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

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

When will the trading range be broken?

Personal Notes

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

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

Last Week

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

Theme Recap

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

The Story in One Chart

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

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

The News

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

The Good

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

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

The Bad

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

 

The Ugly

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

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s award goes to Ryan Detrick of LPL Research. I am showing the power of his work via the two key charts, but reading the entire post will help you to spot these things on your own.

 

The Week Ahead

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

The Calendar

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

The “A” List

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

The “B” List

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

     

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

Next Week’s Theme

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

I expect an active discussion about a looming market question:

When will the trading range be broken?

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

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

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

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

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

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

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

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

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

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

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

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

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

The Featured Sources:

 

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

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

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

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

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

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

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

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

 

How to Use WTWA (important for new readers)

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

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

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

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

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

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

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

Top Trading Advice

 

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

The Trading Goddess considers pot stocks for an election trade.

Insight for Investors

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

Best of the Week

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

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

Please take a few minutes to read this valuable post.

Income Ideas

 

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

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

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

Stock Ideas

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

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

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

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

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

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, you should join us in adding this to your daily reading. Every investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading. My personal favorite this week is the “lucky versus good” analysis from Jonathan Clements. He writes:

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

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

Millennial Investors

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

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

Final Thoughts

There are several points to keep in mind:

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

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

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

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

How is that for a contrarian position?

What is Your Confirmation Bias Quotient?

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

 

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

 

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

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

 

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

 

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

 

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

 

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

 

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

 

The Test is one of Process, not Conclusions

 

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

 

Scoring the Test

 

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

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

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

 

Weighing the Week Ahead: Has the Market Rotation Begun?

We have normal week for economic data, and a big week for earnings reports. The last Presidential debate will grab headlines. We have been monitoring these factors for weeks, but something new is showing up in the data. Let’s call it a “stealth rotation” from bonds to stocks and from bond substitutes to less favored stocks. If the punditry carefully watches the data, they will be asking:

Has a market rotation begun?

 

Last Week

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

Theme Recap

In my last WTWA, I predicted special attention to the early earnings reports and questions about whether the earnings recession was ending. That was a reasonable guess, although most of the commentary seemed to focus on a couple of big earnings misses. There was also plenty of competition from some surprising China data, the ongoing Fed debate, and of course, the election news.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. Stocks had a negative week. You can see the opening gap on Thursday after the Chinese trade data, and also Friday’s failed rally.

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

The News

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

The Good

  • JOLTS continues to show a solid labor market. Chair Yellen uses it as a signal for a tight labor market. The healthy “quit rate” shows that many people are comfortable in voluntarily leaving jobs. Some reports focused strictly on the number of job openings, which is a poor use of the data.

  • Initial jobless claims also show labor market strength.

  • Retail sales provided the week’s best economic news, rising 0.6%, the best increase in three months. (Bloomberg)
  • Corporate earnings nicely beat expectations. FactSet has some interesting early data – 76% of the reporting companies have beaten earnings expectations and 62% have beaten on sales.

 

The Bad

  • Import container counts are again lower. Steven Hansen (GEI) smooths out the effects of the Hanjin Shipping bankruptcy and finds a troubling trend. Does it portend weak holiday spending? The chart below is the year-over-year change in the three month moving average.

  • Chinese exports and imports both declined more than expected.
  • Q3 GDP estimates edge lower as more data is reported. Calculated Risk summarizes the move from various sources. Here is one example:

  • Michigan consumer sentiment slips to 87.9 in the October preliminary report. Jill Mislinski updates the story and the terrific Doug Short chart combining multiple elements of the story in a single look.

The Ugly

The political sideshow. There were polls to determine the “winner” of the debate. Not so long ago debates were seen as a way for the trailing candidate to show equality of stature – same stage, same rules, etc. Many challengers have used this effectively. It is also a way to demonstrate that a “Presidential” image. If an expert from years ago, without any context, read the transcript of this “town hall forum” debate s/he would not believe it. Campaigns are ever-more focused on the undecided or uncommitted voters, especially in the key states. Suppose for a moment that these voters may not have been the ones sitting at the front of the class. What do we expect the campaigns to do? The sound bite negative ads are one approach, but this is reaching a whole new level – and not a high one.

The most important thing you can do as an investor is to vote your conscience while still using sound, unemotional judgement concerning your personal finances.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week. Nominations welcome. I also note that Dr. Ed Yardeni joined us in applauding the Justin Lahart article on CAPE. Dr. Ed provides his own thoughts about market valuation and the advantages of forward earnings.

I am not a fan of valuation measures based on trailing earnings, especially if they trail over the past 10 years. I believe that the stock market is forward looking and discounts analysts’ consensus expectations for earnings over the year ahead. More specifically, I use S&P 500 12-month forward consensus expected operating earnings, which is a time-weighted average of analysts’ expectations for the current year and the coming one.

The Week Ahead

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

The Calendar

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

The “A” List

  • Housing starts and building permits (W). Important forward looking data on a crucial sector.
  • Industrial production (M). Volatile September data. Any sign of a rebound from last month’s loss?
  • Fed Beige Book (W). Prepared for the next FOMC meeting, this provides color from each Fed district, going beyond the data.
  • Leading indicators (Th). Widely followed, despite some controversy. Rebound expected from last month’s negative reading.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Existing home sales (Th). Without the impact of new homes, but still a good read on the overall housing market.
  • CPI (T). Inflation is still not very important, and it will not be until there are a few higher months.
  • Philly Fed (Th). Has earned some respect as one of the few regional indicators that can move markets. The first October data.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

More important than the economic data will be continuing earnings news.

Next Week’s Theme

The Presidential campaign and the final debate continue to dominate the news. The regular economic data this week include important leading indicators about housing. These will not get the attention deserved. Corporate earnings reports will also get some attention, but the emphasis seems to be on spectacular “misses.” Did you even realize that the earnings season is positive so far? Unless you look at the FactSet data, you would not know.

Through this haze there have been a few glimmers of a new trend. If you are alert, you will see more attention to the question:

Has a market rotation begun?

There is some evidence.

  • The ten-year note has moved noticeably higher while the yield curve has steepened.
  • Utilities are losing ground while banks are gaining. Brian Gilmartin astutely asks, whether banks are assuming that role.
  • Economic skepticism remains intense – but perhaps the result of the election. Chris Matthews (Fortune) notes that concern about the economy has grown even as data show improvement.

    …a voter’s political beliefs and the overall political environment instead drives how they feel about their economic circumstances.

    There’s no better way to interpret the latest results from the latest Marketplace-Edison Research Poll, which showed that 30% percent of Americans are very fearful they will lose their job in the next six months, up 10% from last year.

And also….

A particularly telling figure in this year’s survey: While 37% of those surveyed said their personal economic situation has improved over the past year—versus 21.5% who said it got worse—just 30.3% said the overall economy improved. What’s more, 36.9% said it got worse.

If more people’s financial situation improved than deteriorated, why do more people think it’s the opposite for the economy in general?

As always, I’ll have a few ideas of my own in the conclusion.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

The Featured Sources:

 

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

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

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

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

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

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli’s enhanced aggregate spread, considering when it might first give a recession signal. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score. This week Georg also updates his unemployment-based indicator, still not signaling a recession as you can see from the chart below.

GEI reports that the ECRI’s growth index remains solid, despite a marginal fall last week. Meanwhile, the ECRI continues its prediction of “stagflation lite” and Fed criticism.

This is a good time to review the St. Louis Financial Stress Index – vastly superior to anecdotes and headlines.

 

How to Use WTWA (important for new readers)

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

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

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

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

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

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

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

Top Trading Advice

Brett Steenbarger reminds us that we should always consider what we would be doing if not trading. Is it a good choice? He also highlights an interesting trading contest for women. It leads both to prizes and to job opportunities. While performance is measured, the criteria do not encouraging taking wild shots. You can still apply, but do so right away if interested since the contest has started.

Do you have an edge in your trading? Do you have a tested, trusted system? Adam H. Grimes describes this important first step for traders as well as what they should do next.

If you don’t meet Adam’s tests, you should definitely re-read Dr. Brett’s post!

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 Neal Frankle’s analysis of a client question about real estate versus stocks. In a generic sense, it is a common question faced by nearly everyone. Neal realizes that everyone’s situation differs. Using the couple’s investment goals and time frame, he compares three alternative choices. From this analysis one of the choices is easily eliminated. It is an excellent demonstration of sound contextual analysis. To appreciate the result, you should read the whole post. Here is an intriguing chart:

 

Stock Ideas

Chuck Carnevale’s most recent idea is CVS Health Corporation (CVS). His analysis shows that the stock has moved from overvalued territory to fair value – and with plenty of upside.

Our newest 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 Dexcom (DXCM). Check out the post for my own reaction. And his choice from last week, Air Products and Chemicals (APD), has now been endorsed by Athena. Check out the post to see the other picks, ask questions, and choose your favorite model.

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.

Tom Armistead takes a deep dive into the numbers in his study of IBM. Read his post to see why artificial intelligence is a crucial factor.

Lee Jackson recommends four dividend stocks from the defense sector. And also five contrarian picks with good yield.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) 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 Forbes report on a survey of young adults. It is a good read for young people and for investors wanting to understand current trends.

 

Gil Weinreich continues his excellent series for investment advisers, and of great interest to investors as well. He frequently features ideas about best practices for the advisor community. This week he introduced a new contributor, Neal Frankle. It is this week’s “best investment advice.” (And thanks to Gil for mentioning me along with others in his fine group).

Market Outlook

Mark Hulbert notes the seasonal strength typical of year’s end. Could there be a “monster rally?”

 

Final Thoughts

 

There is a continuing gap between perception and reality when it comes to economic progress and risks. This has translated into extremely defensive investment decisions, emphasizing anything that seems to provide yield. The incessant political accusations have made this worse.

The resulting environment encourages stories – even by unbiased journalists – seizing upon the dramatic. I am seeing the “R word” thrown around much more often, and by people without any special experience or track record.

The developing market rotation is still some weeks away from popular recognition, but there are signs it is getting closer. This Bloomberg interview with Tom Lee is well worth watching. Lee’s market read and forecasts have been excellent for years. He has remained bullish, and for the right reasons. I am encouraged when I see him commenting on the themes that I am also seeing.

One catalyst will be absolute losses in bond mutual funds. Investors are about to learn something important and possibly painful: Bonds and bond substitutes do not come with guarantees.

Weighing the Week Ahead: Is this the End of the “Earnings Recession?”

We face a modest week for economic data. While equity markets remain open, bonds will not trade on Monday (Columbus Day). Yom Kippur begins Tuesday at sundown and extends through the next day. The punditry, fueled by recent revelations as well as Sunday’s debate, will pounce on the election news. With the official start of earnings season on Tuesday and important reports by the end of the week, perhaps we can hope to see a serious market discussion before the week ends. I expect the punditry (eventually) to be asking,

Is the earnings recession over?

Last Week

Last week’s news was very good, although there was little reaction in stocks.

Theme Recap

In my last WTWA, I predicted a shift from the gloomy outlook might be improving as some of the current worries were reduced. That was a good guess for an overall theme. There were quite a few “looking ahead” pieces both on TV and in print. The other news – the election, Brexit, and flash crash news was featured on some days, but it is difficult to plan for that.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. Stocks had a flat week, and stayed within a range of about 1%. CNBC breathlessly noted the “triple digit moves” on several occasions. This is a great illustration of making something out of nothing.

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

Personal Note

The market is at a crucial point. It is not a time for sitting on the fence. Next weekend Mrs. OldProf (hometown Green Bay) and I are headed to visit her family in Wisconsin, so maybe I should say not a time for being a “deer in the headlights.” I am planning to write next week, but I can’t be sure. Meanwhile, we have a family fight brewing for tomorrow night, with the Presidential debate at the same time as a football game.

Because of the importance, I put extra effort into this week’s WTWA edition, and I hope it is helpful. People are sometimes bashful about reaching out to us with questions. Please feel free to get in touch via main at newarc dot com.

The News

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

The Good

  • Auto sales beat expectations, up 4.7% to an annualized rate of 17.8M. Calculated Risk puts this into perspective.

  • High-frequency indicators remain strong. New Deal Democrat does an excellent weekly update, which I follow regularly. His latest report shows the strength in both long-leading and short-term indicators. The concurrent indicators are mixed. Reading this post helps to understand why many using less data are more confused about the market.
  • A shortage of truck drivers? A $5000 bonus is available. Another among the many small, unremarked indicators which I follow. (Tyler Cowen)
  • Home prices up 6.2% over last year according to the CoreLogic index. (GEI)
  • Employment reports were generally positive.

  • Jobless claims dropped to 249K.
  • Labor participation increased, while the unemployment rate also increased from 4.9% to 5%.
  • The work week moved higher.
  • Best of all, hourly earnings increased 0.2% over August and 2.6% year-over-year.
  • The median duration of unemployment is down to 10.3 weeks. (WSJ)

  • ISM Non-Manufacturing made a big jump to 57.1, almost 6 points higher than last month and four points higher than expectations.

The Bad

  • Construction spending fell 0.7%.
  • ADP Private Employment gained only 154K, down from 175K in the prior month and missing expectations. This was worse than the “official” private employment estimate.
  • Commercial real estate index stumbles. Calculated Risk tracks this and provides a good update.

 

The Ugly

My original plan was the poll showing that over 40% of potential voters could not name the Vice-Presidential candidates. With the Presidential campaign in a descending spiral and a violent hurricane, my original idea seems lame. There is plenty of ugly news. We can all hope for a better week ahead.

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 Justin Lahart of the Wall Street Journal for his article, Shiller’s Powerful Market Indicator Is Sending a False Signal About Stocks This Time. The article has an excellent discussion of alternative methodologies, including an alternative profit measure that matched the results quite well until 2008. The Shiller CAPE is widely cited as a justification for not owning stocks, but both Prof. Shiller and his co-developer Prof. Harvey do not use it that way themselves. Here is the key conclusion, drawing upon the work of Prof Damodaran the leading expert on corporate valuation:

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 Treasurys 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.

Attacking the most popular excuse for missing the rally is not a popular position. If only more journalists would step up with this kind of investigation.

 

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 modest week for economic data, with some holiday effects included. While I watch everything on the calendar, you do not need to! Check out WTWA to focus on what is really important – and ignore the noise.

The “A” List

  • FOMC minutes (W). Unlikely to provide fresh news, but will still be watched closely.
  • Michigan sentiment (F). Good read on current employment and spending.
  • Retail sales (F). Rebound in store?
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • PPI (F). Not much is expected. This will not be important until we have a few “hot” months.
  • Business inventories (F). August data, but relevant for GDP calculations.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

Other news includes the Presidential debate on Sunday night and the start of earnings season. And of course, near-daily servings of FedSpeak.

Next Week’s Theme

The revelations surrounding the Presidential election campaign are going to dominate the news cycle. Sunday night’s debate will probably fan the flames. With bonds not trading on Monday, stocks will not have that cue. It is possible that these stories will persist, but there is a more important matter: Corporate earnings.

This earnings season could well be a turning point after a long “earnings recession” and a sluggish economy. Stocks have been resilient in the face of bad headlines and seasonal headwinds. Could stronger earnings be the spark for an upside breakout? I expect the pundits to be wondering:

Is this the end of the earnings recession?

There are three basic positions.

  1. Negative. Jim Bianco notes the declining estimates for the quarter and sees parallels to 1987. To be fair, he represents many taking this position. Here is his evidence of the plunging estimates.

  1. Eddy Elfenbein takes a neutral position, noting the trend toward lower earnings. He notes that the picture is much better if you exclude energy.
  2. Brian Gilmartin and FactSet see a possible inflection point. Brian has been the first on this story. Here is his latest analysis. While he is always a good read, it is especially important during earnings season. He provides a lot of analysis on specific stocks. FactSet explains that earnings estimate fall before the season begins, but the final returns beat estimates. Their expectation is that the final reports will break the streak of lower earnings.

The Bianco report seems strange. Surely he knows about the lowered bar and beating expectations. His squiggle chart starts in irrelevant territory and excludes the tail that is obvious in every other quarter. It is difficult for most people to see, exhibiting what I call a high coefficient of obfuscation (TM OldProf). Let us see what really happens. Like 1987? Really?

As always, I’ll have a few ideas of my own in the conclusion.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

The Featured Sources:

 

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

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

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

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

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

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli’s enhanced aggregate spread, considering when it might first give a recession signal. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score. This week Georg also updates his unemployment-based indicator, still not signaling a recession as you can see from the chart below.

Citi does not see a recession either. (HT The Daily Shot)

How to Use WTWA (important for new readers)

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

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

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

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

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

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

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

Top Trading Advice

Brett Steenbarger (as I guessed a few weeks ago) is doing another book and will be taking a sabbatical for the month. He provides us two more great posts — an update on his trading model and an interesting measure of “pure sentiment.”

Adam H. Grimes also provokes thought with a post about losing. Few understand that it is part of winning.

 

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 JP Morgan’s wonderful quarterly chart book. Budget fifteen or twenty minutes to page through this carefully. My guess is that you will lose track of time as you enjoy the objective presentation of data. While it is difficult to find favorites, here are two that can have the biggest payoff for investors.

First, do not expect stocks to fall as rates move higher! As long as the starting yield is low, increased rates are associated with better earnings, a better economy, and higher stock prices.

And second, interest rates at the long end are not all about the Fed. Inflation is the key for the ten-year note. The Fed controls the short end. Look at the evidence.

Stock Ideas

When you read Chuck Carnevale’s articles, prepare for a stock idea combined with a great lesson. I am amazed at how well he does this, week after week. Following up on his analysis of Consolidated Edison (ED), he uses the same techniques on Johnson & Johnson (JNJ). Even if you are not one of the many investors who own these stocks, you will learn a great deal from Chuck’s process.

Our newest 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 Air Products and Chemicals (APD). Check out the post to see the other picks, ask questions, and choose your favorite model.

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.

Tech assumes the sector leadership. Jim Picerno has the story.

Energy seems to have stabilized in the range I identified a couple of months ago. Some believe the OPEC deal has provided a floor. This is important as a place for picking up a few beaten-down names as well as the implications for the overall market. I am doing more research on this topic.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) 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’ (MarketWatch) warning about seven key mistakes. Read them all, but here is a sample:

1. Stocks are risky.

Reality: Sure, they’re risky. But the implication — that other investments are less risky — simply isn’t correct. Bonds and cash investments may not offer the rollercoaster ride that you get with stocks. But they leave you vulnerable to inflation, which is arguably an even bigger threat.

Gil Weinreich had another superb post in his series that explores the intersection between clients and advisors. He includes a description of the qualities that an advisor needs:

The ability to listen, question and analyze; professional knowledge and core beliefs; knowledge of what one doesn’t know, or what is unknowable; a positive attitude; peer relationships that would allow the advisor to test the value of his ideas or seek needed advisor; a propensity to share knowledge with others; discipline; sense of responsibility; and sensitivity to others’ pain.

This may seem simple and obvious, but it is very strong and helpful. Many investors ask the wrong questions and many advisors just try to maximize fees with high-profit products.

Morgan Housel has a similar message, explaining why good advice is important.

Watch out for…

Utility stocks. Bespoke shows how rapidly these can fall as interest rates rise.

Dana Lyons agrees. Check out his post to see why this sector is at a crucial point.

And FMD Capital on the “fear trade” falling apart.

Final Thoughts

 

To many investors it may seem like nothing is happening. If you follow our indicators you will see significant changes. Stocks are both safer and more promising and there are signs of sector rotation. What do you think will happen when those invested in bond funds learn that the values do not always rise?

If the “earnings recession” ends, that will accelerate the current change in tone. We all know that seasonality improves as the year nears its end, but no one has a good explanation. Here is my hypothesis:

Market participants start thinking in terms of a multiple of the next year’s earnings!

I know it seems silly, but just watch those commenting or writing. You will see it. They will begin to describe stocks of interest in terms of multiples of 2017 earnings. They will not mention Dr. Shiller’s method of looking at historical earnings. They certainly will not discuss Tobin’s Q. (Imagine: Well, Joe, we analyzed the replacement value for Amazon and found it to be vastly overvalued. We could replace their buildings, their fleet, and their workforce for 15% of their market cap). Or Google, or Facebook, or IBM, or Accenture, or any non-manufacturing company. I have never seen Tobin’s Q cited in the context of valuing a specific stock.

My own method is a constant revision of estimates using a slightly modified CAPE approach to get my own expected multiple. Since I am always looking twelve months ahead, the calendar changes are not important. This is why tracking forward earnings is so important. In particular, we have an opportunity to look for stocks with improving outlooks matching the improving economy.

We are “front-running” the pack in a completely legal fashion.

Stock Exchange: BBD, TAN, FSLR, APD, and AAP All Deserve Consideration

Technical stock analysts are a rich source of new stock ideas. Those charts always suggesting something. Our trading models each specialize in a different time frame and level of risk. Each week Felix and Oscar host a poker game. We listen in on current trading ideas in the few minutes beforehand. They like to call this their “Stock Exchange.” I am the only human present, and the only one using fundamental analysis.

Their methods are excellent, as you will learn if you follow us for a few weeks. The entire group had a winning call on energy three weeks ago, without any from the fundamentals.

Do the markets predict future events? Or should you use fundamentals to predict the markets?

That is the ongoing debate at the Stock Exchange.

This Week’s Ideas

Our technical experts have varying ideas this week. As usual, I am skeptical, but let us give each of them a chance.

Felix

I look for long-term themes, and I have a great one this week. I see a great chart for Banco Bradesco (BBD). The YTD is strong and steady. Brazil is as tumultuous as ever, except this time they might be improving their banking system.

[Jeff] How do you know about bank reform? Have you been fraternizing with those foreign models again?

[Felix] Would you believe it is just a conclusion from the chart?

[Jeff] Also, the CEO is under indictment for tax fraud.

[Felix] The chart tells you that the company and the market have moved past that issue. Take a look.

 

[Felix] I also had more questions for this week’s post! I thank my fans, and I am happy to answer.

Richjoy403 of SeekingAlpha asks:

 

I’ve wrestled myself to a draw regarding my 4.5 year position in RDS.B (i.e., I can make about equally strong bull and bear arguments). I’m asking how your models and yourself view it?

 

As usual, I answered through Jeff Miller, who could not resist adding his own comment.

 

RDS.B in the top half of our 700 stock universe. I think there are better energy plays right now. I’ll write something more on that when I have finished some research.

 

Another question from Seeking Alpha’s dls680:

 

Jeff – Love your work! Since you asked for questions about specific stocks or sectors I’d like to throw a question out to you (and Felix, since you describe him as an investor who thinks long term) about Wells Fargo.

WFC is technically breaking down while at the same time the bank sector looks like it might be entering an uptrend. I know you’ve liked the Bank sector right along, so what would you say to a long term holder about continuing to hold WFC for the long term?

 

Jeff Miller and I responded:

 

Felix does not like WFC at all. We own it as part of our enhanced yield program, which means dividends and writing calls against the position. For long-term investing I prefer regional banks like STI.

Thanks for the kind words and for joining in our discussion.

 

[Felix] Please keep your questions coming. I could use the overtime pay.

Oscar

It’s been a tough month for Odell Beckham Jr. In a stark contrast to last year’s superstar performance, he’s slumped his way through the first 4 weeks of the NFL season without a single touchdown. However, sharp eyed analysts see Sunday night’s matchup against the Green Bay Packers as a chance to get back on track.

What we’re really talking about here, of course, is mean reversion. When you have a promising player who is underperforming, you don’t expect them to flame out entirely. You’re looking for the big comeback game!

[Jeff] Do you have some stock advice here?

[Oscar] Of course! I was just explaining how you should look at stocks. Take a look at the Guggenheim Solar ETF (TAN). It’s been a rough year to be sure, but I can’t possibly imagine this sector limping along at $20 indefinitely.

First Solar (FSLR) is one of the key holdings in TAN as well as in our custom sector basket. It is a great example. We’re starting to see rebounds here after a possibly overdone correction in early August. I’m expecting to see significant gains over the next 4 week period.

[Jeff] Your pick this week is also attracting some fundamental analysts, including this one on Seeking Alpha, who calls FSLR a “unique value and growth play.”

[Oscar] What does he think about the Cubs?

[Jeff] You are incorrigible! Let’s see what Holmes has for us this week.

Holmes

Oscar is looking for a rebound in his pick, but I am the rebounding specialist. Air Products and Chemicals (APD) came of its recent high of 145.72, and went straight down 7 straight sessions before bottoming and starting a nice little zig zag run up and to the right. That is a stock with rebound potential! I would look for this stock to get back to its highs with a downside stop at 133.75.

[Jeff] it is a bit over-valued, but it does have a 2.5% yield. To get the rebound you expect you will need yield seekers who are not that sensitive to valuation.

[Holmes] There are plenty of those folks around!

Athena

I have a great choice this week, Advance Auto Parts (AAP). This one’s been in the doghouse following an 18% drop last November, but I’m predicting an upside here.

[Jeff] Even after the drop, the stock is still overvalued by 30% or so according to Chuck Carnevale’s first-rate methods.

[Athena] I am sure that Mr. Carnevale is very nice, but my wisdom has been accurate for many centuries.

[Jeff] It might be a bit out of date. I have been looking for some guests to help keep this group in line. Perhaps we can persuade him to visit.

[Athena] That would be fine. I am always willing to share my wisdom.

Questions

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

Cast of Characters

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

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

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

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

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

An Important Note to Readers – from Jeff

All of the characters (except me!) are models, carefully engineered and tested by one of the leading developers of the last thirty years. I humanize them to make it easier to understand the characteristics in their design. I always remind readers that my posts are informational, not investment advice, and that is especially true here. While we are trading based upon all four models, we are always watching and can act quickly when necessary. The models are not suitable for all investors. If you like the approach, reach out to us (info at newarc dot com) and we will provide more information.

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

Finding great stock picks need not be boring. Please enjoy the banter and join in.

Weighing the Week Ahead: Will Election News Change the Course of Markets?

The calendar has a lot of data, but the FOMC meeting is over. The market waits for the next big event. We will soon have another jobs report, but Monday’s presidential debate overshadows the other news. The news cycles this week will be all about the election, and the financial press will be no different. Should investors use this news to change course?

Last WeekThere was plenty of economic news, and it was another mixed picture. The FOMC decision dominated.

Theme RecapIn my last WTWA, I predicted a focus on bonds, especially at the long end. That proved to be one of my worst theme forecasts. While interest rates figured prominently in the discussions, the Fed commentary quashed the selloff in the long bond. The ten-year note rates finished a bit lower than last week.

The Story in One ChartI always start my personal review of the week by looking at this great chart from Doug Short. Stocks had a good, three-day rally. Doug attributes this to central bank policy – no rate increase from the Fed and the B of J.

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

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

The Good

  • FOMC held rates constant with a hint of increases to come. Whether or not you agree with the decision, the market seemed to celebrate. This is despite the reduction by the Fed in estimates for the long-term growth rate. The market continues to applaud stimulus over results.

(click to enlarge)

  • Building permits increased by 3.7%. This is a good leading indicator for housing.
  • Global steel production is again positive.

(click to enlarge)

The Bad

(click to enlarge)

The Ugly

More violence. Talks have broken down in Syria, leaving the two million residents of Aleppo without water (The Guardian). Continuing incidents, tensions, and protests involving U.S. police and assorted bombings. It is not as if leaders were not trying. The U.S. and Russia have joined to back talks in Syria.

Chicago’s homicide rate is much higher.

(click to enlarge)

The TSA, much maligned last summer, collects hundreds of weapons each week, before they get into the aircraft cabin. Here is a typical haul of firearms. Read the entire post to see the other creative weapons.

(click to enlarge)

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week. Nominations are always welcome.

The Week Ahead

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

The Calendar

We have a big week for economic data, setting up for some important reports at the start of October. While personally I watch everything on the calendar, you do not need to! I highlight only the most important items in WTWA. Focus is essential.

The “A” List

  • Personal income and spending (NYSE:F). Can the recent strength continue?
  • New home sales (NYSE:M). A decrease is expected, but how much?
  • Michigan sentiment . An important concurrent indicator for employment and spending. Is there an election effect?
  • Consumer confidence . See Michigan sentiment. This is almost as good and usually correlated.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Pending home sales (Th). Not as important for the economy as new homes, but still a good read on the market.
  • Chicago PMI . The most important of the regional indexes, especially when released on the Friday before the ISM index.
  • Durable goods orders (NYSE:W). Highly volatile August data with a big monthly decline expected. Any chance of an upside surprise?
  • Core PCE prices . The Fed’s favorite inflation indicator, so it is worth watching.
  • GDP third estimate (Th). Few are interested in the final revision (before later benchmarking) of Q2 GDP, but this is what goes into the books.
  • Crude inventories . Often has a significant impact on oil markets, a focal point for traders of everything.

The first Presidential debate will be a news highlight with markets paying attention. FedSpeak is back in full swing. Chair Yellen testifies on Wednesday before a House committee on bank supervision.

Next Week’s Theme

Most investors would prefer to tune this out, but we can no longer avoid it. The polls have tightened. We are on the eve of the first of three Presidential debates. It is expected to attract more viewers than the Super Bowl. Debates are always important, but this time is really special. The debate will provide a focus for the news cycle, including the financial media. I expect that everyone will be asking: Should the election news cause investors to change course?

Please note that this is not a post with political advocacy. Everyone should vote as they choose, and for whatever reason. That said, it is important for investors to understand what is anticipated by markets, and the likely result if things change. I have worked to find articles that reflect a mainstream viewpoint. As always, I welcome alternative suggestions.

We have three key questions. Out of hundreds of posts on these topics, here are a few that are good. Think of it as a starting point.

  1. Who will win? Nate Silver, whose methods have done well, gives Clinton a chance of about 60%. Larry J. Sabato now has Trump leading in the Electoral College.
  2. What actions might result?
    1. Paul Ryan should know. He sees changes in tax policy, regulation, entitlements, and anti-poverty programs.
    2. Economist Mark Thoma warns about problems in taxes, spending and economic growth.
    3. Niall McCarthy (via GEI and Statista) has something of a mainstream viewpoint, citing Moody’s. Whether you agree with these conclusions or not, it probably reflects the current street expectations. Also see Nanette Jacobson of the Hartford Funds.
  3. Will Congress agree? Important, but little good work.

As always, I’ll have a few ideas of my own in the conclusion.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

The Featured Sources:

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

The recession odds (in nine months) have nudged closer to 10%.

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

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.

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).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

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

These are just a few indicators in a battery of twenty-one that we examine, and whilst there are no alarm bells yet, the aggregate composite of all 21 indicators shows the US economy the most vulnerable to exogenous shock since this expansion started:

How to Use WTWA

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

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

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

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Holmes – 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. What scares you?)

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

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

Top Trading Advice

Brett Steenbarger continues to provide a great piece of trading advice every day. Do you have a regular performance review? What does it include? Dr. Brett explains how to improve your trading from this process. He also has a great post on why creativity is important for traders. My guess is that most traders have not even thought about this question. Here’s why you should:

I recall speaking with a successful trader who told me that he was excited about the opportunity in the marketplace. I responded by saying that he was the first person I’d spoken with to tell me that. Everyone else was lamenting the lack of opportunity in markets. He said, “That’s right. I’ve always made my money going against the consensus!” That was shortly before the events of Brexit. That trader was able to capitalize on opportunity because he not only saw the world differently, but experienced it differently.

Adam H. Grimes also takes up the need for creativity and how to accomplish it. He draws upon his experience as a musician, and includes some other great examples for his proposed five steps.

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be this analysis of risk by Michael Kitces. His informative blog is aimed at financial advisors and most of us read it religiously. A look at what your advisor is (or should be) thinking about is information you might not normally see. If you manage your own investments, it will give you some helpful ideas. Michael explains the difference between risk tolerance, risk capacity, and risk perceptions. Many people do not understand how much risk is needed to achieve their performance goals. Good planning is essential. He also notes:

The key point is that if perceptions are (or become) misaligned with reality, investors may engage in “surprising” behavior that seems inconsistent with their risk tolerance. For instance, an individual who is highly risk tolerant, but has the (mis-)perception that a calamitous economic event will cause the market to crash to zero, might still want to sell everything and go to cash. Even though he/she is tolerant of risk, no one wants to own an investment going to zero! In addition, the research suggests that some people may have better risk composure than others; in other words, some investors can keep their composure and maintain a consistent perception of the potential risks around them, while others have risk perceptions that are more likely to move wildly.

Another good treatment of risk comes from Seeking Alpha Senior Editor Gil Weinreich. He regularly raises good questions affecting both advisors and individual investors. His discussion of investment goals and risks highlights Eric Nelson, who cites the current fixed income risk to retirees:

Unfortunately, many people still invest as if bonds are priced to return 6% to 8% per year or more going forward. We continue to see significant inflows into bond funds and ETFs as well as balanced funds with a considerable allocation to longer-term bonds. These decisions are especially risky for retirees, whose greatest investment risk entails holding too much of their portfolio in assets that won’t produce an acceptable long-term return, such as low-returning bonds.

Stock Ideas

Chuck Carnevale continues his analysis of high-quality dividend stocks, searching for those that are fairly valued. His discussion of Flowers Foods, Inc. analyzes the stock and also provides an important lesson.

David Van Knapp analyzes which of the “dividend contenders” might be at risk.

Eddy Elfenbein has a great annual stock list and frequent updates about those stocks and the overall market. His clever commentary is appreciated by all, including those who follow him on Twitter. This week he launched an ETF (CWS after the name of his blog, Crossing Wall Street). The ETF will hold his recommended stocks, which you can buy without making twenty different trades. The news is explained in this interview with Abnormal Returns. I also enjoyed this Bloomberg interview, which also includes some of Eddy’s stock picks.

Peter F. Way’s approach measures the hedging used by big-money players. This week he calls attention to biotech stocks finding 70 that are attractive to institutional investors.

Infrastructure stocks are poised to gain no matter who wins the election. Barron’s interviews Jamie Cook, a top-ranked CSFB analyst. Knowledgeable investors can probably guess some of her key picks.

(click to enlarge)

Our newest trading model, Holmes, has been contributing an idea each week, something we bought for clients a few days ago. I will mention it here, but you can see it sooner (along with other interesting ideas) if you read my new weekly column, the Stock Exchange. I have a “conversation” with disciples of our four trading models. Since each has a different personality and style, there are often disagreements – especially with me! While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas may 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. This week Holmes added several stocks, including CVS. See the Stock Exchange for a more complete analysis and ideas from the other experts.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are several great choices worth reading. My personal favorite is (once again) our winner of the “best of the week” honor (see above). I also liked the “secret to a good marriage” from Suzanne Woolley. Hint: This is a financial secret. How much is it OK to spend without talking with your partner? Answer for yourself before reading the article, which is both entertaining and quite important. (For guys, I advise not learning the cost of salons and something called a Mani Pedi. Mrs. Old Prof informs me that men also get Mani Pedi’s and I am hopelessly out of date. She does, however have ideas about the appropriate spending limits. The ratio is about 5:1).

Market Outlook

Josh Brown, who expertly helps individual investors by revealing behavior of some pros, highlights the importance of the “career risk trade.” Many managers are chasing the returns from the last twelve months.

Watch out for…

A bond bubble? Jim Cielinski looks at persistent buying despite valuations. He identifies four elements and produces this interesting graphic.

(click to enlarge)

Final Thoughts

I have an answer for each of the three questions. On a personal note, this is a sweet spot for me. Given my combination of skills – top college debater, coach of the Michigan team, political scientist, and student of presidential debates — this is a good topic for me. For most of these debates the expert commentators on TV were my colleagues as coaches and judges, from back in the day. Mrs. OldProf was originally amazed that they echoed my comments. Then she came to expect it!

  1. Who will win remains in doubt, but the first debate will be crucial. It could represent a change in what is important. Most presidential debates have emphasized short sound bites to convey a message, regardless of the question. That is what the coaches teach: Get your message in there! Incorrect statements of fact have been pounced upon as gaffes. There is a long history. There is also an equalizing effect. Both candidates are on the same platform. The visual and emotional impact may be as important as the substance. One observer even suggested that we should watch with the sound off. (That would facilitate watching Monday Night Football at the same time).
  2. Both candidates want to spend on infrastructure, which will be an economic stimulus. This will require compromise with Congress. Ostensibly a Republican would have an advantage, but there is dissension in the ranks. Initial decisions will include some executive orders, so there could be an immediate effect on health care and immigration.
  3. The dynamic with Congress will be crucial. A new president needs to forge some compromises on spending, tax reform, trade, foreign policy, health care, and defense. Without knowing the Congressional results this is nearly impossible to predict.

Not on the list of question — I expect a progression of reduced uncertainty.

  1. This week we’ll have more definition of the outcome.
  2. After the election we’ll know more about Congress.
  3. After a few months we’ll have more sense of the dynamics and the potential for compromise.

Political uncertainty has limited economic growth, earnings and stock prices. As the uncertainty is resolved, all will improve.

Weighing the Week Ahead: Time for the Bond Correction?

The calendar has very little important data. The highlight is the FOMC announcement and press conference on Wednesday. Even though the Fed is not expected to change course, bonds have gotten much weaker, sending the ten-year note yield higher. This effect is gaining notice. Should we expect a further bond selloff?

Last Week

There was not much news, and it was another mixed picture.

Theme Recap

In my last WTWA, I predicted a week of wondering whether we should start fearing the Fed. That was the Monday theme, but it did not last long. Governor Brainard gave a very dovish speech right at the deadline before the blackout period. Many had expected a significant tone change from her. Perceived odds of a rate increase declined after that and continued with the weaker-than-expected data reports.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. The overall range, once again, is very narrow. Doug emphasizes the early-week volatility and generally soft data.

Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective. Here is a sample, showing the regularity of drawdowns since 2009, including 5% or more about twice a year and several over 10%. Keeping perspective is easier when you understand what is normal.

 

The News

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

The Good

  • Initial jobless claims were 260K, continuing recent low levels.
  • LA area port traffic increased in August. (Calculated Risk). This indicator may need a “reset” now that the Panama Canal is able to take more traffic. There will also be noise from the bankruptcy of a big shipping firm, leaving some cargo stranded.
  • Inflation – both PPI and CPI remains at benign levels. It is not yet at the point that will attract aggressive Fed action, but is starting to reflect improvement in wages and the economy. Doug Short and Steven Hansen collaborate on the most comprehensive analysis of these data. Check out this deep dive!

  • U.S. households are richer than ever. Scott Grannis reviews the latest updates (June data). While it is 2015 data, incomes also showed a big gain.

  • Frequent indicators are stronger. New Deal Democrat’s update of indicators that most people miss is a regular read for me. One excellent feature is the separation of long-leading, short-leading, and concurrent indicators. This is an excellent check on the more commonly discussed economic indicators. It requires a lot of work to provide information that would be difficult to compile on your own. Here is a key quote from this week’s post:

    Now ALL but one of the long leading indicators are positive.  Interest rates for corporate bonds, treasuries, the yield curve, real money supply, real estate loans, mortgage rates, purchase and refinance mortgage applications are positive. The only negative is that mortgage rates have not made new lows for over 3 years.

     Short leading indicators turned a little more mixed.  Stock prices, jobless claims, oil and gas prices, gas usage, and as of this week the spread between corporates and treasuries, are all positive. Both measures of the US$ are now neutral.  Industrial commodities have joined the volatile regional Fed averages as a negative.

     The coincident indicators remain mixed. For once recently all measures of consumer spending are positive.  The BDI remained barely positive.  Rail, steel, the Harpex shipping index, and bank rates remain negative, with bank rates really spiking. Tax withholding was mixed.  Obviously I do not like a negative YoY tax withholding reading, but I suspect this will resolve next week.

  • Las Vegas visitor traffic has reached a new record high. Bill McBride has the story. And this is even before the new direct flights from Beijing have begun.

The Bad

  • Rail traffic had another bad week. Steven Hansen notes that it is still down 4.9% y-o-y if you remove coal and grain traffic.
  • Industrial production dropped 0.4% missing expectations for a decline of 0.3%.
  • The federal budget deficit is increasing as revenues falter. Scott Grannis has a good discussion. Various sources this week, including Barron’s, noted that the election debate does not pay enough attention to this issue.

  • Election uncertainty is holding back business investment, and it will not stop when the election ends. Duke’s regular survey of CFO’s reports that 1/3 will hold back on investment until there is information about how the new president will govern. Election expert Prof. Larry J. Sabato also expresses concern about the “strange race.” This is a growing concern.
  • Michigan sentiment missed expectations (89.8 v 91.5), but matched last month’s final result.
  • Retail sales declined 0.1% missing expectations of a 0.3% gain. Jill Mislinski covers this thoroughly. The effect on Doug Short’s Big Four indicators is described in the quant section.

 

The Ugly

Corporate misconduct. Deutsche Bank via Bloomberg. “Aside from the U.S. probe into residential mortgage-backed securities, the lender also faces inquiries into matters including currency manipulation, precious metals trading and billions of dollars in transfers out of Russia”. Wells Fargo creating two million phony accounts. (CNN). Exxon accounting issues. (Reuters). Bosch under investigation for possible help to VW in “Dieselgate.” (Bloomberg).

Wells Fargo’s CEO John Stumpf will be before the Senate Banking Committee on Tuesday. The fines and other penalties for corporate offenses sound large, but do not really force accountability. Eddy Elfenbein ponders what a Wells Fargo investor should do. (We also hold stock versus short calls).

Following up on last week’s North Korea story – the Council on Foreign Relations has a collection of papers covering the key issues.

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 Chris Ciovacco (See It Market) for his great explanation of the VIX. Featuring a prior piece by Jeff Macke, he emphasizes that the VIX is not really about fear, but expected volatility.

The misunderstanding of this concept is costly for investors who see it is a leading “fear” indicator, as well as traders who misuse it for hedging. The entire post is worth a careful reading, but keep this chart in mind:

See also runner-up Adam H. Grimes with similar conclusions on the same topic.

 

The Week Ahead

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

The Calendar

We have a very light week for economic data, featuring the FOMC decision and Yellen press conference. While personally I watch everything on the calendar, you do not need to! I highlight only the most important items in WTWA. Focus is essential.

The “A” List

  • FOMC decision (W). No policy change is expected. Will the statement and press conference clarify anything?
  • Housing starts and building permits (T). Crucial element for stronger growth.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Existing home sales (F). Not as important for the economy as new homes, but still a good read on the market.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

FedSpeak will resume after the meeting with several participants on the calendar.

Next Week’s Theme

Last week began with revisionist Fed thinking on Monday and a poorly-explained sell-off on Tuesday. I parsed the explanations which were basically inconsistent. Many relied on the lame “delayed reaction” argument. It is amazing how imagination can be used to make facts fit your favorite scenario. I tweeted a good CNBC sequence where the stock pundits (once again) said that markets were taking a cue from oil. The oil expert then opined that commodity traders were watching stocks!

True enough. Everything declined together on Tuesday, including the interest-rate sensitive names. Pundits were mystified by bond selling even though the FedSpeak was more dovish. Could it be? Regardless (but including) what the Fed does, I expect that everyone will be asking: Is the long-awaited bond correction at hand?

There is a key mistake in most commentary – the idea that the Fed controls all interest rates. “Davidson” (via Todd Sullivan) pursues a theme that I hope will be familiar to my readers.

When I began my career ~35yrs ago everyone talked about “The Credit Spread”. Today, everyone talks about rates as if it is the rate, the short-term rate, and importantly the rate the Fed sets, the Fed Funds Rate. Today’s discussion is universally about the next Fed Funds Rate hike as if the Federal Reserve controls the economy. The extensive economic data we have available has never supported the wide-spread belief repeated ad nauseam in every media that the Federal Reserve controls US economic activity. Actual control lies in the Free Market.

I have not been a fan of Jeff Gundlach on most of his predictions about stocks, but when a “bond guy” gets worried about bonds, we should probably pay attention. Robert Huebscher covers this in an article that has been extremely popular with investment advisors. Here is a key quote:

“This is a big, big moment,” Gundlach said¸ and it won’t pay to “be cute” by trying to benefit from short-term price movements, since the dominant trend will be higher rates.

“It pays not to squeeze the last bit of juice out of the orange,” Gundlach said.

Brett Arends (who also has been no fan of stocks) is sounding a warning about the so-called safe investments.

JP Morganseems to be on the same page.

As always, I’ll have a few ideas of my own in the conclusion.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

The Featured Sources:

 

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

The recession odds (in nine months) have nudged closer to 10%.

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

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

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

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).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

Quant work on GDP was a key topic this week. The Atlanta Fed’s GDP Now project shows a current forecast of 3%, a lot better than most expect.

Lipper explains why things might be stronger than they feel on the earnings front. This is a theme from Brian Gilmartin that we have been monitoring for months.

Mark Perry has a good idea about GDP measurement. Let’s start by asking whether you think the world’s “music well-being” has ever been better than it is now. Mark explains why it is currently awesome. Next take a look at how it is measured by GDP. Everyone will enjoy this chart, which makes obvious the error in using dollar sales as the main indicator.

 

 

How to Use WTWA

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

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

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

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Holmes – 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. What scares you?)

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar holds several aggressive sectors. The more cautious Holmes also remains fully invested. They now have a regular Thursday night discussion, which they call the “Stock Exchange.” You are welcome to join in with questions or ideas.

Top Trading Advice

Brett Steenbarger is posting great ideas day after day. Traders should read his posts frequently. I sense another book coming! My favorite this week is about what you should do if you are in a drawdown.

Are other people, trading similar strategies, also losing money?

That will tell you quite a bit.  If you were making money and suddenly go cold and others in the same markets, with similar strategies are doing the same, then you know that it isn’t simply a psychological issue.  Everyone did not suddenly lose discipline or become an idiot at the same time.  Rather, the strategy is not working under current market conditions, or it has stopped working altogether.

Simple, but wise and often overlooked by traders who start second-guessing themselves.

I also recommend this post on The Psychology of Dealing with Choppy Markets.

Most aspiring traders would save a lot of time and money if they asked Sam Seiden’s question, Are You a Good Fit for Trading? (This was GEI’s Investing Trading Academy’s article of the week).

Adam H. Grimes has another take on psychology, considering how it is linked with experience and methodology.

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Chuck Carnevale’s lesson about how to pick dividend stocks. I almost always suggest that readers take a look at his ideas, but this week’s post is extra special. He provides a wonderful opportunity to test the tools at his wonderful time-saving and profit-building site. Anyone who is a do-it-yourself individual investor should set aside an hour or so to read the article and try out the method.

His example convincingly shows why entry price is important. A given budget permits purchase of more shares. Better value at the time of purchase gives you both extra upside on stock gains and also larger dividends. Take Chuck’s challenge to try it for yourself.

Stock Ideas

 

Eddy Elfenbein’s latest CNBC appearance explains the relationships underlying the gold trade, where someone bought $1 million worth of put options on a single gold stock. The discussion emphasizes the short run, reaching a different conclusion than Felix, who thinks long-term.

Our newest trading model, Holmes, has been contributing an idea each week, a stock we bought for clients a few days ago. I will mention it here, but you can see it a little sooner if you read my new weekly column, the Stock Exchange. I’ll have a “conversation” each week with all three of our models. Since each has a different personality and style, there are often disagreements – especially with me! While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas may be a starting point for your own research. Holmes may exit a position at any time, and I am not going to do a special post on each occasion. If you want more information about Holmes and exits, just sign up via holmes at newarc dot com and you will get email updates. This week’s Holmes added several stocks, including Solar City (SCTY).

Technology stocks are now favored by value funds. That is no surprise to me or to my readers! Barron’s has the story. A subscription is required, but you can probably get it by putting the title or key phrase into Google.

Barron’s also highlights homebuilder CalAtlantic (CAA). The company has been digesting a merger which helped to place it in some of the fastest growing areas.

The top 10 dividend stocks from Morningstar’s Ultimate Stock pickers.

Peter F. Way uses his unique methodology to highlight Dow stocks with the best risk/reward profile. Here is one of several interesting charts:

OK, here is another….

You can get some great ideas from this approach.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. This was a really great post. There are several great choices worth reading, including my pick for best advice of the week. My personal favorite is the Harvard Business Review study of the cost of your inconsistent decisions. Unless you are a regular HBR reader (I listen to a lot of their podcasts) you would never see this story. Tadas does the heavy lifting for you.

Many readers would also enjoy his Saturday post with interesting lifestyle features. Mrs. OldProf liked the item on wine.

Market Outlook

Many people have described current markets as “complacent.” That is not what I see. The fact that the trading range is tight can occur when there are intense feelings in a rough balance. There is plenty of negative market sentiment. Here is a typical popular column listing six worries.

This week I was struck by two excellent posts.

Brian Gilmartin summarized the “Delivering Alpha” conference, where nearly everyone was downbeat. For contrast, here are some notes from Market Folly. It will be interesting to review how well these ideas play out over the next year.

Joe Fahmy explains why the market will not correct when that is what everyone is expecting. His perception of the trading community squares with what I hear.

Watch out for…

Junk bonds. Marc Gerstein has a warning for “yield hogs.”

Final Thoughts

 

Fueled by ill-informed reports from financial media, most investors think only of a single interest rate, controlled by the Fed. This is a costly mistake. It is important to monitor the entire yield curve.

The short end responds mostly to the Fed policy announcements. Most recently the Fed is unsure that their decisions can have the desired impact, so the resulting rate is imprecise.

The long end reflects (at least) five factors:

  1. Expected future rate increases – the term premium;
  2. Inflation, current and expected;
  3. Economic growth;
  4. The Fed balance sheet – estimates are that the current holdings have an effect of 1 – 1.5% on the ten-year note; and
  5. Global interest rates, including policies from other central banks.

Those who attribute the long rate or the slope of the yield curve to a single factor are making a costly mistake. This is especially true for those whose favorite game is to make it all about the Fed.

Investment Implications

The dominant perception holds that the Fed is about to raise interest rates despite economic weakness, probably creating a recession. This is backwards. If rate increases are consistent with economic growth, it would be the “bear steepener” that I have been describing for some weeks. We should embrace short-term rate increases when growth is strengthening and the long rates are also moving higher.

Holdings to reduce or avoid include:

  • Bonds and bond mutual funds. Alliance Bernstein warns that the one statistic you must know is duration of your bond holdings. Do you? That helps you see how much is at risk.
  • Utility stocks and bond proxies.
  • REITs and MLPs that are interest sensitive and without a tie to economic growth. Look for sectors benefiting from demographic changes – health care, senior living.

Holdings to emphasize include:

  • Technology
  • Banks
  • Homebuilders

The consensus, even among the traditional bond advocates, is that the crowded bond trade (bubble?) has reached its end. As investors following the traditional 60-40 formula see absolute losses on their brokerage statements, where do we expect the money to flow?

Weighing the Week Ahead: Should We Fear the Fed?

The calendar has little important data. Friday’s sharp selling was widely attributed to the fear of a Fed rate hike in September. Is it time? Should we fear the Fed?

Last Week

There was not much news, and it was another mixed picture.

Theme Recap

In my last WTWA, I predicted a continuing discussion of the Fed and the timing of the first rate increase, combined with concern over a September market correction. The first part was pretty accurate all week, but the market remained quiet. The modest trading range ended spectacularly on Friday., The “C” word is now on the lips of many.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. The overall range, once again, is very narrow. Doug’s take is that Friday was all about the Fed. He writes as follows:

Today’s action essentially confirms the metaphor of an equity market infant nursing on mother Fed’s breast. The selloff was triggered initially by hawkish remarks by the normally dovish Boston Fed President Eric Rosengren, a voting member of the FOMC. But more surprising was the announcement of an unannounced speech by even more dovish Lael Brainard at the open of the FOMC week, which runs counter to the general policy a silent Fed prior to the FOMC meeting end.

As you will see in today’s “Final Thought,” I have a very different interpretation, still consistent with the data.

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

A Two-Question Quiz

  1. The recent Purchasing managers index for manufacturing recently registered 49.4. Last week’s “services” index came in at 51.4. Each data series has a long-term relationship with GDP. Which of these reports implies the higher rate of economic growth? Which one implies an impending recession? [See conclusion for the answer.]
  2. Suppose you are in an NFL “survivor” pool. You just need to pick a team that will not lose that week. No point spread. What are your odds of making it through two weeks? You may pick the biggest favorite each week.

The News

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

The Good

  • Initial jobless claims fell to 259K, down from the prior week and continuing recent low levels.
  • The Beige Book was mildly positive, providing support for the modest growth scenario.
  • Framing lumber prices remain strong. (Calculated Risk).
  • Sentiment remains bullish. Dana Lyons looks at the ISE Call/Put ratio to refute the idea of a “frothy” market.

  • Durable goods orders had a solid rebound from earlier weakness, increasing 4.4%
  • The JOLTS report registered a new high in job openings and continued strength reflected in the quit rate. This shows the number of people voluntarily leaving their jobs. Josh Brown has a good discussion of this point. The labor market structure from the report is less encouraging. The ratio of unemployment to job vacancies confirms non-recessionary conditions, but also a mismatch between available jobs and workers. (Simple explanation here. Also a good chart via The Daily Shot).

The Bad

  • Employment benchmark revisions showed a decrease of 150K jobs over a one-year period ending last March (BLS). While this is a preliminary report, it is usually a good estimate of what we will see in the actual revisions this coming March. Essentially, this means that the job growth over the one-year period ending last March was over-estimated by 150K jobs, described as 0.1% of the labor force. It is a much larger percentage of the reported net job growth. I frequently cite this report as the most accurate count, but one that arrives too late to be of interest to those in the news and financial communities. If you missed my challenging quiz on the employment report, please take a look.
  • Rail traffic had another bad week. Steven Hansen (GEI) reports on the 5.7% decline for the month of August.
  • ISM non-manufacturing dropped to 51.4. As Bespoke notes, this was the biggest monthly decline since 2008.

Here is some color from the actual report:

WHAT RESPONDENTS ARE SAYING …

“Relatively stable August, with no sharp increase or decrease in sales or pricing. Labor availability and cost remains a very high focal point.” (Accommodation & Food Services)

“Overall, the oil and gas industry remain in [a] ‘wait and watch’ mode. The price of oil has impacted investment considerably.” (Construction)

“No significant changes to report. Still on track for expansion efforts to begin fourth quarter 2016.” (Finance & Insurance)

“Still recovering from the current downturn in the renewable energy market which is expected to pick up in the fourth quarter.” (Professional, Scientific & Technical Services)

“Stable with some increase in construction activity.” (Public Administration)

“The business environment has softened a bit over the last month. There are now opportunities to fill in the marketplace.” (Retail Trade)

“Midyear [is a] slow time for us, summer build is over, fall is historically light, holiday peak build September and October for peak time November and December.” (Transportation & Warehousing)

“Good, but slowing from previous months.” (Wholesale Trade)

 

The Ugly

North Korea is a multiple winner of my “ugly” award. The recent nuclear test is viewed as completely unacceptable by most of the world. Can leaders find an action that peacefully accomplishes widespread objectives? Will those having the most influence over N. Korea cooperate? These are important questions, beyond our normal concerns over investments.

Jonathan D. Pollack (Brookings) has a good explanation of why the recent test is different and more threatening than those in the past.

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 Wisconsin economist Menzie Chinn, who earned a belt full of bullets in a single article. The context is a post for a class in economics. Since so many current financial commentators take pride in not having taken Economics 101, it is a great illustration of why they are wrong! So many mistakes of this sort are made by financial pundits, including intentional misrepresentations. Prof. Chinn illustrates one of the most frequent errors – not using log scales in charts when they are appropriate. Note the deception it would generate in this example, which actually shows a constant rate of increase.

He also debunks the data conspiracy stories, using several links and good explanations. This post might be the single most profitable thing for investors to read this week.

 

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 another light week for economic data. While personally I watch everything on the calendar, you do not need to! I highlight only the most important items in WTWA. Focus is essential.

The “A” List

  • Retail sales (T). The biggest report of the week. The odds of a rate hike will increase if this is positive.
  • Michigan sentiment (F). Consumer confidence has been strong, helping to support the stock market.
  • Initial claims (Th). The best concurrent indicator for employment trends. Quiet strength is the long-term trend, so a spike would be worrisome.

The “B” List

  • Industrial production (Th). Volatile data with a big gain last month. Not much is expected, but this remains important.
  • CPI (F). Still not important, but this number will start to approach the Fed’s 2% inflation target as year-over-year gasoline prices stabilize.
  • PPI (Th). See CPI above.
  • Business inventories (Th). July data, but it is another piece in the Q2 GDP puzzle.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

FedSpeak will enter the pre-meeting blackout period after Monday. Fed Governor Lael Brainard has been dovish, so her Monday presentation will get plenty of attention.

Next Week’s Theme

Last week brought us more quiet for the first part of the abbreviated week. Friday was a very different story. The sharp decline, ending a two-month string of quiet days, commanded attention. What was going on?

The instant conclusion was fear of a September rate increase from the Fed. That sets the tone for next week. Everyone will be asking: Should we fear the Fed?

Normally I recommend spending very little time on yesterday’s news. As I wrote a few months ago, investors do not get paid for this knowledge – only pundits who get to sound smart after the fact!

This week is a bit different. Having a good sense about what happened Friday is important to our advance preparation. Here is an abbreviated sequence of events:

  • Stock futures were set up for a flat opening, just as we had seen all week.
  • Boston Fed President Eric Rosengren, repeating a speech made in August, stated that gradually removing accommodation was the best way to extend the duration of the recovery. The Boston Globe states that this pushed the Dow 400 points lower.
  • Stock futures moved lower by about ½ of one percent when the speech was reported.
  • Since markets are not expecting a September rate increase, and only a 60% chance of one before the end of the year, the original move attracted a lot of discussion.
  • When the Dow declined a little more, CNBC started running the headline that Fed fears were slamming stocks.
  • Several commentators cited the possible end of the Fed support for asset prices. Art Cashin fed the fire, noting in mid-afternoon that if stocks were down 300 on just the hint, an actual increase might take them down 1000.

You will see plenty of commentary on these themes. Feel free to add your own thoughts in the comments, including anything I have missed.

As always, I’ll have a few ideas of my own in the conclusion.

Quant Corner

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

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Think risk first, reward second. 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.

The recession odds (in nine months) have nudged closer to 10%.

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

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

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

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

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.

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he further explains the possible turning point in earnings. Most people will not understand this until it is too late to profit.

 

How to Use WTWA

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

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

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

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Holmes – the top artificial intelligence techniques in action.
  • Why 2016 could be the Year 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 or suggestions for new topics.)

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar holds several aggressive sectors. The more cautious Holmes also remains fully invested.

Top Trading Advice

Brett Steenbarger is posting many great ideas. Traders should make a daily visit. I sense another book coming! My favorite this week is How to Extract Greater Profits from Our Trading.

If we don’t see the market gain a second wind after our having made an initial entry, the conditional probabilities of getting the move in the other direction continue to increase.  We are getting further confirmation that buyers can push the market no higher or sellers can push prices no lower.  It is when we see that our initial position is not getting torched and subsequent market behavior is in line with our thesis that we can add a second unit of risk to the trade.  We extract more from our trading by being largest when we’re “rightest” and smallest when we’re wrong.

Dr. Brett is also helping with the psychological aspects of your trading – Three Trading Techniques for Building Positive Trading Patterns.

Paul Tudor Jones: Decide on your stop point before you enter a trade. Finance Trends discusses this and some other advice from the great trader. Holmes is barking approvingly.

Another piece of advance preparation is asking yourself whether the prospective trade really has enough edge. Don’t forget to keep the volatility of expected results in mind! Adam H. Grimes takes up this question and provides links to some prior related work.

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 the WSJ warning about “structured CD’s.” (subscription required, but you can find it if you Google the title). Many unwitting investors are biting on a pitch that you can double your money in six years with no risk. Some of those needing early access to funds actually lose money on the CD. Performance data are not available for this product, unregulated by the SEC. The WSJ managed to get some results, and they are abysmal.

Stock Ideas

Chuck Carnevale has some good lessons about how to select dividend stocks. For the buy-and-hold income investor he seeks continuity of the dividend as well as limited volatility in the underlying stock. His analysis is rich with stock ideas — some to consider and some to avoid. I hope DIY stock-pickers are reading Chuck’s stories closely. It is important to learn technique and analysis, not just follow someone else’s stock picks.

Abba – no not ABBA – likes T. Rowe Price (TROW). His analysis is based upon a dividend valuation model. I also like the stock, but we write calls against the position to enhance yield.

Market Folly monitors the moves of big investors with good attention to the most recent moves. Warren Buffett now has nearly 80 million shares of Phillips 66 (PSX).

Ready for some biotech stocks? Bret Jensen serves up regular ideas in his forum. His most recent update includes a key stock in the news, Valeant (VRX), which we own as a trade for technical reasons.

Our newest trading model, Holmes, has been contributing an idea each week, a stock we bought for clients a few days ago. I will mention it here, but you can see it a little sooner if you read my new weekly column. I’ll have a “conversation” each week with all three of our models. Since each has a different personality and style, there are often disagreements – especially with me! While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas may be a starting point for your own research. Holmes may exit a position at any time, and I am not going to do a special post on each occasion. If you want more information about Holmes and exits, just sign up via holmes at newarc dot com and you will get email updates. This week’s Holmes added several stocks, including Cardinal Health Care (CAH).

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. This was a really great post. There are several great choices worth reading, including my pick for best advice of the week. My personal favorite is the timely and entertaining advice from Tim Maurer, How Fantasy Ruins Football (and Investing). He discusses several popular financial fantasies. He writes:

Fantasy: Gold is a good hedge against inflation. (Or a good hedge against currency risk, or a good investment. Just take your pick.)

Truth: Of the many traits often attributed to gold as an investment, the only one that really holds up is that the precious metal historically has risen in price when stocks are in deep decline. People tend to buy gold when they are scared (and sell it when they aren’t). But good luck shaving off some of your bullion for bread when The Hunger Games start (or when any dystopian tween books series becomes a reality).

Felix disagrees. That is what makes a market!

I also really liked Ben Carlson’s list of things he learned in his 30’s, especially numbers 9 and 10 (negotiating and saving).

Gil Weinreich of Seeking Alpha takes a helpful look at the “retirement crisis.” There is plenty of good advice. Gil’s series is aimed at investment advisors, but has also attracted many DIY investors, including some who are quite skeptical. It is a good dialogue which figures to help both groups. I am trying both to share and to learn.

Market Outlook

The trade for the next 35 years? Short bonds and long equities! Rupert Hargreaves of ValueWalk reports on Deutsche Bank’s advice and rationale.

Most investors are ill-positioned for this scenario. HORAN Capital Advisors reports on the continuing dramatic shift between stock and bond fund flows.

Final Thoughts

 

There really wasn’t any fresh news on Friday, but there must always be an explanation. Consumers demand it! It is a requirement for news reporters. I am reminded of an old book from my student days –a description of how reporters covered a Presidential campaign. The news world was very different in those days. Without instant communications the various news services had quite different deadlines. The wire services had to be the fastest and Walter Mears of the AP was regarded as the best at determining the lead from a complex story. Everyone also wanted to know how the NYT was going to play any news. The Rolling Stone version of the story (from 1972) is an enjoyable read and captures the flavor. Why is it relevant now?

News executives expect solid work, usually judged by reports of other leaders in the field. If you are going to deviate from the accepted lead, you need some special analysis. This is great for investors if they are able to look a little beyond the obvious and tune out the noise. Remember the following:

  • Simple dominates – even if it is simplistic.
  • Any recent event is a candidate to be the cause.
  • Support for popular themes and theories is encouraged. Oil prices were down over 2%, for example. For many this signals economic weakness. Ignore the recent increase in prices.
  • Don’t worry if the timing seems a bit wrong. You can explain that. The market was “digesting” the information. Or it was a “delayed reaction.”
  • And finally – make it into a big story!

A Reality Check

Not everyone bought into this theme. A number of investment managers questioned the logic. It is hard to sound intelligent when the market is plummeting, unless you have an instant explanation. I do not question Art Cashin’s trader take. There was a lot of money available to traders who perceived the potential for a big directional move. The algorithms joined in, technical levels were violated, and many were waiting for a break from the recent trading range. Those who profit from making sure that people are “scared witless” (TM OldProf) piled on.

Investors have time to analyze and to think more carefully about the causal model. The trading community believes that the economy is weak and fears that the Fed will tighten rates at a bad time. Both elements are necessary. Not only does the Fed see a stronger economy; it is committed to start with modest moves. The early stages of a cycle where very low rates are increased is bullish for stocks and bearish for bonds.

The overwhelming majority of investors made no trades on Friday. Many did not even know what happened until it was over. The vast majority of others are not going to take any action next week. This is good. Investors who try to compete with traders are playing a game they cannot win.

Quiz Answers

  1. The manufacturing index of 49.4, if annualized, corresponds to an annual increase in real GDP of 2%. The ISM non-manufacturing index of 51.4 similarly corresponds to real growth of 1%.

    One way to think about this is that the economy is still growing even when the secular decline in manufacturing is continuing.

  2. About 50-50. Even a two-touchdown favorite in the NFL is only about 75% to win. .75 squared is your chance of winning both games. Why should you care? People naturally take apparently obvious events and turn them into sure things. They become way too confident.

Weighing the Week Ahead: Should We Expect September Mourning?

The abbreviated week’s calendar has little important data. The economic news last week leaves open the timing of the next interest rate increase. As vacationing market participants yawn their way back to their desks and trading floors, what will be the focus? A look at the calendar and the end of summer will have them asking: Should we expect September mourning?

I borrowed the title from Alan Steel’s excellent post on this subject. More from him in the conclusion.

Last Week

There was a lot of important economic news. The picture was mixed, but mostly promising. The Fed can move in September or delay until December.

Theme Recap

In my last WTWA, I predicted another weeklong focus on the Fed. I expected every economic data point to get special attention, parsed through the perceived eyes of the Fed. This was the story all week – even on the quiet Friday afternoon. I asked whether the Fed would get a signal to hike rates. At the end of the week, most were answering “no.” I have had a good streak going on guessing the theme, but the week ahead is really a challenge.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. The overall range, once again, is very narrow. Doug’s take is that the market liked the slightly weaker than expected report, observing as follows:

The “bad news is good news” syndrome once again reaffirms the market’s primary dependence on Fed pampering via low rates. The index hit its 0.65% intraday high about 30 minutes into the session. Profit taking sent the index to its 0.13% intraday low in the early afternoon. But the buying returned, and the 500 ended the session with a 0.42% gain.

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

Please Watch…

…for some upcoming events that might be interesting to WTWA readers.

  1. It is Labor Day weekend. Like you, I am enjoying some family time. Because the employment report is so important to markets, I will publish a little quiz to test your Jobs IQ. It will not be easy. You may keep your results secret or else boast about your knowledge!
  2. I am joining an outstanding group of fellow advisors in a webinar this week. It will be on Wednesday, September 7th at noon EDT. (Sign up here). We meet regularly for our own benefit. This time our leader, Rob Martorana, felt that other might learn from the interchange. The subject is how to interpret financial news. The material is great, and I am looking forward to participating. Please join us if you can. If you miss it, check out the original article. If investors find this to be useful, we will do more.

The News

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

The Good

  • Initial jobless claims remained very low at 263K and beat expectations. (Bespoke)

  • Hotel occupancy remains at near record levels. (Calculated Risk).
  • Withholding tax collections remain strong. (Barry Ritholtz).

    As the total dollar amount of Federal withholding taxes continues to increase, we should expect to see retail sales and sentiment continue their improvements. This has resonance for GDP as well as the Presidential Election.

  • Factory orders rebounded nicely. Up 1.9%, the biggest gain in nine months. Steven Hansen offers a sharp dissent to the headline figure.
  • Earnings revisions have improved. There is a regular pattern of decline in over-optimistic estimates. Few are experts in studying the pace of these changes and how it is likely to impact the market. That is why we read the work of earnings expert Brian Gilmartin, whose most recent post which explains about this difficult question.
  • Personal income rose 0.4% in addition to positive revisions. Consumer spending also increased 0.3%.
  • Consumer confidence reached an eleven-month high. See Doug Short’s analysis for background, comparisons, and the best charts on the subject.
  • Bullish sentiment remains low, a near-term positive for stocks. Bespoke provides this chart.

 

The Bad

  • Auto sales fell to an annualized rate of 17 million. This was not far from expectations for most companies, but a decline nonetheless.
  • Rail traffic continues to decline. Steven Hansen (GEI) does his typical comprehensive analysis.
  • ISM index moved into contraction, registering 49.4 compared to 52.6 last month. Steven Hansen (GEI) has a comprehensive analysis including comparisons to the Markit PMI measure. It helps to consider the “internals” of the index calculation.

  • Employment gains disappointed. I am listing this as “bad” even though most see the overall story as pretty neutral. (WSJ). I am listing the specifics, but all are within their normal sampling error bands. The bond market reaction was also neutral. Calculated Risk said a “decent” report, which captured mainstream sentiment.
    • The net increase in payroll jobs was 151K. While this still represents reasonable growth, it was significantly below the last two months and also below expectations of 180K
    • Private hours worked declined and hourly earnings increased less than expected.
    • Unemployment remained at 4.9% and labor force participation was stable.

  • ADP reported private sector employment gains of 177K – reasonable but also a bit below expectations.

The Ugly

EpiPens. Rex Nutting gets to the heart of it: Saving lives isn’t Mylan’s business; maximizing profits is. The story has widespread implications. We all want to save lives. To do this there must be an incentive for drug development. When does this cross into exploitation? Should U.S. prices subsidize foreign drugs? It is an important issue on many fronts.

 

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 Ben Carlson, who takes on the apparently compelling statistical link between the Fed and stock performance. Since 2008 more than half of the increase in the market comes on days of FOMC meetings. He notes that this argument was featured in the WSJ, but it shows up in various places.

What happens if you change the starting date of the analysis?

Ben points out that the relationship is mostly a result of 2008.

 

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. While personally I watch everything on the calendar, you do not need to! I highlight only the most important items in WTWA. Focus is essential.

The “A” List

  • ISM services (T). Continuing strength in the service sector?
  • Fed Beige book (W). Anecdotal evidence adds color to the data for the next FOMC meeting.
  • JOLTS report (W). The Fed uses this to analyze labor market structure. It is less useful for employment growth.
  • Initial claims (Th). The best concurrent indicator for employment trends, but less attention during “employment week.”

The “B” List

  • Wholesale inventories (F). July data but relevant for revision of Q2 GDP.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

There will be some FedSpeak. There may also be news from the G20 conference. See Treasury Secretary Lew’s presentation at Brookings for a preview.

Next Week’s Theme

Last week brought us more quiet trading with no clear message from the data. As people slowly return from vacation, it is a natural time to review events. We will see plenty of stories about how September is the worst month for stocks. Everyone will be asking: Will September bring a market correction?

Michael Brush, writing at MarketWatch, has a typical example, Get ready for a 5%-10% stock-market drop. Expect more such predictions and advice to do something or other to avoid this kind of decline. This week’s Barron’s cover was similar.

Most expect the record streak of low volatility to end. Here are the top worries:

  1. The calendar. This chart from Michael Batnick (who does not present this as a trade) makes the point.

  1. The Fed. Some are worried that rates will rise. Others are worried that the Fed will keep rates too low.
  2. Energy prices. Some worry about a sharp rebound. Others are concerned about another crash.
  3. China.
  4. Europe. The current focus is Italy. The last hot spots (Greece and Great Britain) are OK for now.
  5. The US election. You can worry about either candidate or just the uncertainty.
  6. Congress is back in session (see conclusion*). Note the shaded area of the VIX chart, marking the recent seven-week recess, perfectly coinciding with the record lows in volatility.

Feel free to add your own thoughts in the comments, including anything I have missed.

As always, I’ll have a few ideas of my own in the conclusion.

Quant Corner

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

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Think risk first, reward second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 

The Featured Sources:

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he expresses more confidence about growth in earnings.

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.

The recession odds (in nine months) have nudged closer to 10%.

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

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

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

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

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. This week, as he always does after an employment report, Georg updated his unemployment-based recession indicator. No recession is indicated.

How to Use WTWA

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. For most readers, they can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

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

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

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Holmes – the top artificial intelligence techniques in action.
  • Why 2016 could be the Year 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 or suggestions for new topics.)

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested, including several aggressive sectors. The more cautious Holmes also remains fully invested.

Top Trading Advice

Brett Steenbarger describes the three main causes of big drawdowns. See if you remember any of them from your own experience. Here is how to think about the diagnosis.

If you’re in drawdown mode, it’s important to ask if the problem is with your betting versus folding or if the problem is sitting at the wrong table or playing the wrong game altogether.

Dr. Brett has another lesson, showing how to milk information from data to find the best trades. Take a look at this chart and then read his analysis.

We have all had losing trades. The Trading Goddess discusses the best way to exit, including the thorny question of stops.

But as soon as you’ve entered the position, the price falls apart and forces you out of the trade when your protective stop is triggered.

Then, as soon as you’re out of the trade, the stock swiftly reverses back up.

After running 5% to 10% higher over the next few days, you’re left in the dust with no position and tear in your beer!

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 final column at The Motley Fool. He has been the best advice choice many times. His work is consistently helpful to investors. He promises that he will keep writing in his new gig, and I hope that is true. This week’s article reviews some of his key lessons. They are all worth careful study, buy I especially like this one:

Progress happens too slowly to notice; setbacks happen too quickly to ignore. The market quickly lost 38% in 2008, and it was huge deal. Books were written about it, and Congressional hearings were held. We’ll be talking about it for decades. The market then slowly tripled from 2009 to 2015, and barely anyone flinched. You had to sit down and show people the numbers to get them to believe you. This is common: Recessions take place over months; recoveries take place over years. It can take decades for companies to become valuable, but bankruptcies happen overnight. Pain hurts more than the same level of gain feels good, but the duration differences between progress and setbacks helps explain why there are so many pessimists amid a backdrop of things getting better over time.

And also this one….

There has never been a better time to be an investor. Ever, in history. More people have access to first-class services than ever before. It’s so important, and we don’t spend enough time realizing how good it is.

Stock Ideas

Chuck Carnevale continues his strong recent series with a look at the “Big Five” Canadian banks. He emphasizes the importance of finding a good entry price! This is a thorough analysis, and you should read it carefully before investing.

Morningstar updates the top buys and sells from their “ultimate stock pickers.” This group was a “net seller” but still holds some favorites. Check out the full article for other ideas.

Holmes will begin contributing an idea each week, a stock we bought for clients a few days ago. I will mention it here and Holmes will also post it each Friday at Scutify.com. While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas may be a starting point for your own research. Holmes may exit a position at any time, and I am not going to do a special post on each occasion. If you want more information about Holmes and exits, just sign up via holmes at newarc dot com and you will get email updates. This week’s Holmes made no portfolio changes. Danaher (DHR), which we bought last week, is still interesting and about the same price as our entry.

Energy

With a new trading range for oil prices there is renewed interest in energy stocks. Dan Dicker (Oil&Energy Insider – subscription required) recommends waiting until oil is closer to $40/bbl. He includes an interesting chart showing how some of the Bakken shale drilling sites developed. He writes as follows:

Oil wells cost money to drill and inevitably run dry. They need to be constantly replaced with fresh drilling to maintain output. Those drilling and maintenance costs sometimes overwhelm the returns of the oil being sold, as is the case this year and the previous two, and sometimes the returns greatly outpace the costs, as was the case before the bust in 2014.  We know that most of the independent U.S. oil companies operating in shale have bypassed this current cash burn problem in the short term by raising efficiencies – which lowers costs – and by slashing capex, which sacrifices the ability of potential future replacement.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are several great choices worth reading, but my favorite is this advice from Jonathan Clements. He explains that people are living longer and must take that into account in setting an investment horizon. He notes as follows:

…your time horizon may extend beyond your own life expectancy. Suppose you are age 80 and you have money you plan to bequeath to your 20-year-old granddaughter, who will then use the inheritance to pay for her own retirement. The investment time horizon for this money might be 50 years, over which the stock market will likely clock dazzling gains.

[Jeff] I agree with this analysis, but I always start by securing enough of a portfolio to assure against life-changing market results. One good place to start is with another source from Tadas, Tim Maurer. He warns against taking too much risk.

Market Outlook

Eddy Elfenbein, continuing to impress on his CNBC segments, explains 5 Signs that Stocks have Room to Run. We turn off the mute and TIVO back when Eddy is on, our highest indication of respect!

Strategy

Michael Batnick (MarketWatch) has a helpful article about what investors could learn from horse bettors. There is a list of ten great ideas, especially for value investors. I especially liked this one:

There is always the temptation to abandon your strategy when it’s out of favor.

“If you begin espousing this approach, you are sure to suffer abuse from your fellow horseplayers. When one of them asks you who you like in a race and you say, ‘I think the 4 is a bigger price than he should be,’ the likely response is, ‘So what? Who do you like?’ Your cronies are apt to tell you that you should be betting on horses, not on prices, and after an inevitable stretch of watching some of their underlays win, you will begin to doubt yourself.”

 

I wrote on a similar theme last week. You might enjoy Why Smart Investors Struggle to Beat the Market.

Ben Carlson explains the importance of rebalancing. If you do not regularly review and execute this strategy, you are missing out on a natural way of selling high and buying low. You are also taking too much risk!

Final Thoughts

Volatility will eventually increase, but there is no reason to expect it right away. Most of the reasons have been recycled all year. Let me comment on the new ones.

  • The calendar. One pundit stated that the reason for weak Septembers was that people were worried about October! Alan Steel covers this topic in a witty fashion. He deals with “the hordes of deviant scribblers…who have made single variable correlations into a media business.” His brief post has plenty of good advice, and you definitely won’t stop reading after the first line about the prune juice and Viagra diet. Take some time to read his other helpful and entertaining posts.
  • Rate increases. James Hamilton has a nice analysis of the concurrent moves of other economic indicators during rate increase periods.

    These 4 episodes have several things in common. First the inflation rate rose during each of these episodes and was on average above the Fed’s 2% target, a key reason the Fed moved as it did. Second, the unemployment rate declined during each of these episodes and ended below the Congressional Budget Office estimate of the natural rate of unemployment, again consistent with an economy that was starting to overheat. Third, the nominal interest rate on a 10-year Treasury security rose during each of these episodes, consistent with an expanding economy and rising aggregate demand.

  • Congress back in session. While the information is accurate, this point is a joke. Mrs. OldProf said that I should footnote and include this line so that everyone would know to laugh. I told her that readers of WTWA know a silly bivariate chart when they see one!

Fundamental factors are more important than the small seasonal effects. The latter often include a couple of large moves that skew the result. The chance of a correction is no higher than it was last month, or the month before.

Weighing the Week Ahead: Have Stock and Oil Prices Decoupled?

This week’s calendar features another relatively light week for data, a lot of politics, slow summer trading, and options expiration. Something has to fill all of that air time! Expect more Olympic coverage, political commentary, and light features. There will be the usual Fed chatter. To the extent that there is real market discussion, I am looking for a new topic: Have Oil Prices Lost Their Impact on Stocks?

Last Week

The important economic news was mixed as was the market reaction.

Theme Recap

In my last WTWA (two weeks ago), I predicted discussion about whether the earnings recession might end in Q3. I suggested we would need to fasten our seatbelts for a showdown on the economy and earnings, probably in quarter three. That might prove out, but we certainly did not need seatbelts last week! We had quiet summer trading with light news and plenty of people on vacation. CNBC interspersed Olympic coverage and even found time to have multiple segments featuring a sandwich on Friday.

Politics, global events, and competition intersected.

Mosquito

 

There was some support for my earnings thesis from our two key sources:

FactSet noted the distribution of earnings results by sector and the continuing overall beat rate.

Brian Gilmartin analyzed the forward curve for earnings, including some important implications.

The Story in One Chart Short

I always start my personal review of the week by looking at this great chart from Doug Short. The overall range is very narrow, with little overall change. Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

The News

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

The Good

  • Gasoline prices are expected to move lower, perhaps as low as $1.92 by year’s end. (EIA forecast via Calculated Risk).
  • Initial jobless claims remain low and even declined by 1000. (See Doug Short for charts and analysis).
  • Mortgage rates are back at the lows, 3.375 for “flawless scenarios.” (Calculated Risk).
  • The JOLTs report showed improved labor market conditions. Most sources are not covering this accurately. It is not an alternative method for estimating net job growth. It does show the trend in job openings, the structure of the labor market, and the voluntary quit rate. Nearly 3 million people each month are voluntarily leaving their jobs, double the number in 2009.
  • Producer prices fell more than expected, 0.4%. Some are citing this as bad news. The bad news will come when stimulus overshoots.
  • Michigan sentiment remained strong, slightly beating expectations. Doug Short does the best analysis and has the most informative chart:

DShort Michigan Sentiment

The Bad

  • Railroad growth remains slow. Zacks explains that this has translated into lower earnings, partly because of the energy sector.
  • Productivity fell 0.5%. Gains in productivity are essential for economic growth.
  • Retail sales disappointed, with no growth month-over-month. It was also a significant miss of the 0.4% expected gain. Doug Short analyzes this disappointing report. As always, he provides helpful historical perspective, including the chart below. It seems to show a return to the pre-recession pace of growth, but without every closing the gap to the prior trend line.

The Ugly

Public retirement commitments. Robert Pozen, in a Brookings op-ed, highlights these costs, and the main reasons:

The unfunded liabilities for retiree healthcare for the 30 largest US cities exceeds $100bn, according to the Pew Charitable Trusts, a Philadelphia-based non-profit organisation. The unfunded liabilities for the 50 US states exceeds $500bn, according to Standard & Poor’s, the rating agency.

Retiree healthcare plans are uniquely American. They exist because the US has never offered universal healthcare before Medicare, the national social insurance programme, at age 65.

Many employees of cities and states retire between 50 and 55, so local governments usually provide them with highly subsidised healthcare between retirement and Medicare, and sometimes beyond.

For a more general analysis of the threat from retirement costs, see Mohamed A. El-Erian’s article on the “titanic risks.”

Noteworthy

There is a lot of current discussion about the “typical” American community. FiveThirtyEight provides some interesting data on both cities and states. You will find the results interesting. Much to my surprise, I am living in the state with demographics closest to the country overall.

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 Justin Fox, writing at BloombergView. He takes on a popular myth that just won’t die – the manipulation of government statistics. Like Fox, I have some personal experience in working with the career civil servants who analyze data. The notion that they do whatever a (temporary) political leader instructs is very costly to investors who believe it. The article takes up various accusations and stories, with plenty of good discussion. Here is one key argument:

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.

I would add that any shenanigans would be the basis for articles and books by those leaving the agencies.

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 another moderate week for economic data and the end of earnings season is near. While personally I watch everything, I highlight only the most important items in WTWA. It is important to focus.

The “A” List

  • Building permits and housing starts (T). Permits are a good leading indicator.
  • FOMC minutes (W). No one really expects any fresh news, but the punditry will find something.
  • Leading indicators (Th). Still highly regarded by many, despite the various redefinitions. Continuing strength expected.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Industrial production (T). Improvement expected in this lagging series, important to GDP.
  • CPI (T). Inflation data remains a secondary indicator. It will take a few hot months to bring it to the fore.
  • Philly Fed (Th). A rebound expected. This result has earned growing respect.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

There is plenty of FedSpeak for those who have been missing that. Options expiration on Friday may delay the exodus to the beach for some.

Next Week’s Theme

Quiet calendars and slow trading offer time for collective introspection. There will be plenty of political discussion, tempting investors to draw unwarranted conclusions about their money. I have noted a new theme in the discussions of the Pundit in Chief and the Senior Stock Trader: Some head-shaking over the daily divergences between oil and stock prices. I might be a little early with this expectation, but it is worth thinking about. Expect the pundits to be wondering:

Has the Correlation between Oil and Stock Prices Broken Down?

Eddy Elfenbein noted the breakdown. I am always encouraged when he reports observations consistent with my own. Here is his chart:

sc08102016d

This week’s problem has two parts:

  1. What will happen to oil prices?
  2. Will stocks follow?

For now, let’s stick to the first question, where there are plenty of opinions:

  • Oil supply and demand is now in rough balance. (“Davidson” and some other experts).
  • Oil is going lower – back below $30. There is still a glut and higher prices reflect a short squeeze.
  • Oil is going much higher. The oil glut is smaller than expected leading to a target of $80. Current trading reflects only momentum, not fundamentals.

….and many similar opinions on all sides.

As always, I’ll have a few ideas to add in the conclusion.

Quant Corner

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

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

The Featured Sources:

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he expresses more confidence about growth in earnings.

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.

The recession odds (in nine months) have nudged closer to 10%.

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

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

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

It is time for another update of Doug Short’s Big Four. The start of another recession would be marked by a peak and significant decline in these indicators. Most investors should take a frequent look at this chart instead of the headlines in the financial press!

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 a number of interesting approaches to asset allocation. This week Dwaine has his own interpretation of the “Big Four” indicators – a recent narrow miss. Despite this, he concludes:

To conclude, looking at the individual co-incident monthly data used by the NBER shows a far more pessimistic view currently than when looking at a syndrome of conditions. But the co-incident data in this particular indicator and the recession probabilities we are registering are not as bullish as the employment data would have you think. In fact, taking our proprietary implementation of the Big-4 index, and comparing it to the last 8 expansions, shows just how meek this recovery has been:

How to Use WTWA

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. For most readers, they can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

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

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

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Holmes – the top artificial intelligence techniques in action.
  • Why 2016 could be the Year 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 or suggestions for new topics.)

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We are continuing with a bullish market forecast. Felix is fully invested, including several aggressive sectors. The more cautious Holmes is now also fully invested.

Top Trading Advice

Traders are worried about the next two months, notes Steven M. Sears (Barron’s). Trading desk chatter about Chair Yellen’s upcoming Jackson Hole speech, a possible rate hike, and mean-reverting behavior in volatility. This has them buying call options on the VIX, popularly known as the fear index. Should you join this trade? I am not making a recommendation, but merely raising an idea for consideration. I do not share the concern about the impact of a rate hike. I also note that several of those quoted are selling derivatives.

Dr. Brett asks, Can Successful Trading Be Taught? He answers “yes” and explains how.

In another great post he explains how to “train your brain.”

We should all seek information from people with the right expertise and the right experience. What could be better than a clinical psychologist, a teacher, a coach of traders, and decades of personal trading experience? Every trader I know would benefit from Brett’s books as well as his blog.

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 some ideas that “keep on giving.” This contradicts the page view theory of posting: Look for “actionable investment advice.”

How to Read Financial News: Tips from Portfolio Managers is worth reading and re-reading. Robert J. Martorana is an insightful author and organizer. He was the editor (I called it ‘ringmaster”) when I wrote for TheStreet.com’s Real Money site. He has organized regular conference calls among advisors, bloggers, and investment managers who all have great ideas and strong credentials. Recently he took some of the calls and turned them into a first-rate educational piece about reading financial news. I am delighted to be included. I hope others find the ideas as useful as I do. If it is popular, perhaps Rob will do more of these.

Another good post on this theme is from Morgan Housel, who describes things that he is “pretty sure about.” It is a great list. My favorites are the following:

Recessions and bear markets are very easy to predict, except for the timing, cause, magnitude, duration, location, and policy response.

Look at today’s five largest companies in the world. Fifteen years ago, one of them didn’t exist, one was a tiny start-up, one was a belittled relic of the dot-com bust, another was fighting to stay relevant after flirting with bankruptcy a few years before. I suspect the next 15 years will be even more extreme.

If you tell people what they want to hear, you can be wrong indefinitely without penalty. This explains the careers of many pundits.

Stock Ideas

Oil exploration stocks? Peter Way has an interesting approach to analyzing the upside/downside risk of this sector.

501110-14709376100679758

It is not too late to buy dividend stocks. Philip Van Doorn explains how to sort through the risks.

David Van Knapp has a “periodic table” of dividend champions. You need to read the entire post to appreciate this. Here is part of it:

223670_14707064705187_rId14

Holmes will begin contributing an idea each week, a stock we bought for clients a few days ago. I will mention it here and Holmes will also post it each Friday at Scutify.com. While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas may be a starting point for your own research. Holmes may exit a position at any time, and I am not going to do a special post on each occasion. If you want this information, just sign up via holmes at newarc dot com and you will get email updates about exits. This week’s Holmes pick is Eastman Chemical (EMN).

Market Overview and Outlook

The consensus market forecast is now Dow 20,000 (sort of). Victor Reklaitis explains at MarketWatch.

Should you hedge against a crash? Marc Faber is (once again) predicting a 50% market crash. Some are outbidding him by calling for 80%! Barry Ritholtz takes up this topic providing a list of his past predictions and this chart:

Should you hedge against Zika? Josh Brown, expressing realistic concern about the virus, emphasizes the need to separate such events from your investment decisions.

Michael Harris suggests, “The frequency of articles in the financial media and blogosphere with calls for a stock market collapse is often a good indicator of a bullish market”. Read the full post for discussion and a chart of events this year.

Should you sell the market high? HORAN Capital Advisors does a complete analysis.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are several great choices worth reading, but my favorite is the NYT article from Ron Lieber, explaining how to maintain your 401(k) – ignore it! You can do better if you follow the risk indicators on WTWA, but most people who closely follow their statements buy and sell at exactly the wrong times.

Election Effects

Expect many more articles on the impact of the election and what stocks you should own. I am sticking with my year-long viewpoint: This is all overdone. The new president, whoever is elected, will face a struggle in passing an innovative agenda. No such analysis can be complete without considering the likely makeup of Congress – and that is just for starters. Barron’s has a cover story featuring a likely Clinton election and analyzing the policies. The NYT analyzes the difference in tax policies.

Value Stocks

If you missed my special post on this topic, addressing the “value trap” question, please take a look.

Watch out for….

Surprises in ETF trading costs. Chris Dieterich (Barron’s) notes that the explosive growth in choices has led to many niche funds without liquidity. He cites some examples where the bid-ask spread imposes a higher cost than the management fee!

Utility stocks. James Picerno wonders whether the “wobbly rally” signals a bubble.

Fancy ideas now aimed at the “little guy.” Some of the big guys are cutting allocations.

Final Thoughts

The correlation between oil prices and stocks never made any sense. Some traders prefer commodity prices as an economic indicator. They are skeptical of the official data. The fact that oil prices represented a supply story rather than weak demand did not stop many from hitting the recession panic button. HFT algo’s picked up something that was working, and a lot of hot money started following this trade. If you were a trader, you had to take notice. On some days CNBC would view oil traders who said they were watching stocks, as well as stock traders who were watching oil. When a trade is working, you should not go too deeply into the reasons.

Investors got the chance to buy some great stocks at lower prices.

Fundamentally, lower gas prices are good. Past price surges were frequently described as a consumer tax with no corresponding benefit. Whether people spent or saved the extra cash, it had a positive effect. Since all transportation costs were lower, everyone was helped, not just drivers, although the effects are difficult to calculate.

When the market responded negatively to lower prices many started reaching for explanations. Attention turned to those living and working in oil production areas, as well as banks making loans to them. This was true enough and easier to see than the larger, but diverse effect on consumers.

A New Chapter?

With the rebound in oil prices, will the punditry cite this as a reason for higher stock prices? I am not counting on that, but two months ago I highlighted the idea that oil prices might have hit a “sweet spot.” Energy company earnings will be better. The potential for higher production places a brake on price spikes. It provides a healthy environment for the economy and the stock market.

The oil/stock relationship may be fading, but count on the trading world to find something new!

Explaining small daily moves in the market averages is like analyzing why a snowflake fell on you rather than the person walking next to you. The many words and hours spent doing this are worse than worthless. The process creates a false sense of logic and order which may well cause mistakes in future decisions.