Weighing the Week Ahead: What Does the Health Care Decision Mean for Stocks?

The economic calendar is light, but it really would not matter. The defeat (via retreat) of the effort to replace Obamacare will dominate financial market stories this week. The pundits will be asking:

What does the health care decision mean for stocks?

Last Week

Last week the news was mostly positive, but irrelevant. Markets were focused on the Obamacare repeal decision.

Theme Recap

In my last WTWA (three weeks ago since my vacation included two weekends) I predicted a discussion about the expected change in Fed policy and the effect on stocks. That now seems like ancient history, but it was a pretty good theme for that week.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. She notes the overall loss of 1.24%, largest since last October. You can also clearly see the Friday fluctuations around the health care breaking news.

Given the time since our last post, let’s catch up with this longer-term chart.

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, including the size and frequency of drawdowns.

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 slightly negative.

The Good

  • Durable goods rose 1.7%.
  • Earnings growth remains solid. Energy has weighed down earnings over the last few years. The general assumption is that earnings estimates are too optimistic. FactSet reports that the expected y-o-y growth in Q1 is 9.1%. You probably do not see that data very often, unless you are wisely following Brian Gilmartin, who has been on top of this story for many months.
  • Rail traffic growth continues although the pace is a bit slower. Steven Hansen has the full story, including charts and analysis.
  • New home sales increased 6.1%. Calculated Risk, the go-to source on housing matters, calls this a solid report. Despite the 12.8% y-o-y increase, Bill notes the downward revisions to prior months. The key upcoming issue is whether builders will provide affordable housing.

 

The Bad

  • Jobless claims increased to 258,000.
  • Existing home sales dropped 3.0%. This was also a small miss of expectations. New Deal Democrat embraces the overall housing strength, calling this the “least important” housing indicator. Calculated Risk has an important summary about existing sales:

    To repeat: Two of the key reasons inventory is low: 1) A large number of single family home and condos were converted to rental units. In 2015, housing economist Tom Lawler estimated there were 17.5 million renter occupied single family homes in the U.S., up from 10.7 million in 2000. Many of these houses were purchased by investors, and rents have increased substantially, and the investors are not selling (even though prices have increased too). Most of these rental conversions were at the lower end, and that is limiting the supply for first time buyers. 2) Baby boomers are aging in place (people tend to downsize when they are 75 or 80, in another 10 to 20 years for the boomers). Instead we are seeing a surge in home improvement spending, and this is also limiting supply.

The Ugly

Hate groups in the U.S. are flourishing. GEI Editor John Lounsbury regularly includes articles that you might miss otherwise, including this important story.

 

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s award goes to Charlie Bilello, whom we also featured on Stock Exchange. This is double recognition that is unlikely to be repeated!

Why is this so important? Because so many are being “scared witless” (TM OldProf euphemism).

Most pundits, media, “smart money”, experts on valuation have been completely wrong for many years. If you have wisely stuck with the fundamentals, you are called part of a “sucker’s rally.”

For some years, the top “fear indicator” has been VIX. No matter that few understand how it is calculated. The VIX has remained low, despite the insistence of many that risk is high. Instead of accepting the results of an indicator embraced for many years, the true believers take the only course possible: Find a new indicator!

Many of them have seized upon SKEW, which shows that the risk of a crash has never been higher. Bilello’s analysis pushes deeper, asking the excellent question of how predictive SKEW has been in the past.

The conclusion is that widely-perceived fear, whether in regular options or tail risk, does not predict a severe decline.

What does? A business cycle peak (AKA a recession). That is the reason for our careful monitoring of that topic.

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 rather light week for economic data.

The “A” List

  • Consumer confidence (T). This is the Conference Board version. Will the amazing strength continue?
  • Michigan sentiment (F). The Michigan version, which includes a continuing panel in the sample, is important.
  • Personal income and spending (F). Until and unless more business spending kicks in, consumers are crucial.
  • Initial jobless claims (Th). The series seems to be flattening at record low levels.

The “B” List

  • PCE prices (F). The favored Fed measure is approaching the 2% target.
  • Chicago PMI (F). Best of the regional indicators gets special attention as a hint about the ISM report.
  • Wholesale inventories (T). Advance Feb data. Desired or undesired? That is always the question.
  • Crude inventories (Th). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

The Fed Speakers Bureaus have been busy. Expect a daily dose of FedSpeak.

Next Week’s Theme

There is little in the way of scheduled fresh news. The health care vote came at the end of the day on Friday. It will be open season for the punditry. Speculating about the President, the legislative agenda, the Speaker, and the market provides plenty of grist. The commentary next week will raise the question:

What does the failure of the Obamacare repeal mean for stocks?

Once again, there is a hidden question which will be the focus for most – the impact on the Trump agenda. While health care is important, the market strength is more related to tax issues and infrastructure spending. Here are the key viewpoints:

  1. The defeat weakens the President and signals lower chances for the economic agenda.
  2. Getting this issue out of the way permits more rapid attention to corporate tax reform.

These issues are most important to those who believe that the post-election rally is all about Trump. More observers are joining me in crediting the stock strength to resolving the election uncertainty and overall economic improvement. Scott Grannis has a helpful chart.

Even the usually sour Barron’s lead column says that an improved global economy accounts for about half of the U.S. stock rally.

Those who focus on the economic fundamentals (nice piece by a semi-anonymous blogger with whom I have corresponded) and corporate earnings emphasize a base of continued modest growth. Improvements in tax policy are an upside kicker. Eddy Elfenbein has his usual incisive and clear explanation of the history of the “Trump trade.”

The single best analysis I saw was from Dan Clifton of Strategas Research Partners. This video is packed with information, so watch it twice and take notes!

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 most of the February 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 some guest experts). We try to have fun, but there are always fresh ideas. Last week the focus was on dealing with news-driven risk.

Top Trading Advice

 

Be careful in your backtesting! Sean McLaughlin understands the issues and provides practical advice.

Brett Steenbarger identifies seven training resources for developing traders, including helpful links.

Are you too confident about your skill at technical analysis? Price Action Lab shows how cognitive bias can lead you astray, including some great examples.

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 Chris Kacher’s popular and insightful chart, spread widely by Sue Chang. The various soft times in market history are considered. My own conclusion is that you had better have a good reason to fight the trend.

Stock Ideas

 

Deep value in a solar stock? Andrew Bary of Barron’s features SolarEdge Technologies (SEDG), citing a possible 40% upside. He quotes my friend Bob Marcin, who is very fussy about deep value, noting that the company “makes a category-killer product for a secular growth industry.”

Chuck Carnevale considers the implications of rising interest rates for stocks. His wide-ranging analysis, which you should read carefully, looks at historical macro effects as well as analyzing individual stocks like Johnson and Johnson (JNJ), McDonalds (MCD), and other important names.

Josh Brown explains why homebuilders are strong in the face of rising interest rates.

Our Stock Exchange always has some fresh ideas. There are ideas from five different approaches. Our momentum newest member, Road Runner, trades upward-sloping channels, seeking attractive entry points. This week’s idea is Netflix (NFLX). You will probably identify with one of the characters, and your questions are welcomed.

Yield Plays

Blue Harbinger does a deep dive into dividend aristocrats. He begins with the membership of the SPDR Dividend Index (SDY) and then moves to his likes and dislikes. It is an excellent and thorough piece. In a somewhat more speculative vein, Mark has a provocative analysis of CVR Energy (CVI), including Carl Icahn’s involvement and possible link to his role as a Trump advisor.

Simply Safe Dividends provides an absolutely first-rate analysis of the potential for utility stocks. There is a good analysis of the likely impact of higher interest rates, and how to pick companies that will hold up the best. Especially interesting is the argument for keeping some utilities in your portfolio no matter what you expect on interest rates.

Some REITs might be fine, even when rates are rising. Here are ideas from Salvatore Bruno.

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 the practical tax-time advice on what records you can safely discard. More abstract but very powerful is this discussion of the trade-off between financial assets and human capital.

In his regular column, Seeking Alpha Editor Gil Weinreich raises an important question: Can even the rich afford to retire? He cites several great sources as well as some possible solutions. My advisor colleagues should join me in making this a regular read, but it is usually helpful for DIY investors as well.

If you have been stock on the sidelines, evaluating possible worries, you might want to read my (free) short paper on the top investor pitfalls. It is a good test of whether you can successfully fly solo. Send a request to main at newarc dot com.

 

Watch out for…

 

Companies with “suspicious earnings.” Rupert Hargreaves explains the warning signs and provides some starting ideas.

Final Thoughts

 

Astute and intelligent investors closely follow the news. That will be a special challenge in the week ahead. Most of what you read about the health care decision will be worse than unhelpful. It will steer you astray.

Most sources will discuss what the health care defeat means for Trump or for the Republicans. That type of story is easy to write and invites readers to join in the speculation. The financial outlets might do a little better with some ideas about the impact on tax reform.

The implications for investors demand more sophisticated analysis. This was a test of two things:

  1. The intransigence of the Freedom Caucus
  2. The GOP leadership and the President’s ability to craft a compromise.

If a “layup change” like Obamacare repeal cannot be done within the Republican party, the entire agenda will require some compromise with Democrats.

This affects both the probability of success and the nature of the resulting policies. This conclusion is much more important for investors than the specifics of the health care legislation. It is also more sophisticated than knee-jerk commentary on the change in the “Trump agenda.”

 

A Conclusion for Investors

I know from my travels and discussions that there is a high degree of market concern right now. Part of it is uncertainty about Trump policies (from investors of both parties), and a general sense that the rally is extended and markets are “high.”

This type of concern is exactly why we must invest based upon data, not emotion.

None of our indicators currently warn about the end of this business cycle. Business cycles do not have an expiration date. They do not die of old age. (Yardeni). These are emotional ideas that feel right, but lack empirical support.

There is plenty of “upside risk.” Earnings growth is improving, even in the environment of modest growth. The recent market strength could go on for years without any policy changes. If some of the Trump agenda (probably with Democratic support) becomes law, it could mean a spike in both economic growth and profits. We already see improved business and consumer confidence.

Three Great Interviews

In the flood of news, it is easy to miss the very best stories.  In my regular Weighing the Week Ahead series I include plenty of links to great sources.  Sometimes there are other items that deserve special attention.  This weekend I recommend that you settle back with some popcorn and enjoy these three videos.

In each case you will get some very solid stock ideas from a great source.  You will also learn a common theme, understood only by a few market experts.  Let us take the stories one by one, and summarize the theme in the conclusion.

John Calamos

John runs the (very) largest investment firm in Naperville, our town.  His office — now a building — is a few blocks down the street from ours, and his assets a few zeroes higher.  I take a special interest in following his commentary.  I sometimes think that viewers might be giving him short shrift when compared to the slick guys from New York.  Someone told me that we midwesterners have an accent!  Really?  It sounds normal to me, and you should not let it deceive you.  John's success comes from a great team and good stock selection.

He has great ideas for stocks that will benefit from rising rates, including some technology ideas!  Watch the interview for more.

 

Ron Baron

CNBC's Squawk Box featured an extended interview with one of the leading fund managers and stock pickers, Ron Baron.

This interview is loaded with help for the individual investor, including great ideas about which companies have enduring  business models.  Here are some key bullet points:

  • Very few succeed by trading the news!
  • The average person who invests in mutual funds makes 3% compounded.  The average mutual fund makes 7% compounded.  People think they are George Soros.  So wrong.
  • The stock market has been through a difficult 14-year period of time.  It is up 1-2% a year since 1999 while earnings have doubled.  It started at very over-valued levels. 
  • Stocks are currently trading at median P/E ratios when interest rates have never been lower.
  • Responding to a challenge from Doug Kass via email — Given the secular headwinds to economic growth, why should stock  multiples hold up?

6.8% a year since 1960 is the growth rate of the economy.  For the last 14 years it has been 4.4% and it is accelerating.  People talk about 2% growth but you have to consider inflation.  When you had stocks at 15 times earnings for 100 years you did not have interest rates at zero.  Look at the comparison.  Businesses are growing and growing faster.  Money is cheap.  Businesses are attractively valued.  When the economy grew at 6.8% stocks were growing by 6.1% plus you have to add dividends which makes it about 8%.  That's for 120 years.  Will it keep up at that rate?  Maybe it will be a little less.  We are using 7%.  That means a double in 10 years — 30K in ten years and 60K in 20 years.

As one who called for Dow 20K at the point of maximum skepticism, I understand and agree!  Once again, you will learn more by watching the entire interview.

 

 

Larry Robbins

Robbins is described by CNBC as a "hedge fund titan" who rarely does interviews.  Since I regularly hear misleading information from managers with high AUM's, I prefer to decide for myself when it comes to credentials.

Robbins demonstrated a special insight in the health and health management fields.  This is a great sector to study with plenty of cross-currents.  We have the demographic effects from an aging population and also the influence of ObamaCare.  We still do not know how the new policies will be implemented or which states will participate.

His interview includes several stock ideas in the health care field.

 

The Common Theme

All three sources demonstrated a very sophisticated understanding of the relationship between stocks and interest rates.  They all note that stock market multiples are actually strongest when interest rates are in the range of four percent.

  • Baron emphasizes the importance of stocks in fighting inflation.
  • Robbins notes the multiple, stating "When interest rates are between 3 and 7 percent, the long-term history
    of the market is to trade between 17 and 18 times earnings.  With our
    portfolio trading at 10 1/2, we'll take our chances."
  • Calamos notes, "…if you go back even 50,60 years, when the 10-year bondwas 4% to 6%, p/es were 20,which means it's a much moregrowth environment.so i think we have to, you know,re-educate investors that, youknow, going back to normal ratesis not a bad thing."

Most traders and pundits, as usual, have an overly simplistic rule linking interest rates and stocks.  Higher rates are worse.  The loudest voices telling stock investors to worry about ten-year yields moving higher from two percent said the opposite when rates were moving down to two percent.  On the way down, it was a sign of economic weakness.  And now, on the way up…..?

For those who prefer data to speculation, please check out my "Scared Witless" (TM OldProf euphemism) post.  I describe a "final destination" where a four percent ten-year yield is something of a sweet spot for stocks.

At the start of the week we saw the knee-jerk reaction to higher interest rates.  Eventually, the normal relationships will return.  It provides an opportunity for those in the know.

Investment Themes: The first step in finding a great stock.

Some stock pickers start with a screen.  I start with a concept:  Look for the hated!

I search for investment themes that are decidely contrarian.  That means that few like the concept, the sector or the stock.  The themes must meet several important critera:

  • Negative sentiment and/or polling
  • Analyst skepticism
  • Modest valuations

and most importantly — hatred.

I am going to list some themes and you probably will not like them.  That is the point.

My mission here is to provide some specific ideas as well as suggestions about how the individual investor can search for and find profitable investments.

Contrarian Concepts

One problem is determining what most people believe.  That is the only way to find the contrarian (and possibly undervalued) side of the trade.  I want to encourage a free-wheeling discussion that will be helpful to all, but let me suggest two rules:

  1. Nothing political.  I understand that you may think that Europe is in a socialist decline or be offended by Romney, but that is not the point.  This is about investments, not political philosophy.  We can predict political outcomes, but the purpose is to find investments.
  2. The time frame must be reasonable.  I personally screen using three to six months.

Theme Ideas

Here are a number of themes that  I nominate for consideration.

The Economy

This is an easy choice.  Even the most optimistic economic forecasters only look for growth of 2.5% or so.  There are many recession callers including many/most pundits (especially non-economists) and the ECRI.  The recession forecasters have influenced earnings forecasts, now showing little growth in 2012, and stock prices.

Time frame:  uncertain.  The recessionistas started making their forecasts last Spring at the time of the Japanese earthquake.  Q3 economic growth did not support the theory.  Perhaps another strong quarter will move attitudes.

Stocks:  Cyclicals and Tech.  Caterpillar (CAT) and Oracle (ORCL) are contenders, but the nominations are open.

Europe Crisis

This is open to some debate.  The credit market has not shown any recognition of improved prospects.  Some think that stocks have recently been "euphoric" but it could also be a reaction to the good earnings season.

Time frame:  week to week, but some specific tests within two months.  I think the verdict (for US investors) will be in within eight months, although the social issues may linger.

Investments:  Greek bonds, Italian bonds, credit default swaps, European banks, the dollar/euro spread, US banks, US stock market — listed in order of declining risk and reward.  My own play is lightly long US banks via JP Morgan (JPM).  Those taking either side should declare a time frame and also what would make them change opinions.

Value Trap Stocks

There are many stocks that nearly everyone agrees are cheap on a P/E basis.  The stocks remain "cheap" because of a general consensus that they will not appreciate no matter what happens.  The popular descriptive but unhelpful term is a "value trap."  It is supposedly a silly mistake to be invested in these names.

Time frame:  this quarter or next.  Many names in this category have continued to improve in value.  At some point this will be recognized.  Catalysts might be technical breakouts above key moving averages, changes in leadership, or an exceptional earnings quarter.

Investments:  Cisco (CSCO) and Microsoft (MSFT) come to mind.  Nominations welcome!

Obama Re-election

This seems like a toss-up, mostly because the Republicans are floundering in the search for an opponent.  Key factors in the race will be the economy and employment, reductions in troop commitment, and the qualifications of the GOP candidate.

Time frame:  the stock effect could occur well before the election, depending upon changes in the factors listed.

Investments:  Health care stocks lead this list, since every Republican is committed to unwinding ObamaCare.  There are many candidates, including insurance companies like United Health Care (UNH) and Wellpoint (WLP) and ETFs like XLV.  Many other drug stocks and device makers are also worth consideration.

The Supercommittee

This is my favorite current theme.  There is a lot of skepticism about progress and ultimate success.  The uncertainty has cast a pall over the sectors destined for cuts in the absence of a successful outcome — mostly health care and defense stocks.

Time Frame:  the committee action is due  by November 23rd and an extension seems unlikely.  Congress and the President will need to approve, but the first hurdle is imminent.  Check out my preview from August.

Investments:  The health stocks are good candidates here as well, but so are defense names.  United Technologies (UTX), and Boeing (BA) are leading choices.

Please Join In

Do you like this approach?  The ideas here are a work in progress.  New themes and stock ideas are encouraged in the comments.

In addition, you can participate in a real-time discussion.  I have recently joined a group of investment experts at Wall Street All-Stars.  I am writing about investment ideas and responding to questions in a daily investment diary.  I invite readers to check this out and also to consider the free trial (just email our office:  main at newarc dot com).   There is also free content and other diaries on various subjects.  It is worth checking out.

Weighing the Week Ahead: A Tall Wall of Worry

The stock market continues to grind higher in the face of skepticism.  It is a familiar story.  Nearly a year ago we highlighted the “wall of worry” concept.  I wrote as follows:

Our Take

We have no illusion that every story
will turn out to be wonderful.  Our own position has varied both with
economic events and the tape.  Over the last several weeks there have
been many positive signs and we have identified many profitable sectors.

The media and the
blogosphere remain skeptical of any positive news.  This is the
definition of the Wall of Worry.  The average front page at Seeking
Alpha has a rash of featured bearish bloggers.  The links from Abnormal
Returns now include many sassy skeptics.  The comments everywhere tilt
heavily bearish.

We now know that this advice was very accurate.  It is time to revisit the concept.

Everyone Knows the Negatives

The economic worries are widely understood.  It was a focus for me in the last few days.

Having just returned from the Kauffman Foundation’s Economic Blogger’s Forum. I am inspired and invigorated.  The organizer and moving force was Tim Kane, who did a fine job in every respect.  I should also acknowledge Kauffman CEO Carl Schramm.  He had a scheduling conflict, so we only got to hear his closing remarks, but his support for this endeavor is crucial.  The conference  brought together economic  bloggers from widely differing perspectives and provided ample opportunity for interaction.  I love the format.  You had a chance for one-on-one discussions, small groups, breakout sessions, and a webcast.

I plan to write several articles drawn from my experience, but let me start with an overall perspective.  This group has plenty of worries.  The final panel was a gloomy approach to dealing with the budget deficit.  You can see the webcast here, including my friendly employment bet with Mish.  More on that later.

This conference represents a pinnacle — the best summary —  of the economic blogosphere.  What should we conclude?  Let’s take it a piece at a time.

Last Week’s Action

Here is my take on the key data from last week.  I am not trying to
be comprehensive, nor am I taking a viewpoint.  I will highlight what I
found significant, trying to be objective.

The Good

The best news of the week was the stock market action — a slow grind higher.  A number of indicators were solid — inflation reads, Fed actions, etc. — but these were all expected as I noted in last week’s forecast.

There were no striking positives in the economic data.  The modest recovery is the accepted norm, with plenty of threats.  Michael Santolli, writing in Barron’s, does a nice job of capturing the story.

Turning the page at Barron’s we find a nice article from Gene Epstein.  He explains why most of the economists who are betting their careers on their predictions have a positive outlook.

The Bad

None of last week’s data were very important.  The inflation numbers were as expected and the Fed decision and statement were also in line.  Jobless claims were down a touch, but still bad.  This was all as I predicted.

There is a nice cottage industry for researchers.  The  requirement is that you have to find a new indicator that is bearish.  Or maybe you can find a new slant on an old indicator — one that is in extreme bullish territory but off of the absolute highs.

If you want your dose of bad news, Alan Abelson is your man.  He cites a number of the regular bearish sources to provide confirmation bias for his followers.

From my perspective, I saw nothing bearish in the weekly data.  It would be nice to see jobless claims declining faster.

The Reality

I wrote about health care and the legislative prospects.  This is playing out exactly as I forecast, but many still disagree.  As I write this on Saturday night, we are facing an imminent vote.  I still expect the legislation to pass.  My viewpoint was widely contested last week, and challenged yesterday by colleagues at the Kauffman event.  We will see the outcome tomorrow.

I understand that many also disagree with the financial forecasts. Congress relies upon analysis from the nonpartisan CBO.  To check that out we need to find the best sources.  Don Marron was one of the Kauffman forum participants.  We were lucky to have someone with his background — a Georgetown prof who is  a former Director of the CBO, former Council of Economic Advisors member, and veteran of the Joint Economic Committee Staff.  I enjoyed talking with him and regard him as  a strong  “outside” source on the CBO forecasts.  He parses the methodology, the assumptions, and explains the conclusions in this nice article.  This is the basis for the Congressional decision.  Check out the entire article.  There are many nuances to measuring the savings in health expenditures.

The Week Ahead

 

This week may have a few different themes.  Housing is important to the economic recovery, so existing home sales will be important.  Data on home prices are also of interest, since this relates to consumer confidence and consumption.

In practice, this rates to be a slow week for data, with plenty of opportunity for the technical analysis types and econ-spinners to do their thing.

Our Trading Forecast

Our own indicators (see our regular ETF updates for an explanation) are now
neutral, and that was our vote in the weekly Ticker
Sense Blogger Sentiment Poll
. Here is what we see:

  • 58% (up from 27% last week) of our ETF’s have positive ratings.
    This is improving nicely.
  • The median strength is -7.5  (up slightly from -15), still
    negative, but improving.
  • 100%  of the sectors are in
    the “penalty box,” showing an extremely high level of risk and uncertainty.
  • Our Index Package has moved to neutral territory.

Investment Implications

Our investment angle still has a health care focus.  Our forecast last week played out pretty accurately.  The health care legislation is moving forward and figures to pass tomorrow.  Here is the chart of the trading market from InTrade:

Chart126891661780221687

 

I  have been accurate in predicting the outcome of the health care debate and most have disagreed.  Meanwhile, the stocks have not given us the pull back that we might expect from the passage of the legislation.  I have some health stocks in my basket, but I am still shopping.

Anyone who has been looking for an entry point has found the last few weeks to be quite frustrating.

Health Care Investing: Time to Pay Attention

In my 2010 preview, I highlighted health stocks as a group to own.  I mentioned the Health Care SPDR (XLV) as a basic choice, but I have a shopping list of specific names in mind.  These include providers, insurance companies, and health information technology.

With today's Health Care Summit, we can start to visualize the end game.

Not Political Opinion

As usual, I am not writing about the merits of the legislation.  I have my viewpoint, and you should, too, but that is not the subject of my work at "A Dash."  I am trying to do something quite different, and more valuable for investors:  Forecasting the end of the health care debate.

If we knew how this was going to turn out, we might be able to pick the right stocks.  That is the challenge.

My 2009 Prediction

In December, I predicted that a health care bill would pass.  I also suggested that the Democrats would threaten the use of a little-known procedure called "reconciliation." This process requires only a majority vote, not the 60 votes needed to overcome a Senate filibuster.  My prediction was completely accurate — at least until the Massachusetts Senate election.  A bill had passed both Houses, including 60 votes in the Senate, but the bills were not exactly the same.  Before a conference committee could resolve the differences, the Massachusetts election reshuffled the deck.  The situation became very uncertain, with most expecting that no bill could succeed.

Updating the Health Care Prognosis

Today's Health Care Summit was a rich source for news commentary and analysis, but here is the most important fact:  President Obama is playing hardball.

Republicans repeatedly asked him to renounce the reconciliation procedure as a means to pass the legislation and the President would not agree.  I see this as a strong bargaining tactic.  Obama hopes that Republicans will compromise on key points, and a bill will pass with bipartisan support.  If not, he is willing to use whatever tactics are necessary.

Readers can check out my prior article for more detail about this, but there are two basic conclusions:

  1. Some form of the legislation is likely to pass, despite current skepticism.
  2. As this becomes apparent, there will be better buying opportunities for some of the key health care stocks.

When the issue has been resolved, the entire health care sector should trade higher.

[I am currently long THC and RMD in personal and client accounts.]

ETF Update: Health Care Legislation and Drug Stocks

Health Reform legislation seems to be assured of passage.  As I have suggested in past articles, all viewpoints are represented aggressively.  It is leading to a compromise that will not be loved by anyone, but will constitute a major policy change.

The Democrats, dealing with the known bottleneck of averting a Senate filibuster, have made the needed changes.  The liberal wing hates the changes, including some who want to start over.  The marginal voters have exploited their positions in virtually eliminating a "public option" and in limiting public funds for abortions.  The Republicans have gone all out to block any bill, pulling out all stops.  By insisting on the reading of every amendment and forcing procedural votes, they hope to delay the legislation despite the apparent super-majority in favor.

Each faction is using the best possible strategy.  The result?  It is not the best possible bill, but it might be the best bill possible.  Here is a nice summary of the compromises.

My focus this week is on another group of stocks affected by the health care legislation — pharmaceuticals.

Background

Each week we provide a
list of sectors that we expect to have the best performance over the next three weeks.  ETF investors can check out the list and
compare our findings with their own conclusions.

In our analysis, we consider Trends, Cycles, and a bit of
Anticipation.  While our ratings share characteristics with momentum
and relative strength approaches, there are important differences. 
Since we apply the model to nearly 300 ETF's, we call it the TCA-ETF
system.  (For new readers, there is a more complete description of our
methods at the end of the article.  We also have a free report with
more detail on the system and results, available on request.)

The model provides a nice feel for the overall potential of the
market.  It is not the forest nor the individual trees, but
something in between.  I'll take a look at the macro picture first, and
then take a look at our featured sector of the week.

The Macro View

From an overall market viewpoint, our indicators show continued risk.  The key elements are as follows:

  • 84% of our ETF's in positive territory (up a touch from 81% last week).  The median strength rating
    for the overall list is a plus 21 (up slightly from +19 last week).   A score
    of "0" implies the average long-term ETF expectancy.
  • We see reduced risk, with 66% (down from 88%) of our sectors are in the "penalty box."  This means that they are
    currently disqualified from the buy list for technical reasons.  You
    can think of this as a sophisticated "stop loss" rule, often applied in
    advance.  It also may indicate the need to take profits in a sector
    where we have done well, but see higher risk.  See our article here for a further explanation
    of this method.  We recently implemented some faster filters,
    accelerating moves both into and out of the Penalty Box.  We are also
    changing some rules to cut down the frequency of trading.
  • Our index package is positive.  For this rating we look at
    the ETF's (both long and short)  for the S&P 500, the Dow, and the
    Nasdaq.  You can see these ratings is the results table for this week. 
    Despite the positive ratings, we note risk in both directions.  All of
    the index ETF's are in the penalty box.

This overall picture has been about the same for several weeks, but is showing slight improvement.

Highlighting Pharmaceuticals

Our featured ETF in the drug sector is SPDR S&P Pharmaceuticals ETF (XPH).  The fund has 24 holdings with very equal balance.  The beta is only 0.71.  The trailing P/E is almost 18.  As is the case with many equity opportunities this year, there is a dramatic difference between trailing and forward P/E's.  In this case, looking ahead shows a P/E ratio of 11.6.  This compares favorably with estimated earnings growth of about 17%.

As the chart shows, this is not the bottom in the sector, but it could still represent a good opportunity.

Xph

Other Experts

Among our regular experts there has been little discussion of the drug ETF's in recent weeks.  The best perspective came from Tom Lydon, who noted the following in November:

Each administration brings its own set of policies to the White House.
Investing in ETFs may be a prudent way to experience a potential
windfall from the country’s new direction without the high volatility
inherent in individual stocks.

Lydon also has a nice piece describing innovation and the role of biotech in the pharma ETF's.

There is also some mention of health care ETF's in the monthly Seeking Alpha panel discussion.

Fundamentals and Health Reform

At our ElectionStocks site we have followed the twists and turns of the health care legislation in a series of articles.  I also emphasized this last week, describing the process of building a minimal winning coalition.

In particular, this article showed that there was more visibility on drug stocks.  The major companies agreed to a payment of $80 billion, about 2-3% of revenues.  That clarified the impact and helped investors see the potential.

As usual, I have tried to emphasize the need for investors to focus not on their own policy preferences, but on the likely policy outcome.  There is always a way to profit if you are a political agnostic.  We should all try to profit from policy changes no matter which party is in power, and regardless of our own opinions about what is best.  The actual legislation is a compromise that will help the health care stocks.

Weekly TCA-ETF Rankings

We
lost about 1.3% last week, dropping 1.0% to the S&P 500.  The expiration-week activity created some volatility.  The dollar showed some strength, a short-term negative for most stocks.  There was continuing uncertainty on health stocks, now getting clarified.  The strength came from strong earnings reports in some tech stocks.

We
provide these ratings as information for readers who may not trade as
frequently as we do.  Those signing up for our free weekly email update
can also get the entire list.

As
noted above, the macro market indicators are in the penalty box, and
most other ETF's are in the penalty box.  Based upon the current model
signals (and noting the high risk levels), we have continued our
bullish posture in the
Ticker Sense Blogger Sentiment poll.

Here
are the top sectors from our expanded universe of 280 ETF's.  The list
also includes the values for the broad market ETF's and their inverses.

Etf sector report 121809

Note for New Readers

Our weekly ETF Update is designed to assist both investors and
traders interested in ETF's and Sector Rotation.  Before turning to the
current rankings, let us undertake a review for readers new to this
series.

Our Method.  In this past article,
we described our basic methodology and why we believe the rankings are
useful for fundamental traders and technical traders alike.  While we
urge readers to check out the entire article, the key point is that
ETF's pose challenges and opportunities different from investment in
individual stocks.  The fundamentals may be more difficult to assess. 
Even with a good grasp on fundamental trends, there is a lot of
technically-based trading in ETF's.  This means that those trading with a fundamental approach (and we do this as well) want to monitor the "hot money" moves.  Here is an article on that point.

The system synopsis.
We look at Trending sectors, Cyclical Sectors, and build in an element
of Anticipation for both entry and exit — thus the name of the model,
TCA-ETF.  While we do not reveal the exact methodology for spotting
trends and cycles, the system is not a "black box."  The basic elements
are used by many, and widely reported.  We even discuss the need for human analysis as opposed to black box trading.

We report the rankings
each week, now on the weekend with a one-day delay, using the Thursday
output from the model.  We monitor and trade this daily, and offer a
free report (request via the email address on the top left of the site)
for those interested in our weekly trading program.

ETF Update: The Home Stretch for Health Care

Health reform has been the big headline for the first year of the Obama Administration.  It is a major policy objective for Democrats.  It is the hot-button issue for Republicans.

For investors, there are many possible impacts.  On today's Meet the Press, Jim Cramer opined that job creation had been stalled because business did not know what to expect about future costs, including health care.  Alan Greenspan agreed.

The issue deserves attention.  As usual, I am not going to offer an opinion about the merits of the legislation.  Instead, I am going to analyze the prospects for passage, the likely outcomes, and what it means for an investor.

As usual, I will include the current ratings from our system.

Background

In our disciplined system, we study sectors continually, looking at the charts and ratings for hundreds of ETF's.  Each week we provide a list of our top-rated sectors for the next three weeks, along with some of our current observations.  ETF investors can check out the list and compare our findings with their own conclusions.

In our analysis, we consider Trends, Cycles, and a bit of Anticipation.  While our ratings share characterisitics with momentum and relative strength approaches, there are important differences.  Since we apply the model to nearly 300 ETF's, we call it the TCA-ETF system.  (For new readers, there is a more complete description of our methods at the end of the article.  We also have a free report with more detail on the system and results, available on request.)

The model provides a nice feel for the overall potential of the market.  It is not the forest and not the individual trees, but something in between.  I'll take a look at the macro picture first, and then take a look at our featured sector of the week.

The Macro View

From an overall market viewpoint, our indicators show continued risk.  The key elements are as follows:

  • 81% of our ETF's in positive territory ( down from 86% last week).  The median strength rating for the overall list is a plus 19 (down  from +23 last week).   A score of "0" implies the average long-term ETF expectancy.
  • Our risk evaluation became more negative, with 88% (up from 75%) of our sectors are in the "penalty box."  This means that they are currently disqualified from the buy list for technical reasons.  You can think of this as a sophisticated "stop loss" rule, often applied in advance.  It also may indicate the need to take profits in a sector where we have done well, but see higher risk.  See our article here for a further explanation of this method.  We recently implemented some faster filters, accelerating moves both into and out of the Penalty Box.  We are also changing some rules to cut down the frequency of trading.
  • Our index package is positive.  For this rating we look at the ETF's (both long and short)  for the S&P 500, the Dow, and the Nasdaq.  You can see these ratings is the results table for this week.  Despite the positive ratings, we note risk in both directions.  All of the index ETF's are in the penalty box.

Highlighting Health Care

Our top-rated health sector is the Health Care SPDR – XLV.  The top five holdings constitute 45% of the fund, geared toward major drug companies.  The fund website does not seem to provide P/E or beta information.  (Readers feel free to provide a pointer that I missed.)  While this is not crucial for our system, it is meaningful for investors with a different time frame.

Here is the chart.

Xlv

It reflects the market viewpoint about big pharma and the health legislation.

Other Experts

Some of our fellow ETF experts have noted the strength in XLV.

Scott Martindale, using a fundamental method, rates XLV at the top of his list.  It always gets our attention when a solid quantitative approach (with different methods) highlights one of our choices.

Maoxian has been long since June, a great call.

Our Fundamental Analysis

The health care legislation is one of the most complex issues I have seen in forty years of following the policy-making process.  Most of the twists and turns in financial media are off of the mark.  Here is a summary of key conclusions and some links.

  • Some legislation will pass.  It will constitute a minimal winning coalition (described here) that passes a hurdle in the Senate.  The key thing to understand is how Congress works to achieve the needed votes.
  • Minimal winning coalitions come from tradeoffs.  The managers of the legislation negotiate changes that will gain a certain number of votes while losing fewer votes.  The average observer hates the result, which is often criticized as "pandering."  The critics do not understand the normal legislative process where compromise is achieved.  No partisan is ever completely happy with compromise.
  • We cover the twists and turns of the health bill on our sister site, ElectionStocks.  The "all clear" for big pharma came with a compromise on what they would need to pay.  We highlighted a key CNBC video showing the best pharma plays, as well as HMO ideas.  It is a good shopping list.
  • The jury is still outThe Hill is an excellent source neglected by many pundits.  They highlight the current tradeoffs.  The issues are whether there is a public option, whether it has a trigger, the CBO scoring of costs, and whether the leadership tries to use the reconciliation process to pass legislation in the Senate with a 50-vote majority instead of 60.  It is amazingly complex, as illustrated here.
  • Health Reform and Jobs, raised by Cramer, is an interesting observation.  It will not affect the health care debate.  Democrats and Republicans alike understand that this is the only chance for passage.  "Washington" is creating the conflict, but it is the normal policy-making process.  The issue will not be subordinated to a generalized concern for immediate resolution.  Cramer is correct in the observation that all seek clarification.  This will come soon — one way or the other.

I tried to explain this in an article describing my prognosis for health legislation.  It would be a good dissertation topic. In my professor days, I would find the right student to study it.  The ironic possibility is that those opposing a public option might have their strongest influence in negotiations about the 60-vote majority, needed for a cloture vote to preclude a filibuster.  If they do not negotiate on that basis, there is a threat of using the reconciliation process.  This would produce a public option without many provisions that they seek.  In my entire forty-year career of observing public policy, I have never seen this situation.

It is one of many cases where I felt I was writing something very unusual and important on the blog, but few agreed about the significance.  My explanation should have been better.

Weekly TCA-ETF Rankings

We lost about 1% last week, dropping 0.7% to the S&P 500.  There were a number of mid-week changes, updated through the close of Thursday's trading.

We provide these ratings as information for readers who may not trade as frequently as we do.  Those signing up for our free weekly email update can also get the entire list.

As noted above, the macro market indicators are in the penalty box, and most other ETF's are in the penalty box.  Based upon the current model signals (and noting the high risk levels), we have continued our bullish posture in the Ticker Sense Blogger Sentiment poll.

Here are the top sectors from our expanded universe of 280 ETF's.  The list also includes the values for the broad market ETF's and their inverses.

121109

Note for New Readers

Our weekly ETF Update is designed to assist both investors and traders interested in ETF's and Sector Rotation.  Before turning to the current rankings, let us undertake a review for readers new to this series.

Our Method.  In this past article, we described our basic methodology and why we believe the rankings are useful for fundamental traders and technical traders alike.  While we urge readers to check out the entire article, the key point is that ETF's pose challenges and opportunities different from investment in individual stocks.  The fundamentals may be more difficult to assess.  Even with a good grasp on fundamental trends, there is a lot of technically-based trading in ETF's.  This means that those trading with a fundamental approach (and we do this as well) want to monitor the "hot money" moves.  Here is an article on that point.

The system synopsis. We look at Trending sectors, Cyclical Sectors, and build in an element of Anticipation for both entry and exit — thus the name of the model, TCA-ETF.  While we do not reveal the exact methodology for spotting trends and cycles, the system is not a "black box."  The basic elements are used by many, and widely reported.  We even discuss the need for human analysis as opposed to black box trading.

We report the rankings each week, now on the weekend with a one-day delay, using the Thursday output from the model.  We monitor and trade this daily, and offer a free report (request via the email address on the top left of the site) for those interested in our weekly trading program.

[Long XLV and RMD]

Health Care Legislation: Our Prognosis

There is an interesting development in the health care debate.  Action by the opponents of health care reform may actually be counter-productive to their avowed interests.

Background

From my perspective, trying to help investors, the analysis of health care legislation has not been very good.  Most analysts were slow to grasp the fact that many committees had some power.  Eventually there was recognition that the bottleneck might be in the Senate, and everyone focused on the 60 votes needed for a cloture motion — cutting off a filibuster.

The Wall Street firms and the media alike have really cut back on staffing, so there are few genuine experts in political science who are working on this problem.  This makes it an opportunity for investors with some real insight.

Recent Developments

Last week the Senate passed the 60-vote hurdle on Majority Leader Reid's plan.  That will now be the subject of a full debate.

Does it mean that there are enough votes for the plan?  No.

Does it mean that the public option will be included?  No.

One of the best sources of insight into the process comes from Nebraska Senator Ben Nelson, who is not in favor of the overall legislation, but nonetheless voted with the majority to move to a full debate.  Sen. Nelson wrote an op-ed piece in the Omaha World-Herald last week, explaining his vote for last week's motion. There is a very nice analysis of the article on our sister site, ElectionStocks.  (I set the agenda for this work and always review the output.  Investors who want to know how policy-making may affect their investments should add the site to their readers.  There is plenty of information about policy initiatives and which stocks could be winners and losers.)

Some Predictions

Regular readers of "A Dash" understand that we do not advocate particular policy positions.  We have opinions, of course, but that is not our mission.  We aim to enlighten readers about the stock implications from what is likely to happen.

With that in mind, here are some of my own fearless forecasts:)

  • Some health reform legislation will pass this year.  There is a lot at stake for the President and the Congress.  Delay simply means defeat.  They will do whatever it takes.
  • The legislation will meet the test of the "minimal winning coalition" which we described here.  It will be a compromise, with whatever inducements are necessary to get the needed votes.
  • Most pundits will hate the compromise.  That is the nature of policy-making in a pluralistic society.  This is not recognized by the Wall Street analysts or Internet pundits.  Many have a political agenda, so there comments will relate to their interpretation of the merits, not the likely outcome.  Others view the wheeling and dealing that is essential to legislative action as some defect in representative government.  They need to take a class; it is covered in Poli Sci 101.  If you don't like it, find your favorite dictatorship.  It is how legislatures work in representative democracies.

The Twist

Here is the interesting part for political observers.  The Senate debate will attempt to gain a 60-vote majority, to avoid a filibuster.  Some liberals insist on the public option.  Some marginal voters want a trigger mechanism.  Others are adamant in opposing the public option since they see it as the start of a government takeover of health care.

If these opponents all hold firm, the most likely outcome at this point, the 60-vote requirement will not be met.

In this case, the Democrats might try to pass legislation through the reconciliation process, a budget procedure intended to facilitate tax cuts and spending cuts that otherwise could not get the 60-vote margin.  Sen. Reid has publicly disavowed this strategy, but the Nelson article makes clear the existence of this latent threat.

Health care legislation through reconciliation would be stripped of many specific provisions, but a public option would probably be included.  Why?  This may pass the test of a budget-cutting measure.  Other provisions would fail on a parliamentary challenge.

The Result

To understand the likely result, one has to have the reconciliation "twist" in mind.  It is possible that some  marginal voters will realize that they can have more leverage over the final bill by avoiding the reconciliation alternative.

We are going to see a few weeks of debate that will determine the final shape of the bill.

Stock Implications

So far in the process, many health care stocks have remained undervalued because of uncertainty.  Typically, they rally when chances for passage seem dim.

Our analysis is that there may be a dip as the market senses the likelihood of passage.  Then, whatever the specific outcome, there will be a rally in many of these stocks when the uncertainty is lifted.

We will go shopping in the health group, with specific sub-sectors and names in mind.