Weighing the Week Ahead: New Year, New Highs, and a New List of Worries

There is a normal dose of economic data this week, but we are entering a quiet, pre-holiday period. As the rally faltered a bit, the Dow 20K talk yielded to a discussion of what could go wrong. I expect this discussion to continue in the coming week, and perhaps the next one as well. The punditry will be asking:

What can derail the rally?

Last Week

In a reversal from the last month, most of the economic news was soft. There was little apparent market effect.

Theme Recap

In my last WTWA, I predicted a week-long fixation on the Dow 20K story. That was very accurate, with the closest call coming just as I arrived at Chicago’s NBC tower for a CNBC interview on my 2010 forecast. I think it represents a delay rather than a jinx. Some might attribute the selling to the Fed and Chair Yellen’s press conference, an “effect” that was reversed the next day. It must have been meJ I’ll stay at the office for the rest of the year!

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. He captures the continuing rally and the move to new highs.

Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis grounded in data and several more charts providing long-term perspective.

Personal

I will have several year-end posts planned for the next two weeks, but will probably skip WTWA next weekend. I am planning a Weighing the Year Ahead installment, probably in two weeks.

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

The Good

  • Framing lumber prices are higher, year-over-year. Calculated Risk sees this as an important leading indicator for housing, so we should, too.
  • Initial jobless claims edged lower, to 254K.
  • Hotels are close to an occupancy record. (Calculated Risk).
  • The Fed provided the expected increase in rates with almost no market reaction. (That is the good part). Tim Duy provides some insight. See also “Davidson” via Todd Sullivan.
  • The Philly Fed showed a big gain to 21.5 (7.6 prior) and trouncing expectations. I am not very interested in the Empire State survey, but it mirrored the Philly result. Business and consumer confidence have both strengthened since the election. Confidence is essential for spending, investment, and economic strength.
  • Inflation is still tame, even as it creeps toward the Fed’s target.
  • Household balance sheets are much stronger. Scott Grannis regularly produces this chart. It is far more valuable than material from those focusing exclusively on debt, and ignoring assets.

  • Homebuilder confidence hits the highest level since 2005. (Calculated Risk).

 

The Bad

  • Industrial production declined by 0.4% from October to November.
  • The rail contraction continues. Steven Hansen continues his coverage with multiple takes and time frames. Check it out!
  • China/drone incident. The drone seizure coincided with Friday selling, a hint of market reaction to sensitive international issues. China will return the drone and claims that the story was “hyped up.”
  • High frequency indicators edge lower. NDD’s useful weekly compilation shows continuing strength in short leading indicators, neutral in the coincident group, and some weakness in the long term. He is downplaying the effects due to seasonality, but it bears watching.
  • Housing starts dropped by 18.7%. This was a very bad headline number. Various sources suggest that it emphasizes multi-family while single-family is strong. This is a shift that is quite acceptable, so we should follow it closely. Calculated Risk, our go-to source on all things housing, has a great analysis and this chart.

The Ugly

The Young. Colleges are profiting from helping credit card companies. The choices are frequently worse than the student could find otherwise.

The Old. Brett Arends opines that cost-of-living adjustments may soon end. Already the inflation rate for seniors, mostly because of medical costs, exceeds the standard CPI calculation.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week, but opportunities abound and nominations are welcome!
The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have a normal week for data, loaded into the latter part of the week. Things will get very quiet after Friday’s opening.

The “A” List

  • Michigan sentiment (F). Confidence is important right now. Will the mid-month preliminary high hold up?
  • New home sales (F). Not much change expected in this important sector.
  • Leading indicators (Th). This widely followed measure is likely to be flat.
  • Personal income and spending (Th). This important read on the economy is expected to show solid growth.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Existing home sales (W). A small decline is expected. Less important than new construction, but still relevant.
  • PCE price index (Th). The Fed’s favorite inflation indicator – still very tame at a touch over 1%.
  • Q3 GDP third estimate (Th). Little change expected in what is now viewed as “old news.”
  • Durable goods orders (Th). This volatile series is expected to be much weaker than the October data.
  • Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

Despite the end of the FOMC quiet period, we have little FedSpeak. Chair Yellen makes an early-week appearance, and that is all I see.

Next Week’s Theme

 

Last week attention focused on Dow 20K. This was true even though it is a rather meaningless round number in a flawed index. It shows the power of symbolism to attract attention. When the rally fizzled out, the story swiftly turned. Everyone questions rapid, short-term moves, so it is a natural for the punditry.

I expect it to carry over into a quiet week, with plenty of focus on 2017. The popular question will be about what could stop the rally. What should we worry about? It is time to rebuild the wall or worry.

What could go wrong?

Pundits were already hard at work last week:

You should ignore the lists or 2017 winners.

Trump’s policies might not get enacted, disappointing markets. S&P businesses are in line for $87.1 billion.

Trump’s policies might be enacted, hurting the economy and markets. (Think trade matters).

Trump might make a bad decision in a crisis. An ill-timed tweet?

Valuations are still excessive. Stocks are too pricey to buy.

The Fed and a strong dollar might hurt earnings.

Stocks might get too expensive for dividend reinvestment. (You can’t make this up).

Bonds are sending a warning.

Or maybe we should look at the bright side?

A nice reversal from the negativity of last January, the worst start to a year ever. (Josh Brown).

The rally is real. Brian Wesbury’s valuation model showed stocks as 30% under-valued on election day.

20% upside for next year? Brian Gilmartin sticks to the facts. This is an earnings-based conclusion.

 

What should investors conclude from these sharply conflicting ideas? As usual, I’ll have a few ideas of my own in today’s “Final Thoughts”.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

The increased yield on the ten-year note has lowered the risk premium a bit. I suspect much more to come. By this I mean that the relative attractiveness of stocks and bonds will continue to narrow.

The 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.

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

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

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. His most recent research update suggests some “mixed signals” from labor markets.

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. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score.

Doug Short: The World Markets Weekend Update (and much more). Jill Mislinski updates the ECRI coverage, noting that their public leading index is at the highest point since 2010. Surprisingly, the ECRI public statements remain bearish on the U.S. economy, the global economy, and stocks. It is as if they never recovered from the bad recession call in 2011. They have been out of step ever since.

James Picerno highlights an important, oft-ignored relationship. Many worry about higher interest rates. He notes the relationship between higher rates and stronger economic growth.

 

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 six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

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

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

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and less risk.
  • Holmes and friends – the top artificial intelligence techniques in action.
  • Why it is a great time to own for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions on this subject. What scares you now?)

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar is fully invested in aggressive sectors. The more cautious Holmes also remains fully invested, but with continued profit-taking and position switching. The group meets weekly for a discussion they call the “Stock Exchange.” This week we had a great topic – whether the focus on Dow20K had an effect on technical analysis. The prior two segments were on limiting risk and maximizing returns. (We report exits from announced Holmes positions if you ask to be on that list. Write to holmes at newarc dot com).

Top Trading Advice

 

Brett Steenbarger continues to provide almost daily insights for traders. Sometimes the ideas draw upon his expertise in psychology. Sometimes they emphasize his skills in training traders. Sometimes there are specific trading themes. They all deserve reading. This week I especially liked the following:

Adam H. Grimes has an excellent piece on finding ideas. You must be experienced, but also avoid confirmation bias. Dr. Brett gives a HT and follows up.

Brendan Mullooly takes one of my favorite approaches – drawing a lesson from outside trading, especially from sports. This approach helps rid us of confirmation bias, providing a fresh look. Check out the full post for data on the impact from overtrading. And the sports analogy? Teams that keep switching quarterbacks!

[This chart was approved by Mrs. OldProf, a native of Green Bay and a knowledgeable football fan.]

 

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be advice from legendary investor Peter Lynch. Instead of finding something from the last week, I wanted to find the best choice for current conditions. Ben Carlson did the Peter Lynch report about two years ago, starting with this very relevant quotation:

Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.

And also….

Now no one seems to know when they are gonna happen. At least if they know about ’em, they’re not telling anybody about ’em. I don’t remember anybody predicting the market right more than once, and they predict a lot. So they’re gonna happen. If you’re in the market, you have to know there’s going to be declines. And they’re going to cap and every couple of years you’re going to get a 10 percent correction. That’s a euphemism for losing a lot of money rapidly. That’s what a “correction” is called. And a bear market is 20-25-30 percent decline.

They’re gonna happen. When they’re gonna start, no one knows. If you’re not ready for that, you shouldn’t be in the stock market. I mean the stomach is the key organ here. It’s not the brain. Do you have the stomach for these kinds of declines? And what’s your timing like? Is your horizon one year? Is your horizon ten years or 20 years?

What the market’s going to do in one or two years, you don’t know. Time is on your side in the stock market.

 

Stock Ideas

Lee Jackson has an interesting screen that produced 5 Dividend Stocks that You Can Still Buy With Market at Record Highs. “We screened the Merrill Lynch research data base for stocks that are rated Buy, pay a dividend and haven’t gone parabolic this year. We found five that make good sense for investors”.

Wind energy stocks have been left behind in the “Trump rally.” Buying opportunity or victim of policy changes?

But keep in mind that solar is now cheaper than wind energy. Tom Randall (Bloomberg Technology) has a helpful analysis of how much and why.

Our trading model, Holmes, has joined our other models in a weekly market discussion. Each one has a different “personality” and I get to be the human doing fundamental analysis. We have an enjoyable discussion every week, including four or five specific ideas that we are buying. This week Holmes likes Amgen (AMGN). Check out the post for my own reaction, and more information about the trading models.

While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas have worked well so far. My hope is that it will be a good starting point for your own research. Holmes may exit a position at any time. If you want more information about the exits, just sign up via holmes at newarc dot com. You will get an email update whenever we sell an announced position.

Some Merrill Lynch top picks for 2017 (via 24/7 Wall Street).

Ben Levisohn (Barron’s) sees 23% upside for FedEx.

Interested in REITs? Try health care.

Get ready for Eddy Elfenbein’s new buy list. This annual event is a great source of ideas for investors who like to think in a time frame of at least a year. You can also join in the whole list via Eddy’s new ETF (CWS). It is both convenient and inexpensive.

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, you should join us in adding this to your daily reading. Every investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading. My personal favorite this week is the important article by Jonathan Clements on your personal risk-free rate. It is not the T-Bill or T-Note from financial analysis, but your own most costly loan. This may seem obvious, but many people fail to consider it in their financial calculations.

Seeking Alpha Editor Gil Weinreich’s Financial Advisors’ Daily Digest is a must-read for financial professionals. The topics are frequently important for active individual investors, so the series is worth following regularly. This week I especially liked the discussion of financial literacy. Even active investors are unable to answer basic questions. WTWA readers would get them all right, so it may seem very surprising.

Watch out for…

Bonds cratering while stocks rally. Eddy Elfenbein presents a telling chart.

Final Thoughts

 

My biggest reason for the 2010 Dow20K post was to alert investors to the idea of “upside risk.” There is always – always – a list of plausible worries. These dominate the news and the financial discussions. The other side is difficult. It is boring to say repeatedly that things are normal and promising. Talking about some new development seems smart – attracting viewers, page views, more gigs to make you famous, and even investors who seek confirmation.

The natural process leads to a focus on problems. These are easy to see, while solutions are not. Therefore, most investors do not understand the ill-named concept of the wall of worry.

The new list of worries, all well-known and reflected in current market prices, is a replacement for those listed on my current “investor fears” page, which replaced those from the 2010 era. It seems smart to study world events and use that knowledge to guide your investment decisions. But it is not!

You cannot make these calls as well as the market does. You are almost certain to over-react.

The investor mistakes I highlighted in 2010 are still with us:

  1. Excessive attention to headline events;
  2. Reliance on poor forecasts of the economy, especially recessions; (James Picerno has a great list of typical forecasts)
  3. Too much reliance on backward-looking earnings, reflective of unusual events and times.
  4. Ignoring the long-term economic forces putting idle assets to work. (Mark Hulbert on 24K)
  5. Emphasizing politics instead of investing. In 2008 many investors hated the prospects and principles of the Obama administration. They sat out the start, and never found an entry point.

It is more profitable to accept a measure of uncertainty, rely upon the best recession and earnings indicators, and remain agnostic about politics.

 

This is a good time to ask yourself about how have you done? If you are wondering whether you might do better with a financial advisor, check out my latest paper, The Top Twelve Investor Pitfalls – and How to Avoid Them. If you regularly navigate these problems, you can fly solo! That is true for 99% of my readers, whom I am trying to help. Some readers might well benefit from our help. Readers of WTWA can get a free copy by sending an email to info at newarc dot com. We will not share your address with anyone.

Weighing the Week Ahead: Are Stocks Ready for Stronger Economic News?

It is (ahem) a very big week for new data. The A-teams are back from their mini-vacations, ready to take a fresh look at the new world. While some will continue to work the Trump Administration/stock theme, it remains mostly guesswork. There is a new theme, which markets and pundits will get around to, perhaps as soon as this week. With a tone change on the economy and deficits, I expect the punditry to be asking:

Can the market embrace some good news?

Last Week

Once again, last week’s light calendar of economic news was nearly all good, but not the focus of discussion.

Theme Recap

In my last WTWA, I predicted special attention to the Trump stimulus plan and how it might be financed. Must of the week’s discussion was about possible cabinet appointments and the policy implications, but spending and taxation got plenty of attention. It was a s good a guess as any.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. He captures the continuing rally and the move to new highs.

Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis grounded in data and several more charts providing long-term perspective.

Personal Note

I am taking a few days off, so there will be no WTWA next week. I hope that the Stock Exchange group does not play hooky.

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 quite good. If I missed something for the “bad” list, please feel free to suggest it in the comments.

The Good

  • Rail traffic is improving reports Steven Hansen at GEI. The story is even better if you remove coal and grain.
  • Technical indicators are strong. Our own technical models remain strongly bullish. Noted technician John Murphy (via Charles Kirk) has this comment:

    “There is little doubt that the market’s trend is still higher. The fact that it’s being led higher by economically-sensitive stock groups like energy, materials, industrials, small caps, and transports is a sign of strength. The fact that tech stocks are starting to strengthen is also a positive sign.”

  • Chemical activity shows continuing strength. Calculated Risk monitors this indicator, which seems to lead industrial production.
  • Durable goods rebounded nicely to an increase of 4.8%.
  • Existing home sales were strong at 5.6M SAAR, beating expectations. Calculated Risk cautiously notes that the results do not reflect the recent higher mortgage rates.
  • Michigan sentiment beat expectations moving to 93.8. Doug Short has a comprehensive review.

The Bad

  • New home sales fell on an annualized basis. The decline included both multi and single-family residences. Calculated Risk offers perspective. Please compare the measured response here and above on existing home sales.
  • Mortgage rates moved above 4%. (MarketWatch).
  • Trucking is still declining, but the rate seems lower. Steven Hansen at GEI reviews the mixed picture.

 

The Ugly Beautiful

At some point, I need to do an update on last week’s “Fake News” ugly award. There is a good cyberspace discussion, but that can wait.

As I occasionally do, I want to focus on the positive for a change. Bill McBride of Calculated Risk had an encouraging Thanksgiving post, Five Economic Reasons to be Thankful. Read the whole post, but here is one that might surprise you – household debt levels.

 

 

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 Jon Krinsky of MKM Partners, with a big assist from Josh Brown. There is a consensus that countries are racing to debase currencies in “beggar thy neighbor” policies. The stronger dollar certainly reduces earnings for some companies, especially if they do not do any currency hedging. The flip-side gets no attention. Josh writes, There is zero evidence of a long-term correlation between stocks and the dollar. Take a look.


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 the data avalanche that we often see when the first two days of the new month are at the end of the week. This quirk of the calendar makes this the biggest week of the year for data.

The “A” List

  • Employment report (F). Expectations are a little lower for the data markets see as most important.
  • Consumer confidence (T). A good concurrent read on spending and employment.
  • ISM index (Th). Still modest growth in this widely-followed measure?
  • Auto sales (Th). Important sector, private data, and not a survey. What more could you want?
  • ADP private employment (W). Deserves more respect as an alternative to the “official” data.
  • Personal income and spending (W). Important economic growth indicator. Will strength continue?
  • Beige book (W). Provides descriptive color for FOMC participants, and occasionally some policy insight.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Construction spending (Th). Rebound expected in this important sector.
  • GDP second estimate (T). Somewhat “old news” but still the base for the ultimate measure of economic growth.
  • Chicago PMI (W). Most important of the regional surveys, with some predictive power for ISM.
  • Pending home sales (W). Less direct impact than new construction, but a good read on the housing market.
  • Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

For those who missed it during the holiday-shortened week, Fedspeak is back! We could also get big news out of the oil production talks between OPEC and non-OPEC members.

Next Week’s Theme

 

This will be a big week for news, and it might also be for stocks and bonds. For a long time, the market reaction has been entirely Fed-focused. If the economy looked better, the Fed would start raising rates. If it looked worse, the Fed was expected to help. Whatever the reason, the tone has now changed. Economic data have been better, and there is more optimism. There is growing acceptance of higher interest rates. The market seems untroubled (so far) by the rate move and the strength in the dollar.

While few remarked on the tone change last week, I expect it to get more attention in the week ahead, especially if economic data remains strong. It will leave us wondering – Can the market finally celebrate good news?

This is a multi-part theme prediction. We do not know that the data strength will continue. We do not know what the FedSpeak comments will be. And finally, we do not know how markets will react. We have a clue about how the political world will react (via Charles Kirk).

“I’m getting a real kick out of how so many Republicans have gone from bear to bull on US economy overnight and how many Democrats have done the opposite.”- Patrick Chovanec

This change will be reflected in comments from the punditry this week.

As usual, I’ll have a few ideas of my own in today’s “Final Thoughts”.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

The increased yield on the ten-year note has lowered the risk premium a bit. I suspect much more to come. By this I mean that the relative attractiveness of stocks and bonds will continue to narrow.

The 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.

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

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

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. His most recent research update suggests some “mixed signals” from labor markets.

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

Georg Vrba: The Business Cycle Indicator, (latest edition below) 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. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score.

Urban Camel at The Fat Pitch analyzes recession forecasts based upon the Presidential Cycle, a popular current theme. This is a great article. (A Silver Bullet candidate at least). Here is a key quote:

More to the point, there are better ways to forecast the next recession than counting months on a calendar or focusing on changes in the presidency. How?

By monitoring changes in the macro data. A persistent slow down in retail sales, housing consumption, employment growth and other macro indicators will likely be a better method for indicating when a recession is becoming more likely. This is the stuff that matters most; the calendar and presidential terms are demonstrably inadequate on their own. Our regular commentary on the macro environment can be found here.

This is very good advice to the recession worrywarts.

If (like me) you are a quant who is always hungry for more data, you will love FocusEconomics. You get a compendium of information from around the world, with cogent analysis. To take one example, here is their update on the Trump effects:

There are so many interesting topics that it is difficult to describe in one example.

 

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 six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

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

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

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and less risk.
  • Holmes and friends – the top artificial intelligence techniques in action.
  • Why it is a great time to own for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions on this subject. What scares you now?)

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar is fully invested in aggressive sectors. The more cautious Holmes also remains fully invested, but with continued profit-taking and position switching. The group did not meet on Thanksgiving Day, but you can expect reports to resume in this Thursday’s “Stock Exchange.” Out of the many Holmes picks this week, I can report one that seemed to capture a theme, Fomento Economico Mexicano SAB, (FMX). This Mexican holding company, trading via the ADR, includes several retail holdings. (Think Coke and Heineken). Holmes likes to play rebounds on a technical basis, so this is an interesting play on Trump policy from a source who knows nothing about the election or the news. (We report exits from announced Holmes positions if you ask to be on that list. Write to holmes at newarc dot com).

Top Trading Advice

 

Brett Steenbarger keeps on bringing it, day after day. His posts are a must-read for traders, but often have broader scope. If you are trying to perform well at anything, Dr. Brett can help you. My favorite piece this week was about a movie featuring young drummers. It is often helpful to go outside of your own world, take an objective perspective, and then look for the lessons.

Adam H. Grimes has a good explanation of how to calculate volatility in Excel. I find that most people consistently over-estimate volatility, perhaps goaded by the CNBC reports of “triple digit moves” and a 50-point bounce since the lows. These are both basically meaningless unless you are trading a very large short-term position.

Bill Luby discusses common misperceptions about the VIX. This is a great example of those who need to use Adam Grimes’ spreadsheet!

You can always tell when the crowd gets long the VIX and ends up on the wrong side of the trade.  “The VIX is broken!” becomes an oft-repeated refrain, as does “The markets are rigged!” and the usual list of exhortations from those who are in denial.  The current line of thinking is that the world must be much more dangerous, risky and uncertain as a result of a Trump victory, yet the VIX is actually down 31.4% since the election – ipso facto the VIX is broken.

The VIX is a market measure, not something readily rigged. If you disagree, you are simply on the wrong side of the market.

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Michael Batnick’s post, This is Not Bearish. The question is the new all-time highs in stocks. I know from experience that the average investor sees this as some sort of warning. Instead of interpreting prices in context, they see a chart or a range and expect mean reversion.

Michael looks at data since 1928. How many new market highs do you suppose have been made since then? How many this year? The answers are 1134 and 11. I suspect that few would come close in their guesses. 18% of all months have closed at all-time highs. Here is what happens after a new high:

The time after a new high is nothing special – and nothing to worry about.

This post was frequently cited, but I enjoyed the color provided by Brian Gilmartin. His story about how a Chicago TV producer uses psychological tests to find the most stressful stories is priceless!

Stock Ideas

 

Brian Gilmartin has a mixed take on health care (seems right to me). Policy is changing. Defensive stocks are in question. More aggressive picks might do well. Check out his objective, earnings-based take for some ideas.

Tiernan Ray (Barron’s) has a helpful article on deal stocks. While value investors always look for cheap stocks, these are also often good takeover targets. It is helpful to keep an eye on the candidates.

Mexico a screaming buy? MarketWatch analyzes the trade rhetoric and prospects. (And note Holmes above).

Freeport McMoran? (FCX). Stone Fox Capital analyzes the relationship between copper prices and the stock price. Not much of a boost is needed, and the copper market has been strong.

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, you should join us in adding this to your daily reading. Every investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading. My personal favorite this week is Jonathan Clements’ piece on the two financial numbers you need to know. Hint: You might have a clue about this, but are probably measuring incorrectly.

Seeking Alpha Editor Gil Weinreich’s Financial Advisors’ Daily Digest is a must-read for financial professionals. The topics are frequently important for active individual investors. I especially liked this post on dividends. Why do so many insist on regular cash payments?

Gil nails it with his answer – the security of regular payments.

If you are wondering whether you might do better with a financial advisor, check out my latest paper, The Top Twelve Investor Pitfalls – and How to Avoid Them. If you regularly navigate these problems, you can fly solo. Readers of WTWA can get a free copy by sending an email to info at newarc dot com. We will not share your address with anyone.

Market Outlook

Eddy Elfenbein provides several interesting facts about the economy, helping us all to keep perspective. You will enjoy the mixture of surprises and items you might guess. Did you know that nearly half of mutual fund managers do not own their own fund?

Eddy’s ETF (CWS), based upon his successful annual list, is getting a lot of deserved attention. It is off to a good start.

Bill Kort reviews the most recent predictions of the end of the world.

Value Investing

The rebound of the value approach continues. Dana Lyons provides the most recent evidence.

Watch out for…

The bond market. The Brooklyn Investor compares bonds and stocks over a long period. The analysis reveals the shortcoming in measures like the Shiller P/E, which consider neither interest rates nor inflation. There are many helpful charts, but here are some examples.

I am always baffled at comments like, “The market has averaged a P/E ratio of 14x for the last 100 years so the stock market is 40% overvalued at 20x…”.

How can you compare 14x P/E to the current level without discussing interest rates?  And if you think stocks should trade at 14x P/E today, then you should also think that interest rates should be much higher than they are now. For example, the 10-year bond rate averaged 4.6% since 1871 and 5.8% since 1950. But these periods include a time when interest rates were not set by the market.

And also this:

 

1955-2014:

            Interest rate range           average P/E

                   4 – 6%                             23.3x
6 – 8%                             19.6x

I looked at the data from 1955-2014 (adding one more year to update this isn’t going to change much) to see what the average P/E ratios were when interest rates were in certain ranges.

From the above, we see that the market traded at an average P/E of 23.3x when interest rates were between 4% and 6%.  The 10-year now is at 2.3%. So we have a long, long way to go for interest rates to threaten the stock market, at least in terms of the bond-yield/earnings-yield model.

Final Thoughts

 

If you want to analyze a change, you need to know when it starts. Here is part of an example from my causal modeling classes.

When does change start?

  • When the new Captain orders a change in course?
  • When the crew knows the new Captain will order a change?
  • When the crew knows the new Captain, but not whether he will order a change?
  • When the crew knows there will be new Captain who might order a change?
  • When the crew knows there might be a new Captain?

I am sure you get the idea. The methods that track the market under various Presidents have many problems, but the starting and ending points are especially important. There are no new Trump policies. We are all still guessing about what they might be.

And yet – there has been a definite change in tone. Economic strength has a lot to do with confidence – the willingness to invest and to spend. A divided government had many dysfunctional consequences, especially repeated issues about the debt limit and spending on crucial programs. We can expect less of that. There will also be a very different reaction to economic data; the political rhetoric that blinded investors will be reduced.

The generalized Fed theory will have less traction. Those who have been wrong about the market for years have used the Fed as a fig leaf. With interest rates rising and the economy improving, that story must change.

The emphasis on commodity prices as an economic indicator, most prominently by the ECRI, is also proving wrong, as is the impact of a stronger dollar.

This is not an endorsement of specific Trump policies. It is the reality of moving out of the election environment – at least for a year or so! This week’s data avalanche could be the first real test of this new attitude.

Stock Exchange: Spotting a Great Chart

Technical analysts dominate the daily discussion of stocks. Fundamental concepts change slowly. Chart patterns change constantly. Usually the calls are dramatic, because no one cares about advice that says, “all is well, keep holding.”

Traders live on stock charts, but investors also pay close attention. Everyone wants to know whether a stock is breaking down, breaking out, or stuck in a trading range. Here is the key question:

How do you spot a good chart?

We have several great charts this week. The Stock Exchange provides an expert-level debate on technical and fundamental analysis. (Important background is available here). Comments, dissent, and specific stock questions are welcome!

This Week—Is Felix right about KHC?

One issue with charts is the wide difference in interpretation. Do analysts see what they want to see? Are the interpretive criteria constant and objective? This week (without telling him) I searched for other opinions on one of our expert selections, Felix’s choice of KHC. The same principles would apply to all the picks, but this is a convenient example. Before turning to Felix, let’s look at other approaches.

This one provides a complex chart and plenty of additional points of interest. It makes a lot of specific predictions, suggesting many trades with moves of less than one point.

 

Here is another, one-year term and 50-day MA. This is a much longer time frame with an implied criterion reflecting that.

And a dramatically different time frame from the same source. Instead of a 50-day MA, we now have two hours.

And one more site, which invites predictions. I am not sure what conclusion you would reach, but the participants have many different conclusions.

The key point of this comparison is the widely differing images and viewpoints. The time frame matters, and so does added complexity.

Let’s see what Felix has to say, and also check out my own conclusion to this article.

Felix

I look for long-term themes, and I have a great one this week. I have a pick without an army: KHC. It is my lone soldier of the week, a strong company. The recent selloffs provide a good point of entry with the rebounds already underway. This should be good for another 5 points.

I’ve had a question this week from A Dash of Insight:

Question from Fred Barone:
Any opinion on CVI thank you

 

Felix: This is a stock I won’t be holding for a while; it has been going downhill since 2013. There hasn’t been much upside. On the other hand, it does rank in the top 25% of my universe, so it is not terrible. I would take a guess that you have been holding this for a while?

[F] Please keep your questions coming. I could use the overtime pay. And by the way, Jeff. Are we working next Thursday?

[J] Next Thursday the market is closed and we are all taking a day off to give thanks and spend time with family.

[F] I don’t have a family and I could use the overtime bonus.

 

Athena

I hope I’m not too late to the party on this one. Teck Resources Ltd (TCK) has been on a solid rise since March. We’ve had the stock price quadruple since then, which is remarkable to say the least. While I don’t expect to cash in on that kind of return in the next few weeks, there is still a tidy profit to be had here.

[J] This pick is not completely hopeless. The company has some earnings. There is plenty of fluctuation but excellent growth expectations. This might work.

[A] The market is sending a message that it will work. I listen, Jeff, and so should you!

Oscar

While I focus on sectors, sometimes ideas get as narrow as a single country ETF. My regular sports channels had a brief blurb about some guy named Abe meeting with Trump. Some of my sources suggested that I should check out the WisdomTree Japan Hedged Equity ETF (DXJ) this week. Much like Japan’s national sport, sumo wrestling, this pick is all about momentum off the bottom.

[J] So you are telling us that you have been following the visit of Japanese Prime Minister Abe? The first foreign leader to meet with President-Elect Trump?

[O] Not exactly “following.” It was on my Facebook news feed.

[J] Why did you choose the Wisdom Tree ETF, which is adjusted for currency variation?

[O] Variation?

[J] Yen for each dollar.

[O] I’m not sure, but on my last visit, dollars were welcome.

Holmes

This week I’m picking DXCM, DexCom a specialty health stock. After a sharp decline on November 1st, this stock has proceeded to consolidate and slowly climb back up from a low of 61.00. I will put in a stop at 62.50.I bought this stock at 70.96, looking for a nice rebound to low 80s or even higher. If we start to rally, I’ll be moving up my stop aggressively. My major concern is that move is based on perceived changes in medical policies from Washington, vs. improvement in the outlook of this company. I’ll be very tight on the trigger if the stock starts to drift lower day after day.

[J] Do you understand that his company has no earnings, no dividend, and no real prospects for the next two years?

 

[H] How have I been doing?

[J] Your picks have been profitable. I also like your frequent decisions to take profits and move on. You are not overstaying your welcome.

[H] That is a very honest. I like that in a human. Next you must learn to be more intuitive. Sometimes stocks rebound before the fundamentals confirm. I often spot such cases.

[J] Are you really considering policy changes from Washington?

[H] Of course not. The price and volume reflect that information!

 

Background on the Stock Exchange

Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am the only human present, and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities. Each week features a different expert or stock.

 

Questions

If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a specialty. Who is your favorite? (You can choose me, although my feelings will not be hurt very much if you prefer one of the models).

Conclusion

 

My first job in the investment business involved a wide variety of research tasks. My boss, a clever fellow, became suspicious of conclusions from our technical analyst. He asked me to create some stock charts with the data inverted. He presented one group to our analyst, and got a verdict of bullish on all fronts. A bit later he presented the same charts, with the pattern inverted. As he suspected, those were also deemed to be bullish!

Technical analysis is interesting, but usually lacks rigorous testing. In today’s example, I do not know precisely why Felix likes KHC, but here are three ideas:

  1. The stock chart is like those I have seen before — descent from a prior high, a new base, and often an uptick.
  2. Some might see this as a “cup-and-handle” but not all such patterns qualify for Felix.]
  3. When we get a pick, it represents thousands of similar training cases, and hundreds of test cases. It is not just an idea with an argument, but a scientific conclusion.

You cannot identify a “good chart” unless you have many, many comparisons.

Stock Exchange: Is Technical Analysis Effective Post-Election?

A truly disruptive event generates surprisingly large moves – sectors, stocks, and sometimes the overall market. Methods that work well in normal times may break down under this stress. Traders and investors must ask:

  • Is my system still working?
  • Should I adjust?
  • Should I suspend operations for a time?

When trading based upon scientifically developed models, these questions are somewhat easier to answer. We have solid expectations for behavior and performance, because of extensive testing on a generous helping of out-of-sample data. Most importantly, the human managers know and understand the model inputs.

We have great respect for our group of models, but we retain human control. This week, for example, Oscar liked our solar sector. We knew something that Oscar didn’t – the likely effect of Trump policy on solar stocks. What appeared to be a buying opportunity, might be an illusion. The trade might still work, but there are other, safer choices that are nearly as good.

Technical analysts can always be tempted by confirmation bias and their knowledge of events. When using models, you very sparingly use exceptions. If you view every trade as a suggestion, you wind up doing your own trading, with your model advice used only for (biased) confirmation.

The Stock Exchange provides an expert-level debate on technical and fundamental analysis. I have placed more background at the end of the article. Comments, dissent, and specific stock questions are welcome!

This Week—Athena Loves Amgen

This week’s featured expert is Athena. Vince (our modeling guru) designed Athena to be very aggressive in finding new positions, but swift to exit those that were not working. These are not “stops” as we normally think of them. Exits are not based upon specific downside limits. Instead, there is an increased risk warning (IRW) that signals a change of behavior in how the stock is trading. The result is exceptionally good risk control both for individual positions and the overall portfolio. While we have not told the other models, Athena is Vince’s favorite.

Here are the ideas for this week, beginning with Athena, our featured expert.

Athena

I love to make a quick buck finding trends. An insider secret: There’s nothing trendier than the baseless speculation following a big election. My pick this week is AMGN, one of many biotech stocks rocketing skyward since this week’s big news. It’s still attractive at this price, but I’ll dump it in a heartbeat, maybe by Inauguration Day.

[J] You actually know about the election?

[A] Yes, but don’t tell the other models. They already resent my wisdom. I do not use fundamental information, but I am aware of it.

[J] This choice does seem logical on an earnings basis, as you can see from this chart. The stock trades at a discount and has a nice 2.7% dividend yield as well.

[A] It is nice to see that you finally agree with me on a choice. My other picks have also done well.

Felix

I look for long-term themes. Oil and gas stocks have been a very long-term holding. We are picking up and I still am adding to the sector. I am going to pick ECR as the example this week. This is a fairly small company with modest revenue but the chart reflects that of the big boys. That is a good sign and something that I like immensely.

[J] You have been early (a euphemism for “wrong” on energy and mining).

[F] I sold some miners, as I will do when necessary. The energy investments will prove out in the long run.

[J] I have suggested a ceiling on energy prices in the low 50’s, mostly due to more supply returning.

[F] That is a short-sighted, I mean short-term viewpoint. You will see.

Questions for Felix

From Seeking Alpha

 Tiki Bar Capital comments:

Great call on healthcare, Jeff! And BMRN in particular.

The biotech sector is close to retesting its lows. Biotech and pharma in general seem like the sectors that will see the biggest rallies once the smoke clears after the election.

1234gel joins in:

Ditto the BMRN call…

[F] Those were not comments for me—or for you. BMRN was an Oscar pick.

From A Dash

Phil

Comments on my two favorites- AAPL & BRK/B?

[F] AAPL is a weak buy and BRK/A as about neutral.

[J] I like AAPL a lot.

[F] This is my question section. I need more of them since I am saving up for Spring Break.

[J] It is only November…

[F] With what you are paying me for each answer, that is how long it will take for a nice trip.

Oscar

Basketball season is back in full swing, which means I’m looking for a rebound. My favorite sector this week is Diversified REITs, demonstrated here by CMO. This area was already looking up at the beginning of October, and now we’re seeing gains as a part of the broad based post-election rally. Grab the rebound, make an easy layup, and move on to the next play.

[J] I thought that Holmes was our rebound specialist.

[O] Sometimes the dog and I agree.

[J] This one has fundamental appeal as well. The dividend of 9.5% is great. The PE is 12.3, above the average level of the last nine years, 7.9. What will happen as interest rates rise? Chuck Carnevale’s excellent tools help us out on that question. This chart shows the P/E versus interest rates over the last nine years.

Holmes

This week I’m picking TSCO, Tractor Supply a specialty consumer cyclical stock. After a sharp decline in September, this stock has proceeded to consolidate and backfill making a low of 61.62 on October 28th. This is a logical place for a stop. I bought this stock a few days ago at 65.91 so it is slightly higher now. I am looking for a nice rebound to low 80s. If we start to rally, I’ll be moving up my stop aggressively. Risking $4.30 to make $15.00 is the sort of Risk/Reward scenario I like. If I’m right just half the time, I can still be a big winner.

[J] There are plenty of these stores around here. It is not just tractors. Think clothing, footwear, hunting supplies, garden, parts, and more. If they do not have it, you probably do not need it. The costal elites do not understand this.

[H] As I told you last week, you only need to track the information from technical data.

[J] You were right about BMRN.

[H] As I told you last week, and I quote “The stock prices tell you everything you need to know about upcoming events, including this election. If a Clinton victory is expected and is negative for health care, that is already reflected in the stock price. My trade works if this sentiment is overdone, and it works big if Mr. Trump wins.”

[J] You were right.

[H] My YTD results are also great.

[J] It is unseemly to boast. See how you can do in the poker game!

 

Background on the Stock Exchange

Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am the only human present, and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities. Each week features a different expert.

What is this about? Since launching this series I have had good questions on three general themes. Here are the questions and some brief answers.

  1. The model characters are fun, but please tell me more about what they do.

    I include the general personality of the model at the end of each article. I will begin featuring one approach each week with more detail, and soon provide a reference page for readers.

  2. Why don’t you show a track record on performance?

    I understand that those trying to sell a newsletter or chat room often provide some sort of time-stamped real-time record. You will find that most of these people are not subject to compliance rules. The “track records” tell you nothing, since they do not have enough trades to get into the “long run.” Confidence in a model comes from knowing how it is developed and tested. I would rather ask a few questions to a developer than see a few months of real-time picks. It is easy to spot the amateurs.

  3. Why should I care about these model picks?

    You probably read many articles with stock ideas. Some are a single idea based upon technical analysis from a source you do not know about. At the Stock Exchange, you get four different recommendations from technical “experts” as well as some fundamental commentary as a rebuttal. I am not trying to sell anything. We are developing an institutional product. The results are good enough that I am willing to share and discuss with readers. Some of my clients are invested in these models, so I am not going to provide every trade in real time. It is supposed to be interesting and fun! Look at the ideas and do your own research.

 

Questions

If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a specialty. Who is your favorite? (You can choose me, although my feelings will not be hurt very much if you prefer one of the models).

Cast of Characters

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not usually announce new picks, but he will answer questions, saying what he thinks about specific stocks. He will also comment on favorite themes and sectors.

Oscar is naturally optimistic and a bit excitable. He likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. While he does not know the definition of “mean reversion” he loves rebounds! There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

Athena trades more frequently than the others, but still limits risk. Her inspiration helps to find good ideas. Her excellent quant skills find attractive risk/reward opportunities. Her wisdom leads her to exit trades that are not working. Athena will provide a new idea each week.

Jeff usually has some comments about stock or market fundamentals. Unlike the other witty participants, he sounds like an old prof.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned.

And finally, you can learn about the eternal debate between technical analysts and those using fundamentals.

Post Election: Pause, Reflect, and Act Carefully

Take a deep breath. Or maybe two.

The biggest trap for investors during an aggressive political campaign? Allowing the political narrative to become the foundation for your portfolio decisions. I have frequently advocated that investors should be “politically agnostic,” willing to make sound investments regardless of who is in power. This is always easier said than done, particularly in an environment of extreme claims.

Acting emotionally and without sufficient thought is usually a costly mistake. Those who sold all stocks when President Obama was elected missed a huge rally. Those who sold futures contracts on the breaking news last night also have big losses this morning. Here are some key points:

  1. Do not go “all in” if you supported Mr. Trump or “all out” if you backed Sec. Clinton. We have a resilient economy and a political system with many ways of resisting extreme actions.
  2. Things will change less than most people expect. Many proposals that sounded attractive on the campaign stump will prove impractical. The responsibility of governing also has an important effect on every new President. There will not, for example, be a recession just because of the election.
  3. The trading reaction is swift and large, but often overdone. I see price weakness in nearly every company that Mr. Trump criticized during the campaign. Does this make sense? Every aspect of the Trump agenda is reflected in this morning’s trading: Hospitals and technology down. Companies with strong links to Mexico down. Drug stocks higher. Interest rates higher. Banks higher. Construction stocks higher. The general ideas sound reasonable, but there is a great distance between concept and achievement.
  4. There will be new opportunities. Careful analysis will provide a better idea of where policy change is likely. Stock picking and sector picking will be more important than in recent years.

I wanted to provide some of the important considerations right away, but there is plenty of work to be done. If you focus on objective analysis, you too can find profitable investments no matter who is in power.

Weighing the Week Ahead: Time for Some Clarity?

We have a light week for data, but plenty of other big news. Earnings season continues. There will be plenty of FedSpeak, and most importantly the results of the U.S. elections. I everyone to be asking:

Will the election results provide clarity for financial markets?

Personal Note

 

I enjoyed my Wisconsin weekend away with Mrs. OldProf, who is completely sick of election stories. Especially after seeing a few ads in a battleground state! She will probably will not read this week’s edition, focusing instead on her Packer-laden fantasy football entry and tomorrow’s game.

I know that some readers will not like my conclusions this week. Please read them as investment advice, not voting advice.

Thanks also to readers for the interest and early comments for my latest paper, The Top Twelve Investor Pitfalls – and How to Avoid Them. Readers of WTWA can get a copy by sending an email to info at newarc dot com. We will not share your address with anyone.

Last Week

Last week’s economic news was all good, despite the modest negative reaction in stocks. The election story is the culprit.

Theme Recap

In my last WTWA (two weeks ago), I predicted a focus on the trading range, and whether it would soon be broken. Breaking election news attracted most of the attention with earnings playing a secondary role. Since then, we have experienced a 40-year flood, so to speak. The nine consecutive days of market declines are the most for 36 years. And still counting. Whether the range has been broken remains open to question, but I was wrong about the key theme.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. Some sources said the market was in the “grip of the worst decline since the financial crisis.” Doug notes that the nine days of decline amounted only to 3.09%. By comparison, the nine-day streak from 36 years ago represented 9.37%. Even single-day declines can be more than this, including the -3.59% on June 24th of this year. Doug’s analysis helps to put the recent trading in perspective.

Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis grounded in data and several more charts providing long-term perspective.

 

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!

The Good

  • Personal income and spending were up 0.3% and 0.5% respectively. These results were better than the prior month, and in line with expectations.
  • ISM manufacturing index registered 51.9 beating the prior month and most expectations. This is roughly consistent with recent GDP readings.
  • GDP for Q3 increased 2.9%, the highest rate in two years. James Hamilton notes that this is still slightly below the long-term trend, but good enough to reduce the recession odds of his model to 12.3%.

Some skeptics have claimed that the good report is “full of beans” in the words of Dr. Ed Yardeni. While the one-time effect of soybean imports was important, he cites several other factors that suggest future strength.

  • Earnings strength continues. Despite the importance of this story, it has not gotten much attention. The earnings recession is over, as I concluded from our first-rate sources a few weeks ago. FactSet has some key points in their update:
    • 71% of S&P 500 companies have reported earnings above the mean estimate and 54% of S&P 500 companies have reported sales above the mean estimate.
    • For Q3 2016, the blended earnings growth rate for the S&P 500 is 2.7%. If the index reports growth in earnings for the quarter, it will mark the first time the index has seen year-over-year growth in earnings since Q1 2015 (0.5%).
  • Corporate narrative agrees. Avondale Asset Management tracks hundreds of earnings calls. Their helpful summary includes quotations from the calls, organized into topics. Here is the encouraging list of topic headings for the U.S. macro section. There is supporting evidence for each of the points below.

 

The environment has stayed slow and steady

The economy is fully healed even if it’s not setting new records

Conditions are still pretty difficult for industrial companies, but turning up

Still, there’s a pervasive sense of uncertainty

CEOs are waiting to see what happens in the election

Companies are setting strategic plans that assume weakness

The consumer has been slowing

But energy and currency are moving from a headwind to a tailwind

Inventories are much leaner than they have been

And pricing pressures are building

 

  • Employment
    • Non-farm payrolls increased by 161,000 and the prior month was revised upward by 35,000.
    • ADP private employment growth was 147K, 23,000 less than expected, but the prior month was revised up by 48,000.
    • Unemployment decreased slightly to 4.9%.
    • Hourly earnings increased 2.8% on a year-over-year basis –
    • One slight negative was initial jobless claims edging higher by 7000, but still historically low at 265K.

 

The Bad

  • ISM non manufacturing registered at 54.8, down from 57.1 in September and missing expectations. Calculated Risk has the story, highlighting a comment in the report about the effect of uncertainty from the Presidential election.

The Ugly

The last days of a very personal and negative election campaign. Scott Grannis called for a “mulligan.” (For non-golfers, a complete do-over). I would probably just slice another drive into the rough! If you want to change outcomes, you must be willing to reform the process and go to work on your swing. In such a long election season, campaign managers finally resort to techniques that are proven to influence the undecided and the faithful. You and I might be turned off, but we are not the target market.

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 winner is Bill McBride of Calculated Risk. Debunking recession calls is not popular. It is not the way to get page views. Please read Bill’s entire post to see the full story about the endless parade of recession calls. Here are some of the key points:

Note: I’ve made one recession call since starting this blog.  One of my predictions for 2007 was a recession would start as a result of the housing bust (made it by one month – the recession started in December 2007).  That prediction was out of the consensus for 2007 and, at the time, ECRI was saying a “recession is no longer a serious concern”.  Ouch.

For the last 6+ years [now 7+ years], there have been an endless parade of incorrect recession calls. The most reported was probably the multiple recession calls from ECRI in 2011 and 2012.

In May of [2015], ECRI finally acknowledged their incorrect call, and here is their admission : The Greater Moderation

In line with the old adage, “never say never,” [ECRI’s] September 2011 U.S. recession forecast did turn out to be a false alarm.

I disagreed with that call in 2011; I wasn’t even on recession watch!

And here is another call [last December] via CNBC: US economy recession odds ’65 percent’: Investor

Raoul Pal, the publisher of The Global Macro Investor, reiterated his bearishness … “The economic situation is deteriorating fast.” … [The ISM report] “is showing that the U.S. economy is almost at stall speed now,” Pal said. “It gives us a 65 percent chance of a recession in the U.S..

The manufacturing sector has been weak, and contracted in the US in November due to a combination of weakness in the oil sector, the strong dollar and some global weakness.  But this doesn’t mean the US will enter a recession.

The last time the index contracted was in 2012 (no recession), and has shown contraction a number of times outside of a recession.

Bill cites this chart:

Bob Dieli also made both of those calls in real time, as he has been doing for a few decades. His work goes mostly to private clients. It helps all of us to monitor objective sources like this. They benefit only from being right.

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 light week for economic data, but some important earnings reports for retail stocks. I watch everything on the calendar, so you do not need to! Check out WTWA to focus on what is important – and ignore the noise.

The “A” List

  • JOLTs report (M). Few understand, but the main use is labor market structure.
  • Michigan Sentiment (F). Has been weaker than the Conference Board version. An important indicator.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Wholesale inventories (W). Volatile and challenging to interpret. Rebound expected.
  • Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

More important than the economic data will be continuing earnings news. We also have almost daily Fedspeak and plenty of international events and speeches. And most important of all – the election.

Next Week’s Theme

 

With increasing uncertainty about the election outcome and resulting policies, markets pushed the trading range lower over the last two weeks. Eddy Elfenbein describes this as an extended period of small lower moves. Each of the daily declines has been less than 0.7%. During the same period, the economy has been showing signs of acceleration. Eddy provides a helpful chart:

Earnings have also been solid in the face of the longest market losing streak in 36 years.

I expect discussion of the election and the implications of the results to be the key market question:

Will we finally get some clarity?

The possible election results are not binary. There is a wide range of possible outcomes, listed below from bearish to bullish. Please note that I am not opining about who I want to win or how you should vote. I am reporting how the market will probably react under differing circumstances, with some references for you to start your own research.

  • No clear result. We might think it’s over when it’s over, but that might not be the case. (Robert Schroeder, MarketWatch)
    • Some states might require recounts, either automatic by state law or after a challenge.
    • A third-party candidate might win the electoral votes of one state in a close split between the major parties. That is the explicit objective of candidate Evan McMullin.
    • Trump and /or supporters might challenge the outcome, possibly with some legal basis. Most people will remember the Bush/Gore controversy and the infamous “hanging chads.”
    • The Supreme Court decided that dispute, splitting along partisan lines. Right now, that would be a 4-4 vote, placing emphasis on how states and lower courts decided.
  • A Trump victory. Estimates are that the market would decline by 5-7%, mostly because of increased uncertainty. Many market participants believe that Trump economic and regulatory policies would be market-friendly. (CNBC)
  • A Democratic sweep with a majority in both houses of Congress. The perception, possibly not accurate, is that this would allow a much more aggressive legislative agenda. This is probably not accurate because of the filibuster potential in the Senate. Cloture currently requires 60 (out of 100) votes. This serves to block nearly everything that does not have solid overall support. Making it more complicated is the idea of the “nuclear option” where the cloture requirement would be reduced. (Barbara Kollmeyer, MarketWatch)
  • Divided control — a Clinton Presidential victory with Republicans maintaining control of one or both houses of Congress. Markets have generally liked a deadlocked government. (Allianz)

Which of these will happen? Join in the comments with your thoughts about the election implications. As always, I’ll have a few ideas of my own in the conclusion.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

 

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.

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

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

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

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. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score.

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.

 

How to Use WTWA (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 six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

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

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

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and less risk.
  • Holmes and friends – the top artificial intelligence techniques in action.
  • Why it is a great time to own for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions on this subject. What scares you?)

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar holds several aggressive sectors. The more cautious Holmes also remains fully invested. They now have a regular Thursday night discussion, which they call the “Stock Exchange.” This week the gang came up with some contrarian, pre-election ideas. You can see the best technical analysis – and you can ask questions!

Top Trading Advice

 

Brett Steenbarger cites that noted trading guru, Bruce Lee, to illustrate our need to be flexible in trading.

In another post he emphasizes the need to ask the right questions. As he often does, this is a good technique for other life missions, not just trading. He uses an excellent specific example of VIX trading.

Options expert Bill Luby sheds some light on VIX trading, a widely misunderstood topic. He explains the difference between “median reversion” and using five-year moving averages. I doubt that most have event considered this significance.

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Ben Carlson’s post, Don’t Be Afraid of All-Time Highs in the Stock Market. This is a concern that you see often, because many people equate a high level of the index with “expensive.” It is also true that declines begin from a peak. Forgotten in this is that most peaks lead to new peaks! Here is a key table:

And a key quotation:

Here’s also another way to think about this — since nearly 7% of all days since 1950 have been an all-time high that means that more than 93% of the time the stock market is in a drawdown state from a previous peak. So 9 times out of 10 you are going to be beating yourself up for not selling at the previous high. This is what makes the markets so interesting and excruciating all at the same time. Most of the time you’re in a state of regret.

Stock Ideas

 

Many people are mystified by the PEG ratio. Chuck Carnevale does a deep dive on the derivation and provides examples to show when and how it should be applied. If you invest in growth stocks, this is a must-read article with many ideas.

Brian Gilmartin draws upon the changes in earnings estimates to highlight attractive sectors for Q416. This is extremely helpful work, and worth a close read. Hint: Technology and Financials.

Is health care a sector to avoid or to embrace? Eddy Elfenbein comments on the decline in the group since July, 2015.

Our trading model, Holmes, has joined our other models in a weekly market discussion. Each one has a different “personality” and I get to be the human doing fundamental analysis. We have an enjoyable discussion every week, with four or five specific ideas that we are also buying. This week Holmes likes Biomarin (NKE). Check out the post, Stock Exchange: Contrarian Pre-Election Trade Ideas in Chips, Biotech, Trucking, and Energy, for my own reaction, and more information about the Holmes method.

While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas have worked well so far. My hope is that it will be a good starting point for your own research. Holmes may exit a position at any time. If you want more information about the exits, just sign up via holmes at newarc dot com. You will get an email update whenever we sell an announced position.

How about housing? Barry Ritholtz has a great post highlighting the big best on housing by one of those who called the decline and has now switched sides, fund manager Donald Mullen. The entire post is worth reading, but here is the key argument:

Given how wary some people are of homeownership, why should we be thinking about demand strengthening? Here are a few possibilities:

  • Millennials seem to be moving out of their parents’ basements, and forming households;
  • Mortgage rates are starting to rise, and the potential for further rate increases could lead potential buyers to getting off the fence;
  • Low equity constrains inventory; that drives up rental demand as well as prices;
  • The economy continues to recover and even expand;
  • Unemployment has been about 5 percent for about a year, and wage increases are finally beginning.

All of these add up to an increase in the number of households, including renters — many of whom go on to become buyers.

This is also what we see from the Calculated Risk reporting on home prices, consistently higher but with room to run.

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, you should join us in adding this to your daily reading. Every investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading. My personal favorite this week is the story about how even math teachers cannot understand 403-b annuities. Tara Siegel Bernard explains in the NYT. I have a lot of experience with people who come to me, seeking to escape something that sounded great at the time. The products are fine for some people, but because of high commissions are sold to many more. Anyone considering an annuity needs some advice ahead of time.

Another good piece is the Barron’s Next article on excessive concentration in stock of your own company. I have seen millionaires lose everything that way.

Seeking Alpha Editor Gil Weinreich’s market is the community of financial advisors, but it also attracts spirited comments from investors. I especially enjoyed this post featuring retired RIA Jim Sloan. The topic is one I rarely cover in WTWA – spending. I focus on clients’ investment plans; these must match their spending needs. Sometimes it is better to find a few economies than to take excessive risk.

Morgan Housel pulls together some themes that are among my favorites. It is a good explanation of why even the smartest individual investors go wrong. Hint: You are good enough to explain why it is not working and toward complex solutions.

Watch out for…

Facebook? Marc Gerstein provides an interesting and balanced analysis, driven by his quantitative methods.

Final Thoughts

 

The election outcomes that the market sees as most distressing are extremely unlikely. The best sources I follow suggest a Clinton victory, a toss-up in the Senate, and the GOP retaining the House. These are not partisan pollsters, but those who benefit only from accurate interpretation of data. Here are the key sources and a starting link. The message changes with new information, as we would expect. Barring any fresh news, the outcome has a high probability.

Larry J. Sabato of the University of Virginia Center for Politics.

Nate Silver, a numbers guru with respect from the Political Science community.

Sam Wang and the Princeton Election Consortium. Their method of median-based probability estimation is interesting and plausible.

The resulting gridlock will be perceived as positive. That will be true only if our leaders learn to compromise. There are decisions ahead that require action.

The first market reaction will be positive, if only because the worst cases were avoided and the uncertainty ended. Hedge fund managers who have lagged the market and are hoping to catch up via big short positions will need to cover. Based upon trader commentary and performance reports, this is a large group.

The second reaction will be sector and stock specific, and it will take time. Most of the financial punditry does not realize the limitations on Presidential power. I expect changes in drug pricing policies, for example, but not a sweep against an entire sector. The targets will be the most egregious excesses.

I understand that many people will disagree with these conclusions, despite my care in identifying sources. They will have theories about bad polls, hidden voters, and the like. I recommend reading this post. It is fine to keep cheering for your candidates until the last vote is tallied, but you do not have to lose money as well.

Stock Exchange: Contrarian Pre-Election Trade Ideas in Chips, Biotech, Trucking, and Energy

Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” Their methods are excellent, as you will learn if you join us for a few weeks. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am the only human present, and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities. Each week features a different expert.

I have placed more background at the end of the article. Comments, dissent, and specific stock questions are welcome!

This Week—Be Fussy with Felix

This week’s featured expert is Felix. Vince (our modeling guru) designed Felix to be an opportunistic, long-term trader with a time horizon of more than a year. This does not mean “buy-and-hold.” Felix is very fussy about new positions and aggressively drops those that are not working. Felix does not do much trading, so he can be a bit boring. To make up for that, Felix is our leader in answering reader questions. With nothing better to do, each week he generates a rating for every stock in the universe.

Here are the ideas for this week, beginning with Felix, our featured expert.

Felix

I look for long-term themes, and I have a great one this week. I am enjoying the long drive of tech. Let’s pick Micron Technology (MU) as an example. The chart looks like my heart monitor when Oscar comes home and makes himself a salami sandwich after I just cleaned up the kitchen. Sky-rocketing!! The ups and downs well make up the overall value of this one.

[J] This is yet another pick from you guys that is totally unsupported by earnings! Look at Chuck Carnevale’s basic chart for the stock.

[F] The earnings may be light this year—

[J] Try almost non-existent.

[F] But the market is forward-looking. You can see that expected earnings for 2017 are much better. That is just the start.

[J] 2017?

[F] Only professors focus on past earnings. Think ahead!

[Felix] I’ve had a question this week from A Dash of Insight:

Energy- have heard from others this sector is “emerging” i.e., getting stronger.  As such, how about XLE and OIH?
Seems to me that growth in this sector will depend on higher oil prices which I do not see coming unless OPEC makes and enforces an agreement to limit production (not likely, IMO).

[Felix] I have looked at XLE and OIH and they rate as middling on my scale. Energy has been low for so long that, yes, it is getting stronger. It is just at a very minimal level right now. OPEC is now finally making some changes (after years of sitting back). The effects might be a bit slower than we’d like, but there are a lot of changes now and in my opinion the future.

[J] Energy stocks are out of the danger range right now. Potential added production seems to provide a cap in the low 50’s for oil prices, but demand remains solid. These are probably reasonable long-term plays.

[F] I’m glad that you agree with me about something. Readers — please keep your questions coming. I get paid for each answer. Jeff makes Jack Benny look like a spendthrift and I need the money.

Oscar

I’ll be the first to admit I’m not a fan of tennis. All that jumping back and forth makes the game hard to follow – gives me a headache, really. At first glance, that might be what you see when you check the chart for Swift Transportation Co (SWFT), a member of my current favorite sector. I use my own sector baskets rather than ETFs, and trucking has a very high rating. Look to the individual stocks for some good ideas. SWFT is on a solid four-month upswing. I would be perfectly comfortable holding onto this one for another month or so.

[J] Why not ETFs?

[O] Intra-day pricing does not seem to reflect the underlying positions. I have a great basket with individually weighted members. I do not compete with the HFT models.

[J] That makes sense, but I expected you to have something inspired by the World Series.

[O] Have you ever seen the old Chicago stockyards? This business reflects the heartland, and the celebration is extending all over town. I am taking the day off tomorrow to attend the parade.

[J] You mean that you are skipping your regular day at Hawthorne? No sure things?

[O] I’ll call in if you need me.

Holmes

I am the rebound specialist. If you like to buy dips and sell rips, I’m your dog. I am also logical, deductive and careful. I cap my risk with stops setting up for good gains but small losses. This week I bought Biomarin Pharmaceutical (BMRN) closed today at 80.90. This stock is displaying a classic pattern of distribution and consolidation and it looks like it’s ready to move towards it 50d MA (86.60). If it gets there, I’d look for it to march even higher towards its 200d MA (91.50). I’ll keep this on a tight leash with 76.00 stop. These strategies don’t always work but the long-run risk/reward record is excellent.

[J] Didn’t you hear anything about the election? If Clinton wins, health care and biotech will get crushed.

[H] What election?

[J] What? No one in my team of models is discussing the Presidential election?

[H] The stock prices tell you everything you need to know about upcoming events, including this election. If a Clinton victory is expected and is negative for health care, that is already reflected in the stock price. My trade works if this sentiment is overdone, and it works big if Mr. Trump wins.

[J] I agree that the health care selloff is overdone, but we might not see improved pricing until February.

Athena

Usually I like to pick stocks that already have more momentum, but this is too good to pass up. HollyFrontier (HFC) looks to be bottoming out here, and I expect to ride this one out for a decent run. The clue here is a long solid base, providing attractive support. Most of my current positions are from April, and they are all doing well.

[J] The near-term earnings look very unattractive.

[A] As I try to teach you each week Jeff, you need to look farther into the future.

 

Background on the Stock Exchange

What is this about? Since launching this series I have had good questions on three general themes. Here are the questions and some brief answers.

  1. The model characters are fun, but please tell me more about what they do.

    I include the general personality of the model at the end of each article. I will begin featuring one approach each week with more detail, and soon provide a reference page for readers.

  2. Why don’t you show a track record on performance?

    I understand that those trying to sell a newsletter or chat room often provide some sort of time-stamped real-time record. You will find that most of these people are not subject to compliance rules. The “track records” tell you nothing, since they do not have enough trades to get into the “long run.” Confidence in a model comes from knowing how it is developed and tested. I would rather ask a few questions to a developer than see a few months of real-time picks. It is easy to spot the amateurs.

  3. Why should I care about these model picks?

    You probably read many articles with stock ideas. Some are a single idea based upon technical analysis from a source you do not know about. At the Stock Exchange, you get four different recommendations from technical “experts” as well as some fundamental commentary as a rebuttal. I am not trying to sell anything. We are developing an institutional product. The results are good enough that I am willing to share and discuss with readers. Some of my clients are invested in these models, so I am not going to provide every trade in real time. It is supposed to be interesting and fun! Look at the ideas and do your own research.

 

Questions

If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a specialty. Who is your favorite? (You can choose me, although my feelings will not be hurt very much if you prefer one of the models).

Cast of Characters

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not usually announce new picks, but he will answer questions, saying what he thinks about specific stocks. He will also comment on favorite themes and sectors.

Oscar is naturally optimistic and a bit excitable. He likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. While he does not know the definition of “mean reversion” he loves rebounds! There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

Athena trades more frequently than the others, but still limits risk. Her inspiration helps to find good ideas. Her excellent quant skills find attractive risk/reward opportunities. Her wisdom leads her to exit trades that are not working. Athena will provide a new idea each week.

Jeff usually has some comments about stock or market fundamentals. Unlike the other witty participants, he sounds like an old prof.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned.

And finally, you can learn about the eternal debate between technical analysts and those using fundamentals.

Weighing the Week Ahead: When Will the Trading Range Be Broken?

We have normal week for economic data, including the first estimate for Q3 GDP. There are also important earnings reports. Election stories have become even more intense. Meanwhile, the market has been pretty quiet. I expect financial media to be asking:

When will the trading range be broken?

Personal Notes

I will be traveling next week and probably will not write WTWA.

I have completed my new paper, The Top Twelve Investor Pitfalls – and How to Avoid Them. Readers of WTWA can get a copy by sending an email to info at newarc dot com. We will not share your email address with anyone.

Last Week

Last week’s news was pretty good, despite the modest reaction in stocks.

Theme Recap

In my last WTWA, I predicted more attention to the “stealth market rotation.” This idea got a little attention on Monday from the Pundit-in-Chief, but that was all. The rotation was less pronounced and the competing stories were good ones.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. Stocks had a slightly positive week, but the real story is the continuation of a very narrow trading range.

Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis grounded in data and several more charts providing long-term perspective.

The News

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

The Good

  • Building permits rose and beat expectations. But housing starts declined (see below). New Deal Democrat analyzes this contrast and the effect on his leading indicators.
  • Philly Fed also beat expectations.
  • Existing home sales rose 3.2%. Calculated Risk is the go-to source on housing, and Bill continues his analysis of the effects of the small inventory. This concept is essential to understanding housing trends.

  • Industrial production registered a (small) increase of 0.1%. Steven Hansen notes that the year-over-year figure is still in contraction.
  • Hotel occupancy still on pace to be the second best year in history. (Calculated Risk)
  • Earnings season shows continuing strength. FactSet reports that 78% of S&P 500 companies are beating earnings estimates and 65% beating on sales. Take a look at the entire analysis. Here are two interesting takeaways.

The Bad

  • Rail traffic continues to decline, even when coal and grain are excluded from the data. Steven Hansen does a thorough analysis of the trends.
  • Jobless claims edged 13K higher, moving away from recent lows.
  • Housing starts declined and missed estimates. The annual rate was 1.047 million. Calculated Risk discusses and notes that his prediction at the start of the year, growth of 4-8% still looks about right.

 

The Ugly

Increased hacking. Yesterday’s widespread outage attacked a domain name service, according to MarketWatch. Engadget says, Blame the Internet of Things and provides the map below. The hacking began with home devices which often have weak security protocols. With that entry, the distributed denial of service attack took down a list of major sites, including “Twitter, Spotify, Reddit, The New York Times, Pinterest, and PayPal.”

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 Ryan Detrick of LPL Research. I am showing the power of his work via the two key charts, but reading the entire post will help you to spot these things on your own.

 

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have a normal week for economic data, along with many important earnings reports. I watch everything on the calendar, so you do not need to! Check out WTWA to focus on what is really important – and ignore the noise.

The “A” List

  • New home sales (T). Continuing strength needed.
  • Consumer confidence (T). The Conference Board version spiked last month. Few expect the gains to hold?
  • GDP for Q3 (F). Even though this is backward looking, it will get plenty of media attention in front of the election.
  • Michigan Sentiment (F). Has been weaker than the Conference Board version. An important indicator.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Pending home sales (Th). Not as important as new homes for immediate economic effect, but a good market indicator.
  • Durable goods (Th). Volatile September data, but important for the overall assessment of the economy.
  • Existing home sales (Th). Without the impact of new homes, but still a good read on the overall housing market.
  • Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

More important than the economic data will be continuing earnings news. We also have almost daily Fedspeak and plenty of international events and speeches. And of course…the candidates.

Next Week’s Theme

Despite the many events that normally increase volatility, the stock market has traded in a narrow range. There is an increasing sense that “something’s got to give.” The exact cause and timing remain unclear, but the obvious choice is Election Day.

I expect an active discussion about a looming market question:

When will the trading range be broken?

Here is a chart of the market over the last year:

If you look at mid-July through today, you can see that the trading range has been quite narrow.

Now let’s turn to the sequence of topics I have written about in the last two months. These remind us of what we were thinking and worrying about each week.

  • Possible rate increase after Jackson Hole 8/28
  • Chance of an Autumn Correction 9/3
  • Should we fear the Fed? 9/11
  • Is the bond correction at hand? 9/18
  • Election effects on the market 9/25
  • Time to get past the gloom? 10/2
  • Earnings recession over? 10/9
  • Market rotation at hand? 10/16

Despite this list of challenges, stocks have held up pretty well.

Many are expecting the trading range to be broken soon. But in which direction?

Election predictions range from a surprise, Brexit-style victory for Mr. Trump to a Democratic sweep. The markets seem to favor a Clinton victory, but a continuation of divided government, mostly because of reduced uncertainty.

At the beginning of the year I wrote that the investment effects of this election were smaller than most would expect. The President has much less power to change policy than most people think – especially in the face of a Senate filibuster. Either candidate would need to forge alliances with the other party to make major changes. OppenheimerFunds has some interesting comments about surprises from past elections, and advice for investors this time.

Data indicate that many are not following this advice. A BlackRock survey (via Financial Advisor IQ) found that 53% of investors have raised their allocation to cash because of the “persistent volatility.” The Presidential election gets credit as a major cause.

The perceived volatility is completely wrong – certainly for the last few months, and also for several years. If you missed my post on testing your Confirmation Bias Quotient, you might want to take a look. Something is causing many investors to perceive volatility that is not really there.

Bloomberg reports that investor cash levels have not been seen since 9/11.

Join in the comments with your ideas on when the trading range will be broken, and in which direction. As always, I’ll have a few ideas of my own in the conclusion.

Quant Corner

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

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. 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.

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

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

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

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

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli’s enhanced aggregate spread, considering when it might first give a recession signal. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score.

“Davidson” (via Todd Sullivan): An excellent, understandable description of the interest rate cycle and its close association with recessions. The description of the factors we can expect to see before a recession will come — someday. Here is a key quote and chart:

Recessions, for the most part, in my opinion, are predictable. The rate spread between T-Bills and the 10yr Treasury is 1.20% today or 120bps (basis points). Based on history, lending continues, a relatively high level of pessimism continues and so does economic expansion. The rate spread is only one of several economic measures we have available that indicates economic expansion is likely to continue for several years.

 

How to Use WTWA (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 six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

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

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

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Holmes and friends – the top artificial intelligence techniques in action.
  • Why it is a great time to own for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions on this subject. What scares you?)

Best Advice for the Week Ahead

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

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar holds several aggressive sectors. The more cautious Holmes also remains fully invested. They now have a regular Thursday night discussion, which they call the “Stock Exchange.” This is the place to get some ideas from the best technical analysis – and you can ask questions!

Top Trading Advice

 

Brett Steenbarger provides a checklist to help you determine if you are “operating in peak performance.” As he often does, Dr. Brett has raised a point that few people think about. This is one that could make a big difference – and not just for traders.

The Trading Goddess considers pot stocks for an election trade.

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be “Davidson” (via Todd Sullivan) and the analysis of current market fears. It is a post packed with good ideas, one of which is in the quant corner as well.

The past 12mos has seen many a ‘high profile’ investor forecast that a recession is imminent. This is the consensus view. Some claim it is driven by economic weakness from one area or another. There are still claims that employment is weak when it is at record highs. Others claim that retail sales and personal income (wage growth) are nearly unchanged for more than a decade. Not so! They are much better. Then, there are those who claim that recoveries only last a certain number of years before they expire. Not so! Finally, there are some who claim no recovery has occurred and that the SP500 is only higher because interest rates are so low, i.e. high stock prices are only supported by the Federal Reserve keeping interest rates at historical lows. Definitely, not so! The range of commentary covers a broad spectrum, but remains pessimistic just the same.

Please take a few minutes to read this valuable post.

Income Ideas

 

Many investors are looking for income stocks. Rightly worried about the valuation and downside risk of utilities, they seek alternatives. Some have joined us in buying sound, conservative stocks and writing near-term calls against the position. This can generate an excellent yield and is safer than owning the stocks alone. It is a lot safer than a basket of utilities.

REITs present another alternative. The trick is to find those that have some ability to hold up in the face of interest rate hikes. Brad Thomas has been writing on this topic, presenting several good ideas. This week it is Apple Hospitality (APLE). I have been adding some REITs to the yield portion of our client portfolios. Like Brad, we include analysis from Chuck Carnevale’s F.A.S.T. graphs as part of our research.

David Fish has an interesting article on dividend increases anticipated before the end of the year. There is also a link to his updated list of dividend champions.

Stock Ideas

Lee Jackson writes about three “red-hot chip stocks.” These interesting ideas are based upon a research report from highly-regarded chip analyst Will Stein (SunTrust Robinson Humphrey).

Our trading model, Holmes, has joined our other models in a weekly market discussion. Each one has a different “personality” and I get to be the human doing fundamental analysis. We have an enjoyable discussion every week, with four or five specific ideas that we are also buying. This week Holmes likes Nike (NKE). Check out the post for my own reaction, and more information about the Holmes method.

While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas have worked well so far. My hope is that it will be a good starting point for your own research. Holmes may exit a position at any time. If you want more information about the exits, just sign up via holmes at newarc dot com. You will get an email update whenever we sell an announced position.

Dillard’s, Inc. (DDS): Has The Pendulum Swung Too Far? Asks Mitchell Mauer. I especially like to recommend articles that are backed by good analysis. Here you can see both pros and cons. It follows a method that is quite useful in selecting stocks.

Is the selling in Gilead Sciences overdone? Stone Fox Capital notes the falling analyst recommendations despite strong earnings. Should the stock really be trading at a multiple of 6. The net payout (stock buybacks plus dividends) is now almost 18%.

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, you should join us in adding this to your daily reading. Every investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading. My personal favorite this week is the “lucky versus good” analysis from Jonathan Clements. He writes:

The problem: We typically judge our financial choices by a single, crude yardstick—whether they make or lose us money. But that measure of success or failure can result in faulty feedback that validates bad behavior. Consider three examples……

Check out the whole post for the examples and an excellent lesson.

Millennial Investors

Barron’s introduces a new site aimed at “a new generation of investors.” There is a combination of advice and some stock ideas. I enjoyed the article about why Apple Pay is more secure than a credit card. They also introduce “The Next 50 Index” with stocks geared toward Millennials.

And from another source – this provides some inspiration about our changing habits.

Final Thoughts

There are several points to keep in mind:

  • The market has been resilient in the face of challenges. Look again at the chart. The worrying seasonal predictions have all been wrong – as January goes, sell in May, September as the worst month. We now approach the period of greatest seasonal strength.
  • The earnings recession seems to be at an end. Forward earnings are trending higher.
  • There is no sign of an economic recession – just more of the same slow growth.
  • Consumer confidence is still strong.
  • Energy prices are back in a range where the threat to producers has been reduced and the consumer prices remain modest.

What is needed to spark a change? The biggest item is increased investment by business. Surveys continue to show caution among these leaders, even when their own business is doing well. When there are specific events to worry about, it is easy (and seems wise) to defer decisions.

Acclaimed system developer, author, and hedge fund manager Ralph Vince summarized the situation with a bold call in a post at Daily Speculations:

Regardless of who wins this election, this market is going to rip to the upside — and I can be quite certain of that without even looking at the numbers, just the very tentative nature of nearly everyone around it. I’ve smelled this dish cooking before, and so have a lot of folks on this site.

How is that for a contrarian position?

Stock Exchange: Featuring Holmes and NKE — Energy and SCHW worth a look

Each week Felix and Oscar host a poker game. We listen in on current trading ideas in the few minutes before the game starts. They like to call this their “Stock Exchange.” I am the only human present, and the only one using fundamental analysis. Their methods are excellent, as you will learn if you join us for a few weeks. Since the time frames and risk profiles differ, so do the stock ideas.

Background on the Stock Exchange

What is this about? Since launching this series I have had good questions on three general themes. Here are the questions and some brief answers.

  1. The model characters are fun, but please tell me more about what they do.

    I include the general personality of the model at the end of each article. I will begin featuring one approach each week with more detail, and soon provide a reference page for readers.

  2. Why don’t you show a track record on performance?

    I understand that those trying to sell a newsletter or chat room often provide some sort of time-stamped real-time record. You will find that most of these people are not subject to compliance rules. The “track records” tell you nothing, since they do not have enough trades to get into the “long run.” Confidence in a model comes from knowing how it is developed and tested. I would rather ask a few questions to a developer than see a few months of real-time picks. It is pretty easy to spot the amateurs.

    This is a brief answer, and I promise to follow up with a longer post. Meanwhile, here is our model developer, my partner Vince Castelli, in his Popular Science feature from 2002. It is one of the few projects he worked on that are now in the public record. He has applied his scientific knowledge to finance for decades.

     

  3. Why should I care about these model picks?

    You probably read many articles with stock ideas. Some are a single idea based upon technical analysis from a source you do not really know about. At the Stock Exchange you get four different recommendations from technical “experts” as well as some fundamental commentary as a rebuttal. I am not trying to sell anything. We are developing an institutional product. The results are good enough that I am willing to share and discuss with readers. Some of my clients are invested in these models, so I am not going to provide every trade in real time. It is supposed to be interesting and fun! Look at the ideas and do your own research.

 

This Week’s Ideas—Focus on Holmes

This week’s featured expert is Holmes. Vince designed Holmes to be a trader, but one that would be safe enough for average investors. It is not a crazy, day-trading program. Holmes looks for stocks that have sold off, formed a base, and have promising rebound potential. The criteria are strictly technical, so the stocks may not be appealing for long-term investors. Holmes is very cautious in making new picks and aggressively dumps losers. Like most traders, Holmes also includes profit-taking and trailing stops. The average holding period is a few weeks. There may be as many as sixteen positions at one time – all from our universe of 700 liquid stocks.

Holmes reduces risk in three ways:

  1. Going completely to cash when market conditions are poor;
  2. Reducing the number of positions when indicated;
  3. Using stops and trailing stops on individual holdings.

I analyze the risk of each of our strategies. While it is partly subjective, I rate Holmes as lower risk than buy-and-hold for the overall market.

Here are the ideas for this week, beginning with Holmes.

Holmes

I am the rebounding specialist. I love great stocks that investors/traders have bailed on. My Bounce Play of the Week is NIKE, (NKE), This mega sports apparel and sneaker maker just keeps running a marathon while investors treat it like a sprinter. Coming off its highs of 67 in early 2016, this stock has been consolidating, digesting, and hanging out at the bottom of its channel. I see a good chance to power back up a few percent or more. I also love the risk/reward aspects of this trade. I would use 48 as hard stop, so I’m risking 3.8 to make 10 or more points. Like Nike says: “Just Do It.”

This is definitely a “bounce” play.  It is close to the lower edge of the channel.  I’ll be happy with a few percent.

J: Valuation is reasonable, but it is not exciting based upon the fundamentals.

H: The chart shows the rebound potential. Most of my ideas are quick winners. I’ll cut bait and move on if this does not work.

Felix

I still like energy and have added a new position last week. Some current holdings are dipping dramatically and some are rising out of those dips, but the long-term strength appeals to me. You can see the sector strength in VanEck’s CRAK.

J: Oil prices are still in a trading range. I think that it is the sweet spot for the economy. I agree with the long-term potential.

F: Oil appears to be making a slow bullish move going into Winter in the Northern Hemisphere.  There have already been a number of long range weather forecasters who are calling for a severe Winter in the US this year.

J: Since when do you pay any attention to weather forecasts?

F: My selections are always based upon the charts, but I also am interested in the message of the market.

And to my many fans: Please keep your questions coming. I could use the overtime pay! Ask about a specific stock, or perhaps an ETF. I am interested in sectors, but need a representative ETF to help.

Oscar

This week I like Oil & Gas exploration, illustrated below by XEC. Sure, the stock’s been hanging around yearly highs for a while now. But would you have bet against World Heavyweight Champ Joe Louis? I see at least a couple months of progress hanging around here.

This is a wonderful textbook example of momentum!  It looks like a real long-term winner in the making.

J: That seems crazy. The PE multiple is over 300. Where did you get such an idea?

O: My turf accountant also has stock picks.

J: You take stock advice from your bookie??

O: He is better than one of those robo-advisors. He says that 2017 earnings will be a lot better.

J: Sixty-eight cents this year, but 3.34 in 2017. I still think it is expensive.

O: As usual, I’ll either cash or go for a small loss.

 

Athena

Following some steep losses in January and June, Charles Schwab (SCHW) has spent the last few months on a rebound. The forward average suggests it’s leveling off, but I think there’s room to catch a few points just before the peak here.

What a great recovery from a major pullback.  Very strong!  This could have a long run.

J: This is trading around the long-term P/E ratio and earnings are rising. In that sense it is fairly valued. Here is Chuck Carnevale’s FastGraph, which shows why I still think it is expensive.

A: You and Chuck are just too cautious. If you want a big reward, you have to take some chances.

Questions

If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a specialty. Who is your favorite? (You are allowed to choose me, although my feelings will not be hurt very much if you prefer one of the models).

Cast of Characters

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not usually announce new picks, but he will answer questions, saying what he thinks about specific stocks. He will also comment on favorite themes and sectors.

Oscar is naturally optimistic and a bit excitable. He definitely likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. While he does not know the definition of “mean reversion” he loves rebounds! There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

Athena trades more frequently than the others, but still limits risk. Her inspiration helps to find good ideas. Her excellent quant skills find attractive risk/reward opportunities. Her wisdom leads her to exit trades that are not working. Athena will provide a new idea each week.

Jeff usually has some comments about stock or market fundamentals. Unlike the other witty participants, he sounds like an old prof.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned.

What is Your Confirmation Bias Quotient?

Most thoughtful investors know and understand the concept of confirmation bias. Very briefly put, we selectively perceive and choose evidence that supports our existing beliefs. It is a powerful natural process. Everyone is susceptible.

 

Morgan Housel has a good challenge: “What’s something you strongly believe that’s likely wrong?” He has a wonderful description of the key problem:

 

And while most of us are OK being told we don’t know everything, being told we have a lazy thought process is hard to interpret as anything but an insult.

So we have the ultimate cognitive dissonance: Fully aware that we’re wrong about something but unable to admit being wrong about anything.

 

Unfortunately for the decision maker, fixing the process is the key to better results. There are various discussions about how to avoid confirmation bias, but they are pretty general and not well-linked to investment decisions. Even worse, many investment discussions descend into an argument about who is biased, instead of an intelligent discussion of the facts.

 

Since it is not easy to detect your own biases, I have devised a Confirmation Bias Quotient to help. I have scaled the test so that high is good.

 

  1. Anecdotes. If you pay a lot of attention to specific stories and examples, give yourself -3. Illustrations can add color to conclusions, but when used as the basic level of analysis if is too easy to find supporting narratives.
  2. Specific examples. Similar to #1 but probably even more common. How do you interpret information during earnings season? If you pay a lot of attention to news reports on specific companies, give yourself -3. (It does not matter whether the stories are positive or negative; -3 either way).
  3. Symbols. If you find yourself drawn to colorful or graphic symbols of events – new paradigm, stall speed, stagnation, or anything similar pointing in any political direction – give yourself -2. If you completely reject analysis of data, take an additional -2.
  4. Demonstrably biased data. Examples are things like ShadowStats, where there has been compelling and responsible refutation, without response, on several occasions. Or like the idea that over 90 million people in the U.S. are without work. There is a legitimate debate about some data, but a general rejection of this type indicates a preference for conclusions before evidence. Take -2 if you find these arguments credible.
  5. Emphasizing unimportant data. Choosing to use data rather than stories is a good step. The problem is that there are so many indicators, and most of them have little significance. If you are looking at the Markit PMI (for Europe, China, or the U.S.), or regional diffusion indexes like Empire or Dallas, give yourself -1. There are so many of these that you can find anything you want, and none of them are established as really important.
  6. Embracing biased interpretations. This happens so frequently that I can only give examples. Suppose that a source complains about seasonal adjustments one month, but not another. Or emphasizes sentiment measures only when pointing in the preferred direction. Or emphasizes some specific factor (birth/death adjustment, core measure versus headline) only when it fits their message. It is pretty easy to spot such sources if you look for them. If you find yourself in this camp, take another -1.
  7. Relying upon biased or weak sources. Mr. Buffett said that you should not ask your barber if you need a haircut. Why ask a bond guy about stocks? Or an emerging market manager about bonds? Or a hedge fund manager, who is not really there to help you, about anything? If you do not have a high level of skepticism about sources, take another -1.

 

If you are really mired in bias, you could have a score of negative 15 at this point. Let us turn to the positive factors. Each is worth a possible +5 points, for a total of +20.

 

  1. A willingness to separate your evaluation of the economy and investments from your personal political beliefs.
  2. Finding the most important economic indicators and sticking with them, even when they convey a message that feels wrong to you.
  3. Discovering sources that have demonstrated expertise and track records in the relevant subject.
  4. Being willing to read carefully the analysis of experts with differing viewpoints.

 

The Test is one of Process, not Conclusions

 

A crucial point: You may well reach a consistent bearish or bullish conclusion without significant confirmation bias. The test is about your information, method, and process — not about conclusions. Different experts can look at the same data and reach different conclusions. In my weekly WTWA column I carefully follow all four of the positive factors listed, and strive to maintain a high CB quotient. It happens that my conclusions have been correctly bullish. Some erroneously believe that this reflects bias. Not so. If the evidence changes, so will my conclusions. Why shift from a winning method for “cosmetic” reasons?

 

Scoring the Test

 

If your score is negative, your biases are costing you money. My estimate is that 70% of investors would have a negative score on this test.

If you have even a small positive score you are actively seeking objectivity – probably in the top 20% of all investors.

If your score is above +10, you are doing a very good job of seeking evidence. Your investment results probably reflect this!