulette with the funds you’ve entrusted to us, even if the metaphorical gun has 100 chambers and only one bullet. In our view, it is madness to risk losing what you need in pursuing what you simply desire.

Barry Ritholtz is on the same theme:

The noise box in your den (and on the wall of your trading room) has been tallying a catalog of potential crises and hazards. That parade of terribles seems to be getting longer each day. Although none of them are new, it is as if all of them have suddenly risen in unison, a chorus of noise, funk and angst. Markets are expensive, the Federal Reserve’s stimulus of quantitative easing and zero interest rates is ending, the euro is collapsing, deflation is a threat, rates are rising, residential real estate is a mess, biotech is a bubble, oil prices are plunging, Grexit will arrive any day.

Stock and Sector Ideas

Surprise! As Pimco reaches beyond its identity as a bond company, it now features income-oriented funds that feature stocks as well. Simon Constable (Barrons) has an excellent story that also includes information about the fund holdings – plenty of ideas.

Barron’s also features Vulcan Materials (VMC). We have been looking at stocks in this sector as solid value plays.

“We’re in the second inning of the cycle,” says Rick Lane, lead manager of Broadview Opportunity fund, which owns Vulcan stock (ticker: VMC). Lane sees Vulcan generating more than $1 billion in free cash in the next three years, which could help drive the stock price to $127, up more than 50% from last week’s $82.

Beware the high-yield market.

The thirty most-shorted stocks. (Akin Oyedele at BI)

Market Outlook

Morgan Housel has another great column, this time on the forecasting failures of Wall Street analysts. He cites the chart below from Birinyi Associates concludes as follows:

Finance is much closer to something like sociology. It’s barely a science, and driven by irrational, uninformed, emotional, vengeful, gullible, and hormonal human brains.

If you think of finance as being akin to physics when it’s actually closer to sociology, forecasting becomes a nightmare.The most important thing to know to accurately forecast future stock prices is what mood investors will be in in the future. Will people be optimistic, and willing to pay a high price for stocks? Or will they be bummed out, panicked about some crisis, pissed off at politicians, and not willing to pay much for stocks? You have to know that. It’s the most important variable when predicating future stock returns. And it’s unknowable. There is no way to predict what mood I’ll be in 12 months from now, because no matter what you measure today, I can ignore it a year from now. That’s why strategists have such a bad record.

Worse than a Blind Forecaster.

Birinyi on forecasts

No wonder Mr. Buffett recommends a five-year horizon.

Ben Carlson weighs in on the same theme using a great success story.

Perception and Psychology

You probably get involved in the debate over “the dress” and what color it is. For the full story — Market Watch’s Shawn Langlois starts my day with his “Need to Know” column. Perhaps more than anyone I appreciate how difficult this is – something like a daily WTWA. He also contribute other pieces like this one on the Internet debate over the dress. Mrs. OldProf and I disagreed on this one, as did our team at the office. If you managed to miss it, take a look and decide for yourself. There are some important investment lessons:

  1. No matter how simple the question, people see things differently.
  2. We do not understand the foundation for our perceptions – not even recognizing why they differ from those of others.
  3. No wonder people see the same chart, or the same balance sheet, and draw different conclusions.
  4. Buyers and sellers at the same price….

Business Cycle

Consistent with our Silver Bullet award is this excellent article from Cullen Roche, warning about extreme viewpoints and stubborn adherence thereto. He suggests that the bull market has another $816 million to go.

Final Thought

One of my regular themes is the difference in time frames between traders and investors.

Traders parse everything through the lens of Fed policy. HFT algorithms look for key words and front-run the humans. Human traders do the same thing – but more slowly. The blog posts hit, “explaining” why the Fed will change course.

If you are a trader, you have a tough job competing in this game.

Investors are free to ignore the immediate psychological reaction and to consider the fundamentals. Here are the most important two points:

  1. The exact timing of the first Fed rate increase does not matter. There is a difference between tight monetary policy and slightly less accommodative policy. Markets do quite well in the early stages of rising rates, especially when starting from a low initial point. This will be ignored by many who will invoke “Don’t fight the Fed.” This will be the fundamental battleground between traders and investors, bears and bulls, and various political types – perhaps lasting for years.
  2. The end of the business or stock market cycle is not imminent. Bull markets do not die of old age. Investors should understand that this one might run for many years. There are many famous and successful investors who have explained this, but I especially like this year-old analysis from Leon Cooperman. It happened just as a famous technical analyst noted that markets were at “an inflection point” not unlike the 1929 crash. (See also David Rosenberg).

Weighing the Week Ahead: Help for the Economy from Housing?

The economic calendar includes much more housing data than we normally see in a single week. With Fed Chair Yellen’s Congressional testimony and the GDP revisions also on tap, I expect many observers to be linking these topics. They will ask:

Is it finally time for a housing rebound?

Prior Theme Recap

In last week’s WTWA I predicted that the punditry would focus on the new record in stocks, and especially on whether energy stocks would support the breakout. Those were indeed two major themes all week and they were frequently linked, so the question was accurate. Mostly the answer was rather negative. The stock rally continued, but without help from most of the energy sector.

Feel free to join in my exercise in thinking about the upcoming theme. 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.

This Week’s Theme

The quirks of the calendar include some of the major economic reports on housing – new sales, existing sales, and pending sales – along with Case-Shiller and FHFA pricing and the mortgage index. There is a lot of fresh information.

We will see the second estimate of Q4 GDP, with many wondering about the role of a possible housing rebound. Janet Yellen will testify before two Congressional committees, elaborating on current Fed thinking. And finally, the remaining earnings reports feature some of the major companies associated with home construction.

The confluence of these factors will spark the question: Can Housing Finally Contribute to the Economic Rebound?

The Viewpoints

There is a wide range of opinion on housing:

  • Fundamental weakness. Some major opinion leaders, including Jeff Gundlach, Laurence Fink, and Sam Zell note the changing demographics and issues in supporting the mortgage market. (This article is from last year, but lays out the reasoning effectively).
  • Miscellaneous bearish factors. CNBC’s Diana Olick covers the housing beat and always seems to find a threat to the rebound. A look at her blog’s index page shows stories about the trickle down of high rents to small cities, expected weakness in Houston from falling oil prices, lack of impact from more jobs, higher mortgage rates, negative effects of a strong dollar, and similar stories.
  • The long bottom. Calculated Risk has been the leading exponent of this view. The data show that some of the new construction represents owner-built starts and homes intended for rent. Bill recommends consideration of this chart:

StartsQ42014

  • Positive developments. Jonathan Golub of RBC notes that household formation is booming:

jonathan-golub-rbc-capital-markets

As always, I have some additional ideas in today’s conclusion. 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 “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 last week.

  • Progress in Greece. After a slow start to the week, including a German spokesman calling the Greek proposal a “Trojan Horse,” there was finally a firm agreement — to delay for four months. As I noted last week, this type of negotiated solution is actually quite typical. Each side does as little as possible. There is an opportunity for face-saving. The worst crisis outcome is averted. Markets seemed less worried about Greece than three years ago, and celebrated the Friday agreement.
  • Weekly jobless claims dipped. Back below 300K. Calculated Risk analyzes and charts the significance.

WeeklyClaimsFeb192015

 

  • Port deal reached. This news broke on Saturday, so it is not reflected in Friday’s closing prices. As I have noted in recent weeks, the Longshoreman slowdown and the accompanying lockout were threatening a major economic disruption. It will still take weeks to resume normal shipping, but this is very good news.

The Bad

There was only a little bad news.

  • Ukraine cease fire breaks down. This is a continuing human tragedy and a major drag on the world economy.
  • Earnings reports have weakened a bit. There are still 75% of reporting S&P companies beating on earnings and 58% on sales. (FactSet). The blended growth rate is 3.5% as calculated there or about 7% if you take out energy. Brian Gilmartin notes that Apple contributed half of the ex-energy earnings growth and warns against arbitrarily excluding stocks and sectors. You need a good reason!
  • Housing starts and building permits disappointed slightly.

The Ugly

The Fed is worried about a rush for the exit in bond funds. Bloomberg’s Matt Boesler tweeted about a passage in the Fed minutes. (Full story from Myles Udland of BI).

…because investors are using mutual funds to invest in bonds, instead of owning the bonds, there could be a problem if investors all want to leave at the same time.

When you own a bond mutual fund, you don’t actually own a bond which will continue to pay a coupon so long as the issuer isn’t in default, you just own a share of the fund, which is comprised of lots of bonds and sometimes other things.

Also, a bond fund is only going to have so much cash on hand, so if the investors in a certain fund all want to redeem their shares of the fund at the same time, it will pose problems for the fund manager trying to meet redemption requests. Most likely, the manager will be forced to sell some bonds, potentially at a discount, as the fund needs to simply raise cash to meet redemptions.

And ace Fed watcher Tim Duy emphasizes the determination to raise rates.

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, but nominations are welcome. I am seeing plenty of bad charts, but little refutation.

On a related theme, could someone explain why PBS continues to feature the guy who called for Dow 5K before 20K, instead of someone who did the opposite? Do they have an interest in the investment success of their viewers? Can anyone find any such items?

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. For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

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.”

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 market indicators. This week he notes an increase in his combined measure of economic stress, although the levels are still not yet worrisome.

2015-02-18_10501

 

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (three years after their recession call), you should be reading this carefully. Doug has the latest interviews as well as discussion. Also see Doug’s Big Four summary of key indicators.

Georg Vrba: has developed an array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal. Georg continues to develop new tools for market analysis and timing. Some investors will be interested in his recommendations for dynamic asset allocation of Vanguard funds and TIAA-CREF asset allocation. He has added a method for Vanguard Dividend Growth Funds. I am following his results and methods with great interest. You should, too.

 

The Week Ahead

It is a normal week for economic data.

The “A List” includes the following:

  • Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.
  • New home sales (W). Time for a rebound?
  • Consumer confidence (T). Conference Board version correlates with economic spending and employment.
  • Michigan sentiment (F). Same concepts as Conference Board, but using a panel design.

The “B List” includes the following:

  • Existing home sales (M). Less important for the economy than new construction, but still significant.
  • Durable goods (Th). Continuing weakness in volatile series?
  • CPI (Th). Inflation is still not important in these ranges, but always watched closely.
  • GDP (F). The second estimate. Backward looking but still noteworthy.
  • Chicago PMI (F). Gets extra attention when occurring right before a weekend. Best regional report for predicting the ISM index.
  • Crude oil inventories (W). Maintains recent interest and importance.

There is plenty of FedSpeak, featuring Chair Yellen’s “Humphrey Hawkins” testimony before a Senate Committee on Tuesday. The House gets a chance to question her on Wednesday. There are at least four other appearances by Fed Presidents on Thursday and Friday.

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 five 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?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has continued a “bullish” posture for the three-week market forecast. The data have improved a bit, but are only slight better than the recent neutral readings. There is still plenty of uncertainty reflected by the high percentage of sectors in the penalty box. Our current position is still fully invested in three leading sectors, and we have gotten more aggressive. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

As I have noted for six weeks, Felix continues to feature selected energy holdings. Felix is not just a momentum trader!

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 new page summarizing many of the current investor fears. If you read something scary, this is a good place to do some fact checking.

My bold and contrarian prediction for 2015 – that the leading sectors would lose and the laggards would win – looked a lot better over the last two weeks. If I am correct, there is a very, very long way to run for the cheapest market sectors – energy, technology, cyclicals, and financials.

Other Advice

Here is our collection of great investor advice for this week:

Personal Finance

Abnormal Returns continues to focus on personal finance in the Wednesday links. Read them all, but I especially like Morgan Housel on risk and David Merkel on why investors underperform stock averages.

Stock and Sector Ideas

Warren Buffett cuts back on big oil. Others debate his wisdom. (Barrons)

Five reasons not to expect a big rebound in oil prices. (Tim Mullaney at MarketWatch).

The place for bonds, even when rates are rising. Mark Hulbert shows how intermediate bonds can show gains even when rates are rising sharply. The basic idea is to keep the maturity short and reinvest as rates move higher. (This is the concept we follow in our bond ladder). Bonds are also essential for those who need to reduce the volatility of a pure stock portfolio.

Cam Hui suggests that it might be time to buy Greece. His article was published the day before the announcement, but is well worth reading, especially for those who like some technical support for fundamental ideas.

A longer term chart of the Athens General Index and the US Greek ETF GREK also tells a similar story. Greek stocks look washed out, especially when they don’t react negatively to bad news.

 

ATG vs GREK

Health insurance companies that support Medicare Advantage are benefiting from the influx of “younger seniors.” (Wedbush via Barrons). I enjoyed some of these names last year, but sold on a valuation basis as new highs were reached. Time to revisit the price targets?

Market Outlook

Robert Shiller may be reducing his holdings of US stocks. Media questioners always try to get him to predict an imminent crash. Market bears use his CAPE ratio as the foundation for demonstrating an over-valued market. Most people would be surprised to learn that he continues to hold over 50% stocks, an aggressive allocation given his age. He has also recently been noting risks in bonds.

Morgan Stanley sees another 1000 points in the S&P 500 as foreign investors join the party.

Final Thought
Most economic recoveries have help from the housing sector. Part of the reason for below-trend growth has been the continuing missing elements. We have had drags from government spending (especially local), business investment, weather, and housing. Gene Epstein takes note of this as follows:

The U.S. economy is in the benign grip of a virtuous circle, with key positive factors reinforcing one another, all of them lubricated by low energy prices. Employment gains are driving up wages and salaries, which are driving consumer spending, which is encouraging capital investment, which is in turn motivating business to hire.

So far, however, the housing market has been barely participating in that virtuous circle. Monthly housing starts have been running at an annual rate of only a little over a million, nothing like the 1.5 million that could be seen if household formation begins catching up with the increase in the population.

Household formation could heat up by 2016 as labor markets become tighter. Then growth of 4% could finally become a reality.

He has a good point. I expect a final surge in economic growth during this business cycle, and it might take two or more years to play out.