Weighing the Week Ahead: Will Trump Policies Extend the Business Cycle?

We have another holiday-shortened week with little fresh data. While there are some Fed speakers on tap, it is not enough to feed the avaricious punditry. There are two competing themes: the spike in inflation and the continuing assessment of Trump Administration policies. Once again, I expect the two to be joined in most commentaries. Pundits will be asking:

Will Trump policies extend the business cycle?

 

Last Week

Last week the economic news was mostly positive, and stocks responded.

Theme Recap

In my last WTWA I predicted a conjunction of two themes as Fed Chair Yellen testified to Congress and President Trump considered candidates for several Fed vacancies. I was only half right. Yellen got plenty of attention from Congressional questioners and revealed that she plans to finish her term as Chair. She also gave some non-specific agreement with some of Trump’s principles about regulation. GOP questioners wanted to talk about the Fed balance sheet. President Trump did not comment about this. This topic will have continuing interest. Presidents are rarely fans of rising interest rates.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. She notes the record high and the overall gain of 1.51% for the week.

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

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 mostly positive.

The Good

  • Retail sales increased 0.4% beating expectations of a flat report. December’s data was revised to a 1% gain from the prior 0.6%.
  • NFIB small business optimism shows that “economic growth is coming.” Dr. Ed opines that this must be a Trump effect.

  • Philly Fed survey rose 43.3, crushing expectations of 17.5 and the prior month’s 23.6. The six-month outlook also remains very strong. From the report:

  • Leading indicators remained strong increasing 0.6% and slightly beating expectations.

 

The Bad

  • Industrial production dropped 0.3%, missing expectations for a flat report.
  • Fewer developed market stocks are outperforming – 44% versus the 57% average. Eric Bush of GaveKal explains that this has a negative correlation with the overall market.
  • Kim Jong-un took two provocative actions, two days apart. Jonathan D. Pollack at Brookings wrote “…North Korea’s impetuous young leader, yet again reminded the outside world of his determination to defy international norms by all available means”. The ballistic missile test was a flagrant violation of agreements, and the assassination of his half-brother continues a policy of killing potential rivals. So far, the market has taken little notice of such events or other possible challenges to the new president.
  • Inflation data showed price increases greater than expected (Briefing.com consensus in parentheses). PPI was up 0.6% (0.3%). CPI up 0.6% (0.3%). Core CPI up 0.3% (0.2%).
  • Housing starts declined in January, so I am scoring this as a negative. The prior months were revised higher, and the result was a slight beat of expectations.Calculated Risk, one of the top sources on housing matters, ascribes the shifts to the volatile, multi-family sector. Bill expects starts to increase 3% – 7% in 2017. The range may seem wide, but he is careful to explain the expected error around his forecasts, which have been quite good. See the full post for charts splitting out multi- and single-family.

The Ugly

Malware is winning the race against antivirus software. Users are not taking the most important precautions. Hint: Strong passwords and a password manager. (Slate).

 

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 Josh Brown for his thoughtful analysis of debt, and what it really means. The arguments about excessive debt, the types of debt, and the threats to the system are easily made. It takes only a chart, and most readers are pre-convinced.

Explaining the data requires a deeper, second-order analysis. In his well-sourced aricle, Josh takes a comprehensive look at employment and lending. You need to read the entire post (twice) but the no-nonsense conclusion captures the key point for investors:

When bankers complain, the rhetoric is almost always a caricature of the reality. Today is no different. There’s probably room to streamline or clean up the crisis era regs, but to make the claim that “the banks can’t lend” flies in the face of the actual facts.

The Week Ahead

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

The Calendar

We have a very light week for economic data, with all reports in a three-day period.

The “A” List

  • New home sales (F). Gains expected in this important sector.
  • Michigan sentiment (F). Important indicator for employment and spending.
  • Initial jobless claims (Th). How long can the amazing strength continue?

The “B” List

  • Existing home sales (W). Not as important as new sales, but is a read on the overall strength of the housing market.
  • FOMC minutes (W). No surprises expected.
  • Crude inventories (Th). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

Fed Presidents will be on the speaking trail. Earnings reports continue. Early actions from the Trump Administration have captured the spotlight and will continue to do so.

Next Week’s Theme

 

If the market did not have the extreme Trump focus, the question would be whether incipient inflation suggests the need for more aggressive Fed policy and the probably end of the growth portion of the business cycle.

With the daily parsing of tweets, executive orders, and (somewhat conflicting) policy statements, analysts are scrambling to define and re-define the “Trump Effect.”

In a holiday-shortened, light week for data, I expect a combination of these two themes:

Will Trump Policies Extend the Business Cycle?

Discussion of this topic includes both the policies and the business cycle. Most are not rigorous in separating them.

Scott Grannis does a good job by focusing on the inflation effect and the business cycle. He notes that core CPI inflation has been rather stable, and that it is “a stake through the heart of the deflation demon”.

By contrast, Barron’s focuses on the stock and market effects. In their cover story, they review each Administration move:

Will the week ahead provide any more clarity and focus? Maybe not, but investors should look for the following key points:

  1. Is there evidence of a business cycle peak? Here is Bob Dieli’s take, vividly comparing the disparate opinions:

  1. Will Trump policies extend the cycle? Some are citing confidence from both businesses and consumers as evidence of a return of “animal spirits.” The Trump administration is forecasting much stronger growth than does the CBO. (MarketWatch).
  2. Many Trump moves are generating opposition, sometimes with the Republican party.
  3. Most voters are looking for compromises. This is true of both parties. “The Hill.”

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

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

The C-Score has again moved lower, reflecting more inflation via gasoline prices. The level is still not worrisome.

 

The Featured Sources:

 

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

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

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

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

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

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

The Brooklyn Investor looks at Warren Buffett’s returns, comparing them to other great investors and probability estimates.

Michael Hartnett’s (BofA Merrill Lynch) methods suggest a “melt-up” of 10%. I can’t argue. When CNBC interviewed me about my 2010 call for Dow 20K, I suggested that the next 8-10% would be pretty easy.

How to Use WTWA (especially important for new readers)

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. All our models are now fully invested. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our four technical experts, and some rebuttal from a fundamental analyst (usually me). We try to have fun, but there are always fresh ideas. Last week the focus was when and how to “buy the dips” with a current example from Holmes.

Top Trading Advice

 

Dr. Brett is back on the job, with several great posts this week. It is difficult to pick a favorite! He has advice on picking the right instruments to trade, identifying real trader education, and why you need to ask the right questions if you are to learn. Do you, for example track prices right after you are stopped out of a trade? There are several other tough, but valuable questions.

Consider attending his trading workshop at the upcoming NY Trading Expo.

Ralph Vince identifies three factors highly correlated with the price of private property. Traders often forget that guessing when to be short is against the odds.

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 Chuck Carnevale’s discussion of MLPs. This is a popular investment for those seeking income. Many just look at the yield. Chuck demonstrates the complexity of these partnerships, explaining valuation, tax considerations, and whether you are simply getting your money back. You should not invest in an MLP without reading this first. In addition to his general warning, he provides several ideas worthy of consideration.

 

Stock Ideas

 

Airline stocks. Warren Buffett? Really? His famous jocular quote was that a capitalist at Kitty Hawk should have shot Orville Wright to save money for his kids. Philip Van Doorn (MarketWatch) presents the story of this changed attitude. Josh Brown explainswhy Mr. B can be flexible while adhering to long-time principles.

Rural broadband? This could be a big beneficiary from an infrastructure plan (Brookings). Also, see my final investing thoughts below.

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. This week the dip-buying Holmes sold Nielsen (NLSN) on some strength and add General Electric (GE).

 

Seeking yield?

Blue Harbinger notes that Verizon’s yield has moved higher despite a reasonable payout ratio. I agree, but I prefer to write calls against stocks like this. If you stick to short-term calls (with the most rapid time decay) you can generate a cash flow of 9 or 10%, including both dividends and premiums from call sales. If the stock is called away, you find a new candidate, since you have gained 4-5% in six weeks. If the stock declines, you sell a new round of calls. If you merely break even, in the long term, on stocks, you are meeting your income objective. I do not typically mention trades before we do them, but we are looking at a buy/write against the April 50 call, which closed at 77 cents bid. You will collect a 58-cent dividend in early April. If the stock does not move, that is over 2 ½ percent in a few weeks. If it is called away, you make about 4.5% and can look for a new trade. This is a great idea for DIY investors who understand options. Naturally, this is an illustration, not a general recommendation. Do not consider it without consulting your financial advisor (yada yada)!

 

 

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, this is a must-read. Even the more casual long-term investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. The piece about the importance of a will is great. I liked the one helping you teach kids about money. (I tried to do this with poker chips, and you can guess the ending). My favorite was gender control over family finances. Do you think it matters who is earning more? (Hint: Mrs. OldProf regards it as completely irrelevant).

Seeking Alpha Editor Gil Weinreich’s strong series is ostensibly aimed at financial advisors – a must-read for them. It also attracts many DIY investors. The topics are always interesting, and the discussion is often spirited. Active versus passive investing is naturally a current hot topic.

Ben Carlson explains how to consider housing expenses as part of your overall financial plan.

In case you missed it, you might enjoy my brief, mid-week post on The Fastest Way to Improve Your Investment Results.

Watch out for…

Overpriced dividend stocks. SD Davis explains the need for looking beyond the hoped-for payments.

Yield plays with “dividends” that are merely a return of your own capital.

Emerging market bonds. Lisa Abramowicz at Bloomberg explains the risks, including a decline in foreign currency reserves.

 

And more on value investing

Black Rock’s Russ Koesterich demonstrates why this style can work in what is perceived as a tough market. Here is his illustrative chart:

Final Thoughts

 

After years of warnings about deflation and impending recessions, the economy is showing some real signs of strength. For whatever reason, much of the punditry clings to the “end of the up-cycle” thesis, in both the economy and in stocks. Neither economic cycles nor bull markets die of old age.

Inflation concerns are premature. The Fed prefers the core PCE measure, which has less emphasis on housing. It runs “cooler” than the CPI. The Fed has also indicated willingness to exceed the 2% inflation target for some time. They can fight inflation more readily than deflation. I do not expect Trump appointments to reverse this consensus.

Most importantly, the punditry calls it a Trump rally since it occurred at about the same time as the election. There is no analysis of reduced uncertainty or improved fundamentals. The main impact seems to be the promise of reduced regulation.

To summarize, there is a significant improvement in confidence, which is great for the economy and corporate earnings. The reasons for more confidence include many sources.

Investing Conclusion

Finding good ideas from major policy changes is an excellent approach — in theory.

In practice, there are many traps. Too often there are incentives for analysts to be first, rather than to be right. While I have suggested caution on this front several times, it is easier for me. I am not required to fill a TV time slot or write a report for brokerage firm clients. If there is no solid conclusion, I am not forced to act. My approach requires good information, including some which is not yet available. The matrix below is a partial representation of my results. There are more sectors, of course, and I have hundreds of tagged articles in a supporting database. I have preliminary entries for most of the cells. The table below is just an illustration of my approach.

Weighing the Week Ahead: Trump V. Yellen Round One

A week featuring the Fed Chair’s semi-annual Congressional testimony, and daily speeches by most of her Fed colleagues, would normally represent a commanding first choice for the upcoming theme. This time is different. (Yes, I know that you are never supposed to say that). The first weeks of the Trump Administration have generated daily news on a wide range of topics, each of which draws attention.

The combination of the two will provide an irresistible topic for the punditry. It will be:

Trump v. Yellen, round one.

Last Week

Last week the light economic calendar provided mixed news, but there was still a rally in stocks.

Theme Recap

In my last WTWA I predicted a discussion about whether the current market optimism was justified. Despite some breaking news during the week, especially about earnings, that theme got plenty of attention.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. She notes the new high and the overall gain of 0.81% for the week.

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

The News

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

This week’s news was again mixed, with a tilt to the positive side.

The Good

  • JOLTS signaled a healthy labor market. Many try to use JOLTS as a measure of job growth. This is unhelpful, since there are better measures for that. It is an example of writing about what you think people want to hear. The data are best interpreted as a measure of the health and structure of the labor market.
    • The quit rate is seen as a measure of health, since it reflects those who voluntarily leave jobs, expressing confidence in other opportunities. There is a nice discussion of JOLTS and several charts from Nick Bunker.

  • The Beveridge Curve is the most important interpretation, emphasized by Yellen. What we really want to know is the tightness of the labor market. Here is a nice explanation from 2012, noting what is needed for labor market improvement and the general counter-clockwise movement after a recession. (Readers looking for a Silver Bullet Award might want to check out the very lame interpretation at ZH, where one of the Tylers only discusses the gap, not the trend or slope. The most recent update is a month old, from the BLS.

 

  • Corporate earnings. I am scoring this as a slight positive. I want to discuss it, so I put it somewhere. The results are mixed. Earnings are below expectations, revenues are higher, and outlook (always negative) is not as bad as the long-term average. There is a year-over-year gain for a second consecutive quarter, not seen for two years. (Factset). Brian Gilmartin also highlights the leading sectors. He also has something you will not find anywhere else – an analysis of the impact on earnings from a border tax. Great work!

The Bad

  • Michigan sentiment dipped to 95.7 on the preliminary estimate, down a bit from last month’s 98.5 and missing expectations. This month’s report has a special feature that we need to know – divided perceptions based upon politics. From the Michigan report:

    When asked to describe any recent news that they had heard about the economy, 30% spontaneously mentioned some favorable aspect of Trump’s policies, and 29% unfavorably referred to Trump’s economic policies. Thus a total of nearly six-in-ten consumers made a positive or negative mention of government policies. In the long history of the surveys, this total had never reached even half that amount, except for five surveys in 2013 and 2014 that were solely dominated by negative references to the debt and fiscal cliff crises. Moreover, never before have these spontaneous references to economic policies had such a large impact on the Sentiment Index: a difference of 37 Index points between those that referred to favorable and unfavorable policies. These differences are troublesome: the Democrat’s Expectations Index is close to its historic low (indicating recession) and the Republican’s Expectations Index is near its historic high (indicating expansion). While currently distorted by partisanship, the best bet is that the gap will narrow to match a more moderate pace of growth. Nonetheless, it has been long known that negative rather than positive expectations are more influential in determining spending, so forecasts of consumer expenditures must take into account a higher likelihood of asymmetric downside risks.

  • High frequency indicators are a touch more negative. New Deal Democrat does an excellent weekly update. I always read it and any serious investor should join me.

The Ugly

Scamming 9/11 heroes and NFL concussion victims? Pretty low, if true. Some will go to any lengths to make a buck. (CBS news).

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week. Nominations are welcome! For inspiration, you might test yourself on the misleading visualization techniques described by Nathan Yau. I see these daily, and so do you. The most common in financial posts is this one:


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.

The “A” List

  • Housing starts and building permits (Th). Little change expected in these important leading indicators.
  • Leading indicators (F). Popular economic gauge expected to remain strong.
  • Retail sales (W). Little is expected from the January data.
  • Initial jobless claims (Th). How long can the amazing strength continue?

The “B” List

  • Industrial production (W). A small gain is expected in the volatile series.
  • Philly Fed (Th). Popular report is the first look at February data.
  • PPI (T). Starting to run a bit hotter. That will attract more attention if it continues.
  • CPI (W). See PPI above.
  • Business inventories (W). December data affecting Q4 GDP. Favorite spin target: Voluntary or involuntary build up?
  • Crude inventories (Th). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

Chair Yellen give s her semi-annual Congressional testimony on Tuesday (Senate) and Wednesday (House). The presentations are the same and the order alternates. If you don’t know why, then you missed that class in Congressional Government! There are also appearances by a host of other Fed Governors and Presidents. Questions will probe the state of the economy, the new political environment, and the likely pace of rate hikes.

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

Next Week’s Theme

 

During the campaign, Candidate Trump had plenty of criticism for the Fed and for Chair Yellen. Since the election, he has had much less to say. With Fed Gov. Daniel Tarullo’s resignation, the President will now have three openings to fill (out of seven). Next year he can replace Yellen as Chair. Although technically her term continues, most resign when replaced as Chair. He has the power to change the style, background of members, and policies.

Yellen is testifying before Congress this week on Tuesday and Wednesday. While the topic is the state of the economy, we should expect some aggressive questioning. Will her testimony or answers draw a Presidential tweet (which we are calling a T-Wop)? The punditry will find this combination irresistible. I expect plenty of media coverage for a clash that will probably be repeated. We can think of it as:

Trump v. Yellen, Round One

The basic possibilities are interesting, but mostly speculative so far. Here is what Trump might do.

  • Trump will support some of the various moves to “audit” the Fed and reduce its power.
  • Trump will T-Wop Yellen this week, and remove her at the first opportunity.
  • Trump will resume the Fed criticism, and start his process for filling the vacancies.
  • Trump will moderate criticism while Yellen is still at the reins.
  • Trump will seek candidates that have some traditional credentials.
  • Trump will decide to keep Yellen as Chair.

Here is what Yellen might do.

  • Make an aggressive statement criticizing some Trump policies.
  • Avoid “Trump” issues in the statement, but provide some frankly critical answers to questions.
  • Announce that she plans to stay on the Fed if replaced as Chair.
  • Suggest that the Fed policy is changing in a way that Trump sought.
  • Make conciliatory remarks about the direction of Trump policy, especially economic stimulus.

What fun! Expect the pundits and their guests to go wild.

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

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

 

The Featured Sources:

 

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

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

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

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

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

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. The most recent update is for the Business Cycle Indicator.

Eddy Elfenbein notes that the early commentary is in: S&P 2018 earnings estimates at $148. Nearly everyone will regard that as too high, but others will start citing it. This happens even more after the third quarter of each year.

The Atlanta Fed notes that their GDP Now model has been running too hot due to net exports. A change might be in the works.

 

How to Use WTWA (especially important for new readers)

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. All our models are now fully invested. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our four technical experts, and some rebuttal from a fundamental analyst (usually me). We try to have fun, but there are always fresh ideas. Last week there was a great discussion about whether your trading results are skill or luck. Do you know? And BTW, Athena likes AMD.

Top Trading Advice

 

Are you (like me) missing Dr. Brett already? Consider attending his trading workshop at the upcoming NY Trading Expo.

Signal Plot explains how to measure your trading performance – and you must do this.

17 Trading Resolutions for 2017. Yes, it is a little late, but you can join in just as others quit going to the gym. Dave Landry has a nice list of ideas. Some of these seemed wise, but others sounded like the Delphic Oracle. What do you think?

Trading methods not working? Here is an idea. When you hear about a hot IPO look for a stock with a similar name. Buy it on the confusion/greater fool theory! It worked for those buying dating site Snap Interactive (STVI). This is not the first such occasion. (I hope readers can recognize tongue-in-cheek).

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 this post from Seeking Alpha Editor Gil Weinreich, Are Bonds Bad? How about Funds? He cites Evan Power’s analysis of the current retirement risks, responding to a Kiplinger article that retirement was now 10 times riskier.

Wow! This is a great discussion of a topic with widespread significance. With all of the scary stories about retirement, it is helpful to read something that is calm and analytical.

Gil’s daily column is a must-read for financial advisors and usually valuable for individual investors as well.

Stock Ideas

 

Eddy Elfenbein’s best ideas are in his new ETF (CWS), which is off to a nice start. That does not stop him from making valuable commentary on news, markets, and other stocks. Last week he mentioned Ingredion (INGR), an intriguing idea.

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. This week the dip-buying Holmes (who has been very hot) liked Casey’s (CASY). In a big surprise, Holmes sold the next morning, so I did a rapid update for readers. This is very unusual behavior, but it is only one of sixteen Holmes positions. Holmes is worth watching.

 

Seeking yield?

Lee Jackson suggests five dividend stocks that should do reasonably well in a market correction. These are the kind of stocks where we “enhance yield” with sales of rapidly-decaying near-term calls. We make four times as much from the call sales as we do from the dividends.

Chuck Carnevale does a deep dive on Pfizer. I agree, but I see it as another call-selling candidate.

Portfolio Management

David Merkel provides important advice about rebalancing your portfolio. I love it, and not just because the featured band is from one of my old schools. The band is great and the “Tuba March” is awesome.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, this is a must-read. Even the more casual long-term investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. This week may be the finest entry in a long series. I strongly recommend a look at the great links cited. Look at all the posts on the fiduciary rule. The average investor needs to understand who is selling and who is acting in his interest. For retirees or near-retirees, the Michael Kitces post is very valuable. Most people do not think about the priority of various retirement needs, but they should!

 

Thinking about Social Security?

Jesse Rothstein has a nice explanation of the tradeoffs in choosing when to start benefits.

 

Watch out for…

Trading the VXX, a “nearly perfectly-engineered tool to separate worried investors from their money. It is the unfenced swimming pool of ETF/ETNs.” See Paul Kedrosky’s tweeted chart.

Warnings about value traps (from 24/7). Once again, one person’s value trap is my candidate for selling near-term calls. There is always a way to profit if you are right about the major stock characteristics.

And more on value investing

From Validea. You need mental toughness. Strategies that work very well in the long term will have dry spells.

 

Final Thoughts

 

Before turning to the Fed, I want to comment on a major news theme from last week, in line with what we expected. Is the Trump Rally running out of steam? Some might find this ironic when results remain strong. Here is the three-part problem:

  1. Pundits and investors, seeking a simple post-election explanation for the stock rally, attributed it to Trump policies.
  2. Now that some of these policies seem delayed, they expect markets to get softer.
  3. But what if the rally was a return to earnings fundamentals and the elimination of pre-election uncertainty, as I suggested last week (with some support from Dr. Ed)?

What about the Fed?

Once in office, Presidents always like low interest rates. Trump will probably replace Yellen, but with whom? If the cabinet provides any precedent, we can expect some non-Ivy League, non-economists. I have frequently argued that most intelligent people with a reasonable background would be part of a Fed consensus after their appointment. The importance of the issues, the venue, and the evidence presented by staff all nudge in this direction. I once had the chance to suggest this idea to former Dallas Fed President Bob McTeer, and he agreed. (It is easy to draw out a confirming answer in such conversations, but we talked at some length and I really wanted to know).

Parsing through the possibilities described above, I expect to see little change in Fed policy. The new President will wind up appointing people with traditional credentials, but perhaps with different policy viewpoints. He will not reappoint Yellen, although people forget that the Fed Chair is often appointed by Presidents of both parties. (Greenspan and Bernanke are the most recent examples). He will not aggressively push for a change in policy. In fact, some are already claiming that the modest Fed rate increases are anti-Trump. Yellen will probably not remain after her term as chair, unless the new appointees are jarringly different in methods or policy preferences.

The Fed news has dramatically different significance for traders and investors.

For traders, this week will be especially difficult to game. Since that community has over-emphasized the Fed for the entire rally, unable to explain the gains any other way, there might be some big fluctuations. Since there is little precedent for this, we cannot even guess what the content-based algorithms will do.

For investors, it is another opportunity. Since the events have little real impact on expected earnings and the economic cycle, we can have shopping lists ready. My portfolio rebalancing has raised my cash levels. It is not fear of a correction, but a natural process.

Why You Never See the Best Employment Data

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

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

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

Why Don’t We Hear About This?

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

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

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

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

The Estimates

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

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

Implications for Investors

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

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

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

And Finally

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

Other Reading

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

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

The Quest for Investing Excellence and the Lesson of Dow 20K

The new movement to passive investments is a sharp break from the historical quest for excellence. Many articles claim that no one can do better than the market average. If that is true, you should just throw out your investment library and skip the popular lists of “best investment books.”

This post will suggest a short list of books that would have needed quite different titles. They also would not have become best-sellers! In the conclusion, I will provide some ideas about why this is important for your investment decisions. Here are the hypothetical titles followed by a cover shot of the real book. Suggestions for more examples are quite welcome!

 

In Search of Mediocrity

Market Sheep

The Average IQ Investor

The Little Book that Equals the Market

Common Stocks and Average Profits

Buffett: The Making of a Lucky Investor

Stay Even with Wall Street

Implications

In this series on investment expertise I have (so far) covered the following:

  • There are indeed experts. Sometimes it is obvious, and sometimes they are difficult to find. Consider the case of Phil Mickelson.
  • Forecasting is not always folly. I provide specific examples of expertise, and a checklist for finding the best modeling experts.
  • Dow 20K. The round-number milestone has finally been achieved – at least for today! There are many who are stepping up to claim some credit for their prediction on this front. Some were way too early, and others made the call as we got much closer. Each prognosticator had a method.

My own Dow 20K forecast came when the Dow was at 10,000 and many prominent pundits were calling for Dow 5000! My opinion was controversial at the time. Check out the history of the forecast to remind yourself of how bad things were (unemployment over 10%, and I was ridiculed for suggesting it might fall to 8%).

While it is nice to get some recognition (like this spot from CNBC when we got close to the milestone last month), I see it more as a validation of my methodology. I seek out the best experts. I am constantly looking for excellence. I know that I do not have all of the answers, but my background taught me how to search and to learn. Following superior methods helped to keep my readers and clients on the right side of the market through a long rally hated by most of the punditry and many traders.

There are many paths to trading and investment success. Mine was not the only way, but it was a good way. Having strong evidence and indicators is crucial for confidence.

What Now?

Most of the key factors I see as important are still in place. I summarize them each week. The list of worries has changed a lot but it is still there. The time will come to pull back – but it is not here yet.

 

Finding Investment Excellence

There is a lot of recent buzz about active management – basically showing that excellence is difficult to achieve. The conclusion is popular, especially among those who have no aspiration to beat average.

I cannot do this in a single post, but I must start somewhere. As I often do, let me start with something far away from financial markets as the original illustration. As the TV lawyers say when wandering off course, “Your honor, just give me a few questions and I’ll connect it all up.”

Experts Exist

Let us suppose we have a difficult situation, not unlike a complex market. In this case, you are golfing. Your ball is in the rough, and there is a danger of going over the green on your approach shot.

If you are a golfer, you will get a laugh out of Golf Digest’s 26 most difficult shots. I have experienced all of them. The “shot over water” was especially intimidating at Butler National, where I asked my caddy about the drop zone. He wisely told me, “You need a better swing thought.” That was great advice!

Here is an example of Phil Mickelson hitting a 64-degree wedge. It is not a cherry-picked result. A google search will show many other similar shots.

The commentator observes that Lefty might be the only one who could hit that shot.

Finding the Expert

I hope everyone is convinced that there are experts in golf. In fact, there are experts in any field. In most cases there is a problem of “Untangling Skill and Luck” as Michael Mauboussin astutely poses it. In the case of Mickelson’s flop shot, the skill is evident. Many important cases are more challenging. What about someone with a model that provides a 10% improvement in forecasting hurricanes? Or earthquakes? The social gain from such expertise is important, but it might be difficult to identify.

If you are an investor in search of excellence, this is the challenge. For over ten years I have taken pride not in my own expertise, but in the ability to spot the best experts in various fields. That is now more important than ever for those who want more than mediocrity.

Neglected Investment Ideas

Peter Lazaroff’s series has interesting questions for some of the top investment bloggers. It is getting good attention. I am enjoying it, and I’m sure others are as well. The comments from the heavy-hitters on his list are all very interesting.

Except for one question.

He asks them “What in the world of finance is not getting enough attention?” This is a great question, but he is asking the wrong panel! The collection of top bloggers and the leading curator of financial information basically define the reading agenda. If they really believed that something was not getting enough attention, they would write about it. The answers they give do not really cite anything unique.

If you really want to consider what is neglected, you need to look a bit lower than the most recognized bloggers. Topics that these people write about – but which do not attract notice – are the real answer to this question.

I certainly do not pretend to have the only answer, but I do have a good one. In my regular Weighing the Week Ahead feature I sometimes award a “Silver Bullet” to someone who took up an unpopular cause and provided corrective information. Their articles are not popular and have no natural audience. The authors do great work without reward, so I try to recognize them. Some might disagree with my choices, but not my intent.

Each year I do a review of these outstanding posts. I always hope that my preview will get a lot of buzz — not for me, but for those I try to recognize. None of the most popular bloggers linked to these posts…..something that really surprised me. I guess that I am not the right one to bestow any awards. Tadas, or Josh, or Barry could do it better, and with much more impact.

In case you are interested, here are the posts for last year’s winners: Part one and Part two.

And if Peter had asked, my list of neglected topics would be quite different – emphasizing things that really did not get any attention!

Weighing the Week Ahead: Will Q4 Earnings Confirm Recent Economic Strength?

We have a light calendar for economic data and a short week of trading. The biggest news will come from corporate earnings reports. Some financial stocks reported on Friday, but this is the first big week for Q416. Earnings season is always important, but sometimes it is special. This week the pundits will be asking:

Will improving corporate earnings confirm perceptions of a stronger economy?

Last Week

Last week the economic news was strong, but with little reaction from stocks.

Theme Recap

In my last WTWA I predicted a punditry focused on the incoming Trump Administration. The confirmation hearings provided a lot of fresh news, and there was not much going on in daily trading. My guess that people would be “digging down” for clues about policy changes was a pretty good one.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. As you can readily see, both the range and the weekly change were very small. You can also see the 1% intra-day move during the Trump press conference.

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!

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. This is a good week to illustrate the problem with the so-called “economic surprise” indexes. So much depends on how you determine the expectations. If conditions are good, they are good, even though some expect continued improvement each week.

The Good

  • Mortgage applications up 5.8%, despite concerns that higher rates would hurt the market. This is a very nice surprise.
  • Jobless claims at 247K continues at an extremely low level.
  • Michigan sentiment at 98.1 on the preliminary survey remains very strong (although a slight miss on expectations).
  • Sea container counts end the year on a strong note. Steven Hansen (GEI) does his expected deep dive into the data, providing plenty of long-term analysis. Here is a key table:

  • NFIB small business outlook surges. Scott Grannis has the story, including references to consumer confidence as well.

 

The Bad

  • Retail sales? More spin – good or bad?

U.S. retail sales disappoint at end of the year (MarketWatch) at 9:10 ET.

Holiday retail sales rise 4% to beat NRF expectations (MarketWatch) at 10:29 ET.

 

  • Gasoline prices are up about 20% year-over-year. New Deal Democrat has the story.
  • Business inventories? Some regard this as bad because of the m/o/m increase of 0.7%. Last week I called this a very spinnable number. Inventories are either wanted or unwanted. Going into the number we knew that the level was depleted. This is really a neutral report.

The Ugly

Volkswagen Diesel Scandal. We now know that this was the responsibility of important executives – not just low-level employees or a faceless corporation. Fiat Chrysler is also charged, but claims important differences.

 

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. There is week’s award goes to David Moenning (a nomination from a reader, Lasrman) for his helpful discussion of “Alts.” He writes as follows:

The pitch is strong. “Alts,” as they are called, are touted as a source of diversification, a way to create non-correlated portfolios, and a means toward potential risk reduction during severe market declines. I’ve heard some folks even suggest that alts are a way to produce a solid “riskless” returns!

And….

…who doesn’t want to own an investing strategy that is designed to produce a nice, steady 6-8% return without the vagaries associated with the traditional asset classes?

And the problem….

Investopedia goes on to note that most of these alt strategies are designed for sophisticated investors. “Most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals because of the complex natures and limited regulations of the investments,” the website says.

[Jeff] The most attractive track record I ever saw was from Bernie Madoff – consistent strong returns and minimal drawdowns. It was too good to be true. David’s experience is quite like mine. I get pitches for these products on a regular basis. Some of them are theoretically sound and might work. The average investor does not have the skill to evaluate them.

We also published our annual review of winners. If you take a look at the excellent work reviewed (here and here) you will see the advantage of following these contrarian sources. You will be surprised at how much it can help your investing!
The Week Ahead

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

The Calendar

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

The “A” List

  • Housing starts and building permits (Th). The most important leading data in a key sector.
  • Industrial production (W). The expected rebound would improve overall confidence in the economy.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Beige Book (W). The Fed’s district-by-district look will be scoured for signs that rate hikes might come more quickly than expected.
  • Philly Fed (Th). Earliest read on the new month has gained more respect in the past year.
  • CPI (Th). Interest in the inflation reports is building, but the worrisome stages are not imminent.
  • Crude inventories (Th). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

Fed speakers are still on the trail, with appearances every day. Chair Yellen will make two appearances.

Earnings reports will be the most important news.

Next Week’s Theme

 

It is a short week, with a light calendar of data. The Trump story continues as confirmation hearings shed a little more light on possible policies. There will be plenty of FedSpeak.

Despite these factors, the start of earnings season should give the punditry a break from All Trump, all the time. Because of recent economic strength, people will be skeptically searching the earnings news for signs of weakness or a negative outlook. The key question will be:

Do Earnings Reports Confirm a Stronger Economy?

The basic positions are simple.

  • Reports normally beat estimates, and there is plenty of potential this season (FactSet)

  • Some recent laggards are looking strong—energy, tech, financials (Brian Gilmartin).
  • Corbin Perception suggests that expectations are very high. This is an interesting collection of survey data. Read the full report, but here is a nice summary:
    • Heading into 4Q16 earnings season, 85% of surveyed investors expect results to be in line or better than consensus, an increase from 78% last quarter
    • Expectations for improving organic growth surpasses worsening for the first time in more than a year
    • Investor sentiment towards the U.S. has improved dramatically; 70% now forecast higher U.S. GDP while recession fears have pushed out
    • Rate hikes drive sector views: participants most bullish on Financials while Utilities and REITs see dramatic pullback in sentiment
    • 67% of investors report feeling better about the U.S economy post-election; recession fears off the table for 2017
  • Earnings are inflated by peak profit margins and bogus analyst forecasts. “Organic” growth is low and so is revenue growth. (I see these comments, but we would all appreciate some credible sources).

 

What does this mean for investors? 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

 

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

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

The Featured Sources:

 

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

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).

Davidson (via Todd Sullivan) notes that Markets Do Not Peak Until Spread Shifts To Zero

The indicators in this fine post are consistent with what we see from our regular sources. Many of these subsume the concept mentioned.

 

 

How to Use WTWA (especially important for new readers)

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar is fully invested, but the sectors are less aggressive. The more cautious Holmes has taken some profits, but is still about 90% invested. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our four technical experts, and some rebuttal from a fundamental analyst (usually me). There are fresh ideas each week. You can also ask questions and have a little fun.

Top Trading Advice

 

Sir Michael Hintze suggests that “Trump volatility” is good for active managers. This is also true for investors and traders. Check out Eddy Elfenbein’s account of the Trump press conference effects on healthcare.

Adam H. Grimes has advice aimed at new traders, but everyone can benefit. a useful and timely post for traders turning the page on the calendar. While the focus is on motivation, he has several specific suggestions. He analyzes each of the following important points:

Decide if you want to trade or gamble.

Have an open mind, but a critical mind.

Understand what “proof” looks like.

If you want to trade, bet size is really important.

Psychology matters, but these things are more important.

Dr. Brett Steenbarger illustrates how to make Internet discussions work well. He links to the Grimes post and extends some of the arguments. An intelligent discussion of important factors is one of the most important sources for traders (and investors). He has almost daily posts. Any serious trader should read them all. Another great example from this week shows how to turn failure into strength.

Those who join us in reading Brett Steenbarger’s regular posts will enjoy his appearance on Barry Ritholtz’s acclaimed MiB series.

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 Morgan Housel’s account of his dinner with Daniel Kahneman. It is a nice summary of Kahneman’s basic ideas – all worth reading. Morgan has a great sense for what is important and what you need to know about it. Here is my favorite quote:

On education changing thinking: “There are studies showing that when you present evidence to people they get very polarized even if they are highly educated. They find ways to interpret the evidence in conflicting ways. Our mind is constructed so that in many situations where we have beliefs and we have facts, the beliefs come first. That’s what makes people incapable of being convinced by evidence. So education by itself is not going to change the culture. Changing critical thinking through education is very slow and I’m not very optimistic about it.”

 

Stock Ideas

 

Do you believe that managers with a ten-year success record might have good ideas? If so, look at these picks. (We own several of them, which encourages me to put the rest on our watch list).

Many stocks are attractive, despite the popular valuation perception. Rupert Hargreaves reports the Jefferies take. Hint: Cyclicals and value look good.

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

Seeking yield?

How about Raytheon? William Stamm describes the dividend hike and the potential.

Kohl’s 5% looks safe. (Josh Arnold). This is one where we enhance yield by selling near-term calls.

But watch out for companies where the dividend might not be safe. Can you depend on 5.7% from Blackstone? (Brian Bollinger)

And a key question: Should dividend investors be worried about rising interest rates? Rebecca Corvino provides some great links.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, this is a must-read. Even the more casual long-term investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. My personal favorite this week is Megan McArdle’s post on the importance of saving. Investors should understand that the 401(k) is not a substitute for the old guaranteed benefits plans.

I have often commented that when Tadas has the time to write a standalone post, it is a special treat. This week he wrote about the “evidence-based” movement, the endurance of outmoded ideas, and what it all might mean for investors. A general conclusion is that many investors should minimize fees, choosing cheap robo-advisors or doing some basic rebalancing on their own.

Seeking Alpha Editor Gil Weinreich’s Financial Advisors’ Daily Digest has quickly become a must-read for financial professionals. Somewhat to my surprise, the topics also stimulate comments from active individual investors. It has added to the value of the posts for both groups. Gil engages the same topic as Tadas – the need for financial advisors. (and also here).

This is a topic that hits close to home. I am quite sure that an intelligent investor who never made the common mistakes could avoid the fees of a professional advisor. I even provide a way for investors to check this out. Just ask for our free report, The Top Twelve Investor Pitfalls – and How to Avoid Them. If you regularly navigate these problems, you can fly solo! If not, you might be losing 4-8% each year. Less than 1% of my regular audience consists of clients. I started writing to help average investors, and that remains my principal motivation. I am disappointed to see what seems like an increasingly commercial approach by so many of my friends. I know that they all seek to provide excellent and special service.

 

Final Thoughts

 

As the Q2 and Q3 earnings seasons began, I wrote about the possible end of the “earnings recession” and an inflection point in forward earnings. Those events have come to pass, but we now have a new concern: the outlook. Conference calls and the company’s guidance is always interesting, but this quarter is special. Companies cannot know what the policy changes will be, nor can they predict the effects on their business.

In each week’s “Final Thoughts” I offer opinions based upon facts. Sometimes my conclusion is a description of what I find important to watch. So it is this week. My scorecard for earnings season will look for the following company characteristics:

  • Confidence. I expect most to have a murky outlook, with no reason to set the future bar very high.
  • Important trade relationships – imports or exports. Comments on these fears may create some buying opportunities.
  • Concern about a stronger dollar. Everyone is teed up to watch for this, and we should as well.

Earnings reports help us interpret the strength of the economy using non-government data. In this earnings season, it is especially important to know the story as well as the numbers.

 

2016 Silver Bullet Awards Part Two

Each week I try to give special attention to those who do important work, even though it is probably unpopular. These contributors are so important, and their work is so helpful, that we recommend taking another look at the end of the year. (Part One is here).

 

7/13/16

In a WTWA first, CNBC anchor Sara Eisen earned a Silver Bullet Award for her excellent interview with Fed Vice-Chairman Stanley Fischer (Transcript and video via CNBC). As we wrote at the time:

One-by-one she asked all of the key questions in the current debate over Fed policy – potential for negative rates, Brexit impact, does the Fed make decisions based the economic impact abroad, the state of the economy, recession potential, employment, George Soros, and the strong bond market. Whether or not you agree with Vice-Chairman Fischer, it is important to know what he thinks.

Sara Eisen displayed first-rate journalism, as expected from a Medill School graduate. Unlike so many other financial interviewers she did not argue with her subject nor push her own agenda. She did raise all of the current Fed misperceptions common in the trading community. Her preparation and poise helped us all learn important information. It was well worth turning off my mute button and dialing back the TIVO.

8/13/16

We gave the Silver Bullet to Justin Fox for his writing on one of the most persistent myths – the manipulation of government statistics. His whole post is available here, but we particularly liked this bit:

First, because I know a little bit about the people who put together our nation’s economic statistics. The Bureau of Labor Statistics, Bureau of Economic Analysis and Census Bureau are run on a day-to-day basis by career employees, not political appointees. Even the appointees are often career staffers who get promoted, and many have served under multiple administrations. When top statistics-agency officials do leave government, it’s often for jobs in academia. Credibility with peers is generally of far more value (economic and otherwise) to these people than anything a politician could do for them.

To those with even basic experience in civil service, the political manipulation theory makes little sense.

9/3/16

Ben Carlson won a Silver Bullet for investigating the apparent link between Fed meetings and stock performance. While many (including at least one WSJ writer) took the rumor at face value, Ben asked a clever question: What happens if you change the starting date of the analysis?


As it turns out, any relationship between the two is likely a result of 2008.

9/11/16

Menzie Chinn was a big winner this year. Professor Chinn, a Wisconsin economist, debunked many annoying data conspiracies in one fell swoop. In so doing, he also illustrated how an inappropriate use of log scales can mislead readers.

We called his piece the most profitable thing for investors to read that week – if you missed it, be sure and catch up!

9/17/16

By late in the year, it was increasingly apparent that individual investors were misreading the VIX as a “fear indicator” rather than a measure of expected volatility. Chris Ciovacco did an excellent job in making that distinction. His image here is particularly persuasive.

Runner up awards to Jeff Macke and Adam H. Grimes for their similar conclusions on the same subject.

10/8/16

Shiller’s CAPE method has often caused some eyebrow-raising on A Dash, most notably since he doesn’t use it himselfJustin Lahart of the Wall Street Journal thought to analyze just how this method (and others like it) would work in practice:

For New York University finance professor Aswath Damodaran, this is the real sticking point. He set up a spreadsheet to see if there was a way that using the CAPE could boost returns. When the CAPE was high, it put more money into Treasuries and cash, and when it was low it put more into stocks.

He fiddled with it, allowing for different overvaluation and undervaluation thresholds, changing target allocations. And over the past 50-odd years, he couldn’t find a single way he could make CAPE beat a simple buy-and-hold strategy. In the end, he doesn’t think it represents an improvement over using conventional PEs to value stocks.

“This is one of the most oversold, overhyped metrics I’ve ever seen,” says Mr. Damodaran.

Mr. Shiller agrees that the CAPE can’t be used as a market-timing tool, per se. Rather, he thinks that investors should tilt their portfolios away from individual stocks that have high CAPEs. But he says he isn’t ready to modify his CAPE for judging the overall market.

10/23/16

With the blogosphere in full election season fever, some started to worry that the 2016 stock market gains were a precursor to something much worse. We gave the Silver Bullet to Ryan Detrick of LPL Research for discrediting this argument with two easy charts:

11/5/16

We make a special effort to recognize writers trying to debunk the endless onslaught of recession predictions. Bill McBride of Calculated Risk did this very effectively, with a few 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 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 several times outside of a recession.

We strongly recommend reading the original post in its entirety.

11/27/16

Jon Krinsky of MKM and Downtown Josh Brown both earned the Silver Bullet award in late 2016, for taking on myths about currency strength and stock performance. In sum: there is zero evidence of a long-term correlation between stocks and the dollar.

12/31/16

Our final Silver Bullet award of the year, given on New Year’s Eve, went to Robert Huebscher of Advisor Perspectives. His full article is definitely worth a read, but choice excerpts follow below. Good financial products are bought, not sold!

But I caution anyone against buying precious metals from Lear Capital. It is not an SEC-registered investment advisor and its web site states that there is no fiduciary relationship between it and its customers.

And also…

For example, Lear will sell you a $10 circulated Liberty gold coin (1/2 ounce) for $753.00 (plus $24 shipping). I did a quick search on eBay and found a circulated Liberty coin selling for as low as $666 (with free shipping).

Buying silver is no different. Lear will sell you a pre-1921 circulated Morgan silver dollar for $30 (plus $10 shipping). On eBay, I quickly found one of these for $22.00 (plus $2.62 shipping).

Conclusion

As always, you can feel free to contact us with recommendations for future Silver Bullet prize winners at any time. Whenever someone takes interest in defending a thankless but essential cause, we hope you’ll find them here.  Have a Happy New Year and a profitable 2017.

2016 in Review: Best of the Silver Bullet Awards Part One

Since the earliest days of A Dash of Insight, Jeff has brought attention to journalists and bloggers who dispel myths in financial media. We congratulate these writers with the Silver Bullet Award – named in honor of the Lone Ranger, who lived by a strict code: “…that all things change but truth, and that truth alone, lives on forever.”

In a year rife with misinformation and disinformation, it is fitting that we gave out a record 23 Silver Bullet Awards in 2016. For that reason, we’ll be doing this year in two parts; our winners for the first half of the year are summarized below. Readers may also want to check into our 20132014, and 2015 compilations, as many of the same issues persist to this day.

Have any thoughts or predictions on what will dominate news cycles in 2017? Know of a great analyst flying below our radar? Feel free to post in the comments with any suggestions or nominations.

1/3/16

It didn’t take long to find our first Silver Bullet winner of 2016. Matt Busigin took on US Recession Callers ahead of the ISM data release:

Through a combination of quackery, charlatanism, and inadequate utilisation of mathematics, callers for US recession in 2016 are embarrassing themselves. Again.

The most prominent reason for recession calling may well be the Institute of Supply Management’s Manufacturing Purchasing Manager Index. The problem with this recession forecasting methodology is that it doesn’t work.

As we now know, the US economy did not slip into a recession in 2016 – lending further credence to Busigin’s critique of these methods.

2/7/16

Paul Hickey of Bespoke Investment earned the second Silver Bullet award of 2016. While others were content to see doom and gloom in the level of margin debt on the NYSE, Hickey dismissed this as a minor concern.

Although declining margin levels are often cited as a bearish signal for the market, Hickey believes that it is a small concern given the indicator’s coincidental nature. On the other hand, the prospect of rising rates spooks investors much more, and holds them back from buying stocks.

“Margin debt rises when the market rises and falls when the market falls,” Hickey said. “If you look at the S&P 500’s average returns after periods when margin debt falls 10 percent from a record high, the forward returns aren’t much different than the overall returns for all periods.”

3/5/16

The causation-correlation fallacy is a favorite of ours on A Dash. Robert Novy-Marx distinguished himself with an excellent paper titled “Predicting anomaly performance with politics, the weather, global warming, sunspots, and the stars.”

“This paper shows that several interesting variables appear to have power predicting the performance of some of the best known anomalies. Standard predictive regressions fail to reject the hypothesis that the party of the US President, the weather in Manhattan, global warming, El Niño, sunspots, or the conjunctions of the planets are significantly related to anomaly performance. These results are striking and surprising. In fact, some readers might be inclined to reject some of this paper’s conclusions solely on the grounds of plausibility.”

We often note how bloggers and media search back to find tedious explanations and tie a day together. For more reading, we recommend our old post “The Costly Craving for Explanations.”

3/20/16

“Davidson,” by way of Todd Sullivan, was recognized for writing on the confusion of nominal and real data on Retain and Food Service Sales. His key takeaway:

Retail and Food Service Sales are at the highest levels ever measured and trending higher. Would you believe that today’s pace is more than 35% higher than our last recovery. Comments in the media would lead you to believe otherwise. Perhaps you have heard a number of recession forecasts. I have heard at least a dozen well known investors say a recession will occur before this year is out. My view differs considerably and remains very positive.

3/26/16

Jacob Wolinsky found it suspicious that Harry Dent was predicting the next big crash – and happened to have just the product to help investors cope. This “Rounded Top” chart had started to make its way across the panicky world of financial media:

The whole of Wolinsky’s article is still worth a read (especially given its twist ending).

4/3/16

The economic impact of lower oil prices in early 2016 was surprising to many observers. We recognized Professor Tim Duy for his research on the economic impact of lower oil prices.

This problem, however, just scratches the surface. Look at either of the first two charts above and two red flags should leap off the screen. The first is the different scales, often used to overemphasize the strength of a correlation. The second is the short time span, often used to disguise the lack of any real long term relationship (I hope I remember these two points the next time I am inclined to post such a chart).

Consider a time span that encompassed the entirety of the 5-year, 5-year forward inflation expectations:

4/10/16

If we spent a little time looking for the newest conspiracy theory about the Federal Reserve, we could probably give out the Silver Bullet every week. Ethan Harris of Bank of America Merril Lynch (via Business Insider) got this week’s award for shutting down a new “theory” about central banks and the dollar.

“There is a much simpler explanation for all of this. Central banks have turned more dovish because they are being hurt by common shocks: slower global growth and a risk-off trade in global capital markets,” he argued.

“Hence it is in the individual interest of the ECB to stimulate credit and bank lending, the BOJ to push interest rates into negative territory and the Fed to move more cautiously in hiking rates,” he continued.

Some may also point out that there’s a gap between Yellen’s recent messages and some of the recent speeches from FOMC members.

But Harris has thoughts on this, too:

  1. Yellen has consistently leaned more dovish than others.
  2. Most of those more hawkish speeches were from nonvoting members.

4/17/16

The mythology surrounding the Fed bled over into the next week as well. We gave Steven Saville a Silver Bullet award for targeting ZeroHedge with this very thorough rebuttal:

A post at ZeroHedge (ZH) on 8th April discusses an 11th April Fed meeting as if it were an important and unusual event. According to the ZH post:

With everyone’s focus sharply attuned on anything to do with the Fed’s rate hike policy, many will probably wonder why yesterday the Fed announced that this coming Monday, April 11, the Fed will hold a closed meeting “under expedited procedures” during which the Board of Governors will review and determine advance and discount rates charged by the Fed banks.

As a reminder, the last time the Fed held such a meeting was on November 21, less than a month before it launched its first rate hike in years.

As explained at the TSI Blog last November in response to a similar ZH post, these “expedited, closed” Fed meetings happen with monotonous regularity. For example, there were 5 in March, 4 in February and 5 in January. Furthermore, ZH’s statement that 21 November was the last time the Fed held such a meeting to “review and determine advance and discount rates charged by the Fed banks” is an outright falsehood. The fact is that a meeting for this purpose happens at least once per month. For example, there were 2 such meetings in March and 1 in February.

4/23/16

During the economic recovery following the Great Recession, critics often argued that net job creation emphasized part-time and low-paying jobs. Jeffry Bartash of MarketWatch thought to look at the data, and concluded the US economy is still creating well-paid jobs. The key takeaway is in the following chart:

5/8/16

Breaking down mean averages can produce some strange results, and you can never be sure how financial bloggers might spin that data. We gave a Silver Bullet award to Jeff Reeves for breaking down this baffling valuation of Tesla.

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

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

Reeves’ full article, still available on MarketWatch, is still very smart and very readable.

5/21/16

The “flattening” yield curve had become the newest scare issue by late May. Barron’s Gene Epstein and Bonddad’s New Deal Democrat both took this to task, with satisfying results. In particular, the latter’s article had a solid mix of compelling charts with snappy writing:

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

5/29/16

We gave this week’s award to the former President of the Minneapolis Fed, Narayana Kocherlakota. As conspiracy theories persisted, he explained the nature of Fed meetings and their timing:

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

6/12/16

New Deal Democrat earned a second Silver Bullet award for his work debunking a notoriously deceptive chart:

“The problem with this graph is that includes two slightly to significantly lagging indicators.  Your employer doesn’t start paying withholding taxes until after you are hired.  State tax receipts aren’t paid until a month or a quarter after the spending or other taxable event has occurred.  Worse, since both have seasonality, both have to be measured on a YoY basis, which means the turn in the data will come after the actual turn in the economy.”

Conclusion – Part One

As always, you can feel free to contact us with recommendations for future Silver Bullet prize winners at any time. Whenever someone takes interest in defending a thankless but essential cause, we hope you’ll find them here. Expect to see Part Two of our Silver Bullet review later on in the week. Happy New Year!

Is Forecasting Always A Folly?

Forecasting season is upon us. Anyone who gets to be quoted in print or speak to a reporter is asked an opinion. Expertise not required! It is paradise for pundits.

Many have decried the “folly of forecasting.” People love to laugh at supposed experts, looking back at old forecasts. Since most forecasts are based upon a model, modelers are thrown under the bus as well.

Barry Ritholtz wrote on this topic in his excellent Apprenticed Investor series. There are now over 200,000 blog hits on this phrase.

Background

But please consider this: Most models and forecasts are bad – very bad – but not all. The trick is to figure out which is which. Barry notes the possible exceptions:

There are only two kinds of predictions that have some value to investors: One is probability-based, and the other is risk-based. If you apply the same rules — no one knows the future, they are subject to revision and should not be taken as gospel — then these are sometimes worth considering.

Here are a few examples.

  • Millions of people attempt to paint, but only a handful are successful. Could you pick the winners?
  • Millions attempt to write, but there are few best-sellers. Could you guess them in advance?
  • Worldwide wine consumption is over 30 billion bottles. How many are really good?
  • In the U.S., 11 million people are playing baseball in a given year. Fewer than 900 are in the major leagues. There is so little difference that only an expert could identify the best players by watching them bat.

Finding the best in any large field is a real challenge!

The issue is especially important for financial analysis. I have been pondering this question for weeks. How can I best explain an important but unpopular viewpoint? I recently began this theme with by citing a bogus analysis in the New York Times. In simple fashion, I showed that if you only had the long-term average – that the market returned a positive result 2/3 of the time – you would do much better to predict “Up” every year rather than guessing 2/3 up and 1/3 down. This counter-intuitive result should be cause for thought, since it is an expensive and common investor mistake.

Ben Carlson inspired another approach. He publishes consistently strong work at his blog, A Wealth of Common Sense, which I always read and frequently cite. He discusses the difficulty of selecting the best stocks and sectors. This is the updated sector asset quilt he created, followed by his principal conclusion.

Like any asset quilt, there’s no rhyme or reason from one year to the next. I’m sure you could torture the data here using a momentum or value-based strategy to improve upon the results of the S&P 500, but unless you’re using a rules-based approach, you’re really just guessing when attempting to figure out which sectors will perform best over any given time frame.

That conclusion seems persuasive to a very intelligent observer using annual ranking changes. Can a first-rate forecaster add any value?

 

Finding the Real Experts

Ben is quite correct in noting that most contrived explanations will torture the data. Is this true of every approach? Here are some things I look for in evaluating a model:

  • It does not use too many variables compared to the available data
  • It has a good record using “out of sample” data as well as in real time
  • The underlying method is logical, proceeding from a theory
  • The modeler has both experience and expertise

Two sharply contrasting success stories reflect the two most common model types, trend following and mean reversion.

Dr. Robert Shiller is a leading economist at a top university, a Nobel Laureate, author of many papers and books of value to investors, and a popular media guest. Among investors, he is probably best known for his Cyclically Adjusted Price to Earnings ratio (CAPE) method. One of the methods that he endorses is the Barclays ETN, CAPE. Barclays implements CAPE in a mean reversion method. They look at the historical CAPE for each sector choosing the sectors most under-valued by this comparison (throwing out the bottom one). This is a mean-reversion method based upon fundamental data. At the introduction over four years ago, Barclays had promising backtest data. This did not attract many investors, most of whom cite CAPE as a method for timing the overall market – which Dr. Shiller himself does not do. After four years, the fund remains very small (under $34 million).

How has it done in real time?

Probably riskier than buy and hold the market, but much stronger returns. Those choosing to use CAPE as a reason to exit the market (not Dr. Shiller’s recommendation) would have done better to buy the ETN.

Dr. Vincent Castelli is not a professor at a top university, but he could have been. He will not win a Nobel prize, because his best work was top secret. He spent a career making U.S. armed forces safer and more effective, heading a group of other scientists from various disciplines. His modeling is known in quant circles, where he demonstrates, advises, and coaches. He is probably not going to become famous on CNBC.

His approach to sector analysis begins with the time-tested method of trend following. The tricks are in separating signal from noise, recognizing trends in a timely fashion, and exiting while you can protect profits. As an expert in modeling, Vince touches all the bases for sound work — ruthlessly pruning variables, a generous out-of-sample test, and real-time comparisons.

These two brilliant men took quite different approaches to life and later to analyzing stock sectors. Each found a profitable approach where most of us would see nothing.

Conclusion

There are many paths to successful investing. Remain open to profit opportunities by giving open-minded consideration to other approaches. Finding the best experts is just as important as finding the best stocks or sectors.