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.

Why Wall Street Strategists Always Seem Bullish

Let us divide those writing about forecasts into three camps:

  1. Those who make specific forecasts, sometimes required as part of their job;
  2. Those who criticize, but do not forecast;
  3. Those who make dramatic, non-consensus forecasts to get attention.

I plan a few more posts on this theme, but today I want to consider group 2. If you are seeking attention, it is easy to write a popular article about forecasting. Start with the viewpoint that the experts are dumb and that the average investor can do better. People love to be smarter than experts. Surveys show that 90% of all people are above average in intelligence! Well, maybe not 90%, but far more than half. They are very receptive to this approach.

Taking this easy target, the NYT cites a source claiming some great credentials. His report got a million page views and even more publicity in the sequel. I see plenty of bias and errors in his work, but let me start with the most colorful claim:

Now imagine having a coin calibrated to show “positive” 2/3 of the time, and “negative” 1/3 of the time. Flipping this coin would therefore outperform a Wall Street strategist!

This is an oft-cited concept. If the market declines 1/3 of the time (actual performance is a bit better, but we’ll go with the author’s numbers) and no Wall Street strategist forecasts lower stocks, supposedly that is proof that the experts are too bullish.

The author has quite obviously never had to forecast anything, and his math is seriously flawed. Suppose you merely forecast an up market. You will be correct 2/3 of the time. He uses his magical coin. 2/3 of the time it forecasts “up” and it is correct on 2/3 of those occasions. 4/9 in the win column. The coin forecasts “down” on 1/3 of the years, and it is correct 1/3 of the time. That is another 1/9 in the win column. So less than 56% right instead of 2/3.

The author also produces this mystery chart:

What is the wavy pink line? The wavy blue line is (apparently) a consensus average. The pink diamonds are an actual result. So, what is the pink line? A good chart has an explanatory legend, but this is a mystery.

If – instead of the mystery pink wavy line – you compare the blue line to the actual, it is directionally accurate in eleven cases, slightly wrong on four, and more seriously wrong on four others. The focus on the two lines distorts the results. There are other issues, including the time frame for analysis, but I am sticking to points that should be obvious to the average reader.

Everyone makes mistakes, but when you are calling out a lot of experts and possibly misleading investors, you bear a special responsibility to check your work. In the academic world of peer review, this article would not have been published as written.

Turning to the New York Times, readers expect a very high standard of reporting. The article does seek a little balance by looking for an accurate forecast, that of Seth J. Masters 2012 forecast of Dow 20K. It was good reasoning, like my own analysis two years earlier. Perhaps the author might have used (in George W’s words) “The Google” to search for Dow 20K.

The answer to the title question? Analysts are bullish because the long-term market trend is higher. In any given year, markets are likely to rise. If someone goes against the long-term trend, there had better be a compelling reason.

More to come on experts and predictions. My basic theme? A well-done forecast identifies the possible scenarios, specifies key variables, shows the range of errors, and focuses thinking for both the analyst and the reader.

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

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

Can the market embrace some good news?

Last Week

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

Theme Recap

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

The Story in One Chart

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

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

Personal Note

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

The News

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

This week’s news was quite good. If I missed something for the “bad” list, please feel free to suggest it in the comments.

The Good

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

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

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

The Bad

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

 

The Ugly Beautiful

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

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

 

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s award goes to Jon Krinsky of MKM Partners, with a big assist from Josh Brown. There is a consensus that countries are racing to debase currencies in “beggar thy neighbor” policies. The stronger dollar certainly reduces earnings for some companies, especially if they do not do any currency hedging. The flip-side gets no attention. Josh writes, There is zero evidence of a long-term correlation between stocks and the dollar. Take a look.


The Week Ahead

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

The Calendar

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

The “A” List

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

The “B” List

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

     

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

Next Week’s Theme

 

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

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

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

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

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

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

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

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

The Featured Sources:

 

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

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

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

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has several interesting approaches to asset allocation. Try out his new public Twitter Feed. His most recent research update suggests some “mixed signals” from labor markets.

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

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

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

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

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

This is very good advice to the recession worrywarts.

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

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

 

How to Use WTWA (especially important for new readers)

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

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

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

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

Top Trading Advice

 

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

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

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

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

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

Insight for Investors

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

Best of the Week

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

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

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

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

Stock Ideas

 

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

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

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

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

Personal Finance

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

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

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

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

Market Outlook

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

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

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

Value Investing

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

Watch out for…

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

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

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

And also this:

 

1955-2014:

            Interest rate range           average P/E

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

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

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

Final Thoughts

 

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

When does change start?

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

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

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

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

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

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

Weighing the Week Ahead: Time for Some Clarity?

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

Will the election results provide clarity for financial markets?

Personal Note

 

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

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

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

Last Week

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

Theme Recap

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

The Story in One Chart

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

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

 

The News

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

The Good

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

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

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

 

The environment has stayed slow and steady

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

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

Still, there’s a pervasive sense of uncertainty

CEOs are waiting to see what happens in the election

Companies are setting strategic plans that assume weakness

The consumer has been slowing

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

Inventories are much leaner than they have been

And pricing pressures are building

 

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

 

The Bad

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

The Ugly

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

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s winner is Bill McBride of Calculated Risk. Debunking recession calls is not popular. It is not the way to get page views. Please read Bill’s entire post to see the full story about the endless parade of recession calls. Here are some of the key points:

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

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

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

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

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

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

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

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

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

Bill cites this chart:

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

The Week Ahead

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

The Calendar

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

The “A” List

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

The “B” List

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

     

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

Next Week’s Theme

 

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

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

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

Will we finally get some clarity?

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

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

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

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

 

The Featured Sources:

 

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

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

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

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

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

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

 

How to Use WTWA (important for new readers)

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

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

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

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

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

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

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

Top Trading Advice

 

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

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

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

Insight for Investors

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

Best of the Week

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

And a key quotation:

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

Stock Ideas

 

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

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

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

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

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

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

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

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

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

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

Personal Finance

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

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

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

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

Watch out for…

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

Final Thoughts

 

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

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

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

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

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

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

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

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