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.

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

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The Bad

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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.

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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.

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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.

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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.

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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.

Weighing the Week Ahead: What Does the Election Mean for Stocks?

This week’s calendar includes a big serving of data, an FOMC meeting, the Democratic convention, and plenty of earnings news. The financial media will be asking: What does the election mean for stocks?

Last Week

The economic news was excellent, and the market reaction was positive. It was a light week for data, but the important news was positive—especially housing.

Theme Recap

In my last WTWA, I predicted that we should expect some challenge to the post-Brexit rally. People would be focused (even more than we usually see) on what could go wrong. It was a big week for earnings and politics as well. The market’s answer to the question reflected some optimism about the second half of the year.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. You can clearly see the successive highs and the final breakout on Friday. 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.

Personal Note

I am on vacation this week, and I probably will not write next weekend. I am still keeping an eye on things, so I will put up a short piece if there is really important news.

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 are at a 43-year low. (Jeffry Bartash, MarketWatch).

  • Housing
    • Existing home sales are strong and would be even stronger with more inventory. Calculated Risk explains the reduction in distressed and foreclosure sales. June sales were the best in ten years.

  • Housing starts and building permits. Growth is solid and prices are higher, but this is not another housing bubble. Patrick Clark (BloombergMarkets) does a good job of explaining the difference in the current growth phase. He writes as follows:

    But residential real estate isn’t in a speculative bubble, industry observers contend. Instead, a low inventory of available homes is driving prices higher—prices, however, will eventually recede as buyers throw up their hands, or as more new homes come on line. The structural issues that led to the housing collapse last decade aren’t present.

    The largest price appreciation is coming in places where population is growing, but zoning laws have restricted the pace of new construction.

The Bad

 

The Ugly

Another week, a new terrorist event. I continue to hope for a week where the ugly award once again goes to a financial problem.

 

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. There is plenty of misinformation to refute!

To help in spotting ideas, here is a handy guide from The Guardian’s Science observer, David Spiegelhalter, Our Nine-Point Guide to Spotting a Dodgy Statistic. (Thanks to reader AR for this suggestion). Most of the examples are British, but with universal application. I especially like the “indicator switching,” a favorite ploy of market pundits.

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 pretty big week for economic data, featuring the FOMC decision. While I watch everything, I highlight only the most important items in WTWA. It is important to focus.

The “A” List

  • FOMC rate decision (W). A rate increase is not expected; the statement will get close attention.
  • Consumer confidence (T). Conference board version is an indicator for jobs and spending.
  • Michigan sentiment (F). Unlike conference board, has a panel component.
  • GDP (F). First read on Q2 – big rebound expected.
  • New home sales (T). Important economic sector. Can the growth continue?
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Pending home sales (W). Less important for the economy than new construction, but a good read on the overall market.
  • Chicago PMI (F). An early read on next week’s ISM number.
  • Durable goods (W). Volatile June data, but the trend is important.
  • Employment cost index (F). Q2 data. Wage growth confirmed?
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

The big story will still be corporate earnings. The Democratic Convention will grab plenty of news. FedSpeak is on hold for the FOMC meeting, but there are some Friday appearances.

Next Week’s Theme

Markets seem to have digested the Brexit story, and surprisingly shrugged off the terrorist violence. The economic data have quieted recession worries, and even turned positive. We have competing potential themes this week.

The economic news and earnings reports are important. So far the earnings news has been solid. Brian Gilmartin was early and accurate in calling for an earnings trough. His latest post highlights the importance of Apple earnings and previews the other upcoming big reports. FactSet notes that both bottom and top-line results so far are exceeding the average “beat rate” from the last several years. Alliance Bernstein observes that headwinds to earnings growth has abated. Avondale has plenty of color about earnings calls, with a surprisingly positive take on the economy, Brexit, and earnings outlook.

A competing issue will be the FOMC meeting. While no policy change is expected, circumstances have improved enough to put one or two rate hikes back on the table this year. Tim Duy has a chart-packed analysis of what the Fed is seeing. The look at labor market tightness is especially important.

6a00d83451b33869e201bb091f4936970d-500wi

Instead of these key issues, everyone will be asking:

What will the election mean for stocks?

I rather hope that I am wrong, and that the important economic and earnings news will take center stage.

 

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%. This does not completely reflect Brexit effects, so we may get a further revision.

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.

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. His latest update describes the elements of the indicator we cite every week.

 

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 our neutral market forecast. Felix is once again fully invested, including some more aggressive sectors. That continues to work well during the rally. The more cautious Holmes is now about 80% invested, taking some profits last week. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now. It is not a resounding endorsement of the overall market, but a vote for opportunistic trading. I am curious about what it will take for Holmes to turn “mildly bullish.”

Top Trading Advice

Are stocks coiled for an upside move? Dana Lyons, using the mid-cap 400 to illustrate, writes as follows:

Specifically, the 7-day range in the index spans less than 1 percent for just the 8th time ever. And, at precisely 1.00%, the 8-day range is the narrowest in more than 20 years. In fact, all of the historically tighter ranges occurred in the low-volatility early to mid-1990′s period.

He sees a good setup for an upside breakout – tradable if it fits your time frame.

Brett Steenbarger explores the creative aspects of trading, revisiting a recent post that proved to be his most popular ever. Traders will benefit from both.

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 insightful market outlook provided by “Davidson” via Todd Sullivan.

…(E)conomic fundamentals are reliable in forecasting economic activity 12mos-18mos ahead. Fundamentals provide guidance to markets well before and often in contradiction to consensus market psychology. Fundamentals provide a long-term rate of return (Natural Rate) that can be used to compare returns from markets and individual securities. Having fundamentals which can do this for us make them a good tool to separate the investments which carry value from those which reflect more hope than substance. Many forecasters have called for a ‘Market Top’ every year since 2010 ($SPY). In counter-point, fundamentals have continuously forecasted higher equity prices since late 2008. Over the long-term, history shows that fundamentals have always driven market psychology which in turn drives market prices. A market top is not near. A top is not even close. Markets are a ‘Human System’. We should worry most when most are not worried.

Good advice.

Stock Ideas

I always like articles that illustrate good analysis while discussing a potential stock. Valuation expert Aswath Damodaran discusses “story stocks” using Tesla as an example. (He also mentions Amazon). Here is a chart of the basic thesis:

Can distressed energy company bonds be a better choice than the stock? Some traders are buying bonds and selling short the stock. Investors who own the stock might find it preferable to replaced it with bonds. (The FT).

Barron’s warns about pharmacy benefit managers (on the cover) and utilities. IBM and Cisco get friendlier treatment.

Market Overview and Outlook

Providing a contrast to the oft-cited, infamous 1929 chart, Shawn Langlois (MarketWatch), reviews evidence about whether the current bull market might be just getting going.

 

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 Michael Batnick’s advice on how long-term investors should focus. Read the whole piece, but the essence is this Carl Richards sketch.

Value Stocks

It is important to remember the length of stock market cycles. Even the best approaches can be out of favor for several years. HORAN Capital Advisors notes the encouraging rebound in value stocks, emphasizing the remaining upside potential.

 

Watch out for….

Target date funds. Check out five reasons to think twice. The “set it and forget it” approach might not work for you. (MarketWatch).

Long-term fixed income. Marc Gerstein says, “Owning long-term bonds are like using your jaw to punch Mr. Market in the fist.” Here is his “hate list.”

 

 

Final Thoughts

I have not written much about the election, because there is no clear implication for stocks – at least not yet. Many supposed impacts (drug prices?) are over-estimates of effects. Since we are concerned with investments, we look at political issues only through the prism of those effects.

More important is a mistaken viewpoint that stocks reaching a new high means that investor sentiment is euphoric. Not so.

BofA opines this week that it is time to buy stocks. Rupert Hargreaves (BI) reports:

Hartnett’s simple bullish message is based on the pessimistic attitude of investors in the market following Brexit and amid the general global economic malaise. Indeed, according to Bank of America’s research, investors ended June with the highest cash allocation on record at 5.7% on average and reported the lowest equity allocations in four years. Moreover, it looks as if investors are capitulating into bonds with annualised year-to-date return from global government bonds in 2016 at 25%, the highest return in 30 years. These three bearish indicators combined with the fact that inflows into precious metal funds hit a record during the first week of July, all point to the fact that investors are very bearish on the outlook for global equities. Bank of America, Merrill Lynch’s Bull & Bear Indicator, fell to an “extreme bear” reading of 1.6 on June 28.

There is plenty of room for stocks to advance, depending upon three factors:

  1. The economy – reasonable growth and no recession;
  2. Corporate earnings – getting out of the energy funk and inducing some business investment; and finally
  3. Attracting (even more) investors from alternative allocations.

At the mid-point of 2016, the key for investors is to understand the remaining market potential, and avoid obsession with scary headlines.

Economic cycles very rarely “stall out.” Recessions begin at a business cycle peak, something that is still at least a year away.

Weighing the Week Ahead: Time for the Summer Rally?

This week’s calendar includes plenty of data and a holiday-shortened week. The employment report looms, with many worried about a repeat of the weak May results. With Brexit apparently digested and the Fed on hold, I expect some attention to the possible upside. The financial media will be asking: Is it time for the summer rally?

Last Week

Brexit was the big story. The market rebound was surprising to many, forcing a change of perspective. The economic news was mostly good, but got short shrift.

Theme Recap

In my last WTWA, I predicted another week about Brexit, with emphasis on the possibility of a market turning point. That is certainly how the week started. CNBC even bumped Shark Tank and the West Texas guys from the 7PM EDT slot for another round of Markets in Turmoil. After stocks moved higher, the schedule went back to normal.

Last week’s “Final Thoughts” section was also on target, suggesting a weak Monday, but emphasizing the need for investors to consider the plausible range for the week’s trading.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. You can clearly see the exciting path for the week – early weakness from the continuing Brexit selling, a big, three-day rally, and a flat Friday as people left early for the long weekend. 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.

SPX-five-day

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

  • The ATA trucking index for May was strong up 2.7% on a seasonally adjusted basis and 5.7% year-over-year. (Calculated Risk).
  • Congress and the President managed enough cooperation to pass Puerto Rico relief legislation. (The Hill).
  • Consumer confidence increased significantly to 98 versus the prior reading of 92.4. This beat estimates by over 5 points, but some noted that the survey preceded the Brexit news.
  • Personal spending increased 0.4% m-o-m and almost 5% over the prior year. This will be a positive for Q2 GDP.
  • Fed stress tests were positive, as was the case last week. This week the question was whether banks could execute plans for dividends and stock buybacks. Nearly all passed, but Morgan Stanley was a notable exception. (MarketWatch).
  • The ISM report was strong. The index reading of 53.2 (if annualized) is consistent with GDP growth of 3.2%. Scott Grannis illustrates this relationship.

NAPM vs GDP

 

Looking at the sub-categories provides some useful color.

ISM June 2016

 

The ISM also has a separate report on expected Brexit effects. I found them to be surprisingly small. The Chicago PMI also showed a very strong increase. (Calculated Risk).

The Bad

  • The rail contraction continues although the rolling averages are improving a bit. Steven Hansen has the update.
  • Pending home sales decreased 3.7% in May and 0.2% y-o-y. (Calculated Risk).
  • Construction spending decreased 0.8% in May. Calculated Risk notes that this is mostly from public spending, illustrating with this chart:

ConSpendMay2016

 

The Ugly

Rio Olympics. The stories are starting to mount, with the WSJ calling it a perfect storm of problems. The recession has crushed budgets for public services. Violence and pollution have grabbed headlines. Zika is causing some athletes to reconsider participation. It is a shame that a great tradition is threatened.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s winner is CNBC anchor Sara Eisen, for her first-rate, myth-busting interview with Fed Vice-Chairman Stanley Fischer. (Transcript and video via CNBC). One-by-one she asked all of the key questions in the current debate over Fed policy – potential for negative rates, Brexit impact, does the Fed make decisions based the economic impact abroad, the state of the economy, recession potential, employment, George Soros, and the strong bond market. Whether or not you agree with Vice-Chairman Fischer, it is important to know what he thinks.

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

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, and only four days of trading. I expect it to start slowly culminating in the biggest news on Friday. In my calendar I highlight only the most important items, helping us all to focus.

The “A” List

  • Employment report (F). Deserved or not, this is always the biggest news of the month. Rebound expected.
  • FOMC Minutes (W). You might wonder how this could provide fresh news. The punditry will find a way.
  • The ISM Services Index (W). Will strength match the manufacturing index?
  • ADP Private Employment (Th). A good alternative to the “official” numbers.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Factory orders (T). Volatile May data, but an important sector
  • Trade Balance (W). Also May data, but a factor in gauging GDP.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

The week may start a bit slowly as participants return from the long weekend. There is plenty of FedSpeak for those needing a fix. More Brexit commentary and predictions will also be a feature, with emphasis on European markets and specific companies.

Next Week’s Theme

After two weeks of Brexit stories, market participants seem ready to move on. We have a pretty busy week for economic data, with the news occurring over only four days and a sleepy start on Tuesday. Friday’s employment report will be the big story of the week, and might be a multi-day theme.

Despite this, I am intrigued by two posts from my blogging friend Eddy Elfenbein. (Eddy seems to have scored a regular appearance gig on CNBC. His comments are always on target, and they should give him more time. I turn off the mute and TIVO back whenever I see him).

First, Eddy noted that the market has been in an extremely tight trading range for almost two years.

Second, he crunched some data showing one-day results for every day of the year for a 120-year period.

One

The two-month period beginning right now has historically provided about half of the annual stock gains. Eddy wisely warns that this is interesting, but not a basis for prediction. I agree, but the theme should attract some attention.

In addition, the Fed is expected to remain on hold and Brexit worries digested. Many will be asking:

Is it time for the summer rally?

Feel free to join the discussion in the comments, but here are the key themes I see.

Bearish

  • The rally has created an overbought market.
  • Market valuation is extended and earnings are weak.
  • Brexit remains important – more than people realize.
  • There is a real threat of global recession.

Bullish

  • The Brexit story seems to have a favorable ending. Ed Yardeni writes:

    The Brexit vote didn’t change my secular bullish stance. That’s because I don’t believe it will cause a recession in the US. I expect that earnings growth will resume during the second half of this year and that interest rates will remain as low as they are now for the foreseeable future.

  • Earnings may well be at a turning point. (Brian Gilmartin, with some support from FactSet).
  • Recession odds (judged by the best methods) remain very low. Stock prices erroneously reflect high macro worries.
  • Low interest rates make stock returns attractive to many investors.

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

Indicator Snapshot 070116

 

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.

This week the recession odds (in nine months) have nudged closer to 10%. This does not completely reflect Brexit effects, so we may get a further revision.

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.

ECRI-WLI-YoY-since-2000

 

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. His latest update describes the elements of the indicator we cite every week.

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. Dwaine’s most recent update, shows the increase in the number of countries with back-to-back quarters of losses in GDP.

2016-07-01_1721

 

As we review the weekly indicators it is important to maintain perspective. A 20% chance of a recession would be average. It is not a reason for fear, since it says that a recession is very unlikely. There will be a time to exercise more caution, but we are not yet close to that point.

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.
  • Felix and Holmes – 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 our neutral market forecast. Felix remains almost fully invested but with somewhat more cautious choices. This was good for most of the week. The more cautious Holmes is still fully invested, in selections that dodged the Brexit fallout pretty well. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now. It is not a resounding endorsement of the overall market, but a vote for opportunistic trading.

Top Trading Advice

One of the reasons I enjoy and learn from Brett Steenbarger is the unique quality of his insights. He often discusses a topic that you might think is simple and obvious in retrospect. The value is that no one actually follows the key process in real time! His recent post on Confusion and Clarity in Trading is an excellent example. How many times are you in a situation where you simply do not know? How often do you admit it?

Adam H. Grimes also has simple but powerful advice: Take notes! Use them to identify biases and action points.

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 Josh Brown’s first-rate warning about the latest round of financial scams. Josh has street cred on helping investors – often by revealing what is going on behind the scenes. I reviewed his book Backstage Wall Street, noting that it would save reader thousands of dollars. I have also often cited his second book, written with Jeff Macke, on several occasions. What he writes is colorful, fun, and always adding to his main theme of helping the individual investor.

This week’s post emphasizes that intelligent and prominent people can be victims. It happens even if you are dealing with a prestigious firm. It can easily happen to you. There are many good points, but here is the conclusion:

Peter Lynch said that “Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves.” If your advisor’s answer to the potential for corrections or volatility is to sell you silly (OP: ahem – stuff) from outer space, then your follow up question should be whether or not he or she gets paid for the privilege of your having bought it.

[Jeff] Sadly, I often see such complicated and illiquid assets in the accounts of new clients, usually after a big commission has already been paid and there is no cheap escape.

Stock Ideas

Barron’s mentions Volkswagen, big U.S. banks, and Southwest airlines as candidates for major moves.

Chuck Carnevale ventures a bit out of his wheelhouse, using his typical valuation methods on a more speculative stock sector – biotech. This is very interesting reading, with plenty of ideas and suggestions.

John Buckingham of the Prudent Speculator has plenty of ideas worth considering.

It is always interesting to compare the results from different research processes and screens. Here is Value Walk’s growth screen for June.

growth-screen

 

Brexit Reprise

  • Brexit selling might already be over. The story is getting boring. This was from Tuesday!
  • Brexit might not really occur. Readers might recall that I predicted this a few weeks ago, suggesting that the referendum result might wind up as a negotiating ploy. It was a Barron’s story this week, and others are joining in.
  • Economic predictions are already suspect. I started to quote the culprits, but decided not to. What is the point. Beware of writing when you are reaching outside of your “happy zone.” The basic economic effects on the U.S. will be modest. Most of the dire predictions relate to falling dominoes, an easy and typical scare tactic.
  • Most investors lost money. (MarketWatch).

MW-EQ606_openfo_20160701114702_NS

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, and I have two favorites this week. The first, from Josh Brown, is reported above. The second is a brief and cleverly-written story by Carl Richards. It is difficult to quote it without spoiling, so please take a few seconds to read it yourself. Here is the Sketch Guy’s chart:

062716bucks-carl-sketch-master768

Kurt Feuerman has a similar story about the news barrage from perma-bears whenever markets turn volatile. It is well worth reading his account of past crises, looking at the charts, and enjoying the picture of a nasty-looking bear. Here is a key quotation:

Right now, for instance, is a good example of when to exert your objectivity. Fear is running high. Along with that, there’s a pervasive distrust of equities. But let’s look a little closer. The yield on equities is roughly 2.2% versus the 10-year Treasury yield of 1.5%. Once again, there’s a mad dash to safety assets, so the rates on Treasuries continue to fall. Yet the current situation actually creates a double positive for stocks: interest rates are likely to stay lower for longer, which helps support equity valuations while also providing investment-grade issuers with the ability to borrow cheaply and increase shareholder value.

Watch out for….

Chasing performance from last year’s best hedge funds. Abnormal Returns takes two successful funds with completely different strategies. Here is how they are now doing:

ALFA2_0616-1024x394

Final Thoughts

I doubt that I can match my “final thoughts” from the last two weeks. I hope readers were helped in weathering another round of macro news with plenty of speculation about U.S. stocks.

The potential trading range I laid out two weeks ago was pretty much on target. The preliminary expectations about the vote led to a larger reaction than would otherwise have occurred. Media milked this for all it was worth, taking the prior Thursday close as the correct starting point, despite the run-up. Just staying cool can be a challenge!

What about a summer rally? It is a good guess about the theme for the week. As is often the case for the weekly theme, I don’t know the answer and neither does anyone else. That said, I rate the possibility higher than most, and therefore another good contrarian play. We have had a long-time tight trading range, so a breakout would be meaningful for many. Rightly or wrongly, much will depend on the employment report.

The economy is the key to future earnings. Recession odds are low, earnings are improving, the oil issue has stabilized, and the Fed is on hold.  Many “trading range worries” are now behind us.

Weighing the Week Ahead: Is Small Employment Growth Big News for Stocks?

This week’s economic calendar is the lightest in recent memory. After Monday, FedSpeak fans will be disappointed, since we are entering the quiet period before the next FOMC meeting.

Like nature, pundits abhor a vacuum. To fill it they will be asking:

Is the weak employment report big news for stocks?

Last Week

Most of the economic news was fine – until Friday morning! The weak employment report, widely viewed as the most significant economic data of the month, clearly changed the market perspective. Astute market observer Eddy Elfenbein described the instant market sector rotation from financials (which I like) to utilities (which I hate). This is going to change, but what it will take is a key question.

big06032016g

 

Theme Recap

In my last WTWA, I predicted that the big discussion would be about the risk/reward for stocks and possible breaking of the recent trading range. That did get some attention – at least as much as anything else other than politics – until Friday morning. New highs now seem to be on hold.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. He 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.

SPX-five-day

Special News

Abnormal Returns is one of our regular sources and references, helping all of us on many occasions. This week Tadas is supporting a great cause, charity: water. Check out the description at Abnormal Returns, where you can either purchase T-shirts with the new logo, or join me in making a direct contribution.

Please also be sure to check out the special offer at the end of today’s post – a reader opportunity that I have sought for many months.

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

  • ADP private employment report showed a solid gain of 173K, and the prior month was revised higher.

Change-in-Nonfarm-Private-Employment-May-2016

NAPM vs GDP

  • The Fed’s Beige Book showed overall economic improvement. Steven Hansen reports (but does not show much enthusiasm for the news).
  • Wage growth is improving. The Atlanta Fed report came before Friday’s news, but presumably it will get even better.

6a00d8341c834f53ef01b8d1f0ee1f970c-500wi

  • Sentiment remains negative, and that is a positive for stocks. The Bespoke Premium service (check it out!) provides this chart:

Bespoke sentiment

 

The Bad

  • Consumer confidence (via the Conference Board) declined from the prior month (92.6 vs 94.7) and also missed expectations. I regard consumer confidence as important, so declines are worrisome.
  • Auto sales disappointed. Trucks and SUVs were strong, but passenger cars very weak. The WSJ has a good report.

BT-AJ025_CARSAL_16U_20160601174539

  • The yield curve is flattening. Dr. Ed asks if this is a “global yellow light.”
  • Employment growth weakened. By all measures, and despite the deceptive decline in unemployment, the May employment situation report disappointed. The WSJ has a collection of reactions from economists. Conclusion: A dud! Business Insider has a similar compendium. Some highly respected sources suggested that the results were even weaker – perhaps a negative number – if the seasonal adjustments were accurate. The following chart is from the BLS report:

CES0000000001_933544_1465097389712

The Ugly

Defective air bags. Bloomberg’s feature story, Sixty Million Car Bombs: Inside Takata’s Air Bag Crisis, describes the story behind the development and sale of a product that proved to be dangerous. Warnings from some within Takata were not heeded. The company denies that “data integrity problems” revealed in documents from the U.S. Senate investigation were directly related to air bag ruptures. This is a fascinating article that shows the temptation to cut corners when big profits are at stake. It will take three years to replace all of the defective air bags.

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. Think of The Lone Ranger. 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 an extremely thin week for economic data. I highlight only the most important items, helping us all to focus.

The “A” List

  • Michigan sentiment (F). Information about consumption and job creation you can’t get elsewhere.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • JOLTS Report (W). Mostly misinterpreted. Not an indicator for job growth, but rather the labor market.
  • Wholesale inventories (Th). Has impact on Q2 GDP.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

A Monday appearance by Chair Yellen will have an impact before noon, setting the context for the rest of the week. There is a little other FedSpeak, but we are entering the quiet period before the next meeting.

Brexit news will also grab attention.

Next Week’s Theme

It is a very light calendar. Like nature, pundits abhor a vacuum! There are pages to paint with pixels and airtime to fill with opinion. The space available is always about the same, even if the need is reduced. CNBC has gone to reality TV and features at night, and it is creeping into the daily schedule. My solution of TIVO and mute is a good way to avoid the reports on the stress in the nine-figure real-estate market and whether the latest blip in some indicator should change my market attitude.

You will learn more watching those good ol’ boys from West Texas!

My exasperation… [Mrs. OldProf noted my jaw setting and reminded me to restrict my opinions to the conclusion. Thanks to her and please check there.)

Friday’s employment report seemed sharply different from other recent economic news. The key question for the week will be:

Is the weak employment report big news for stocks?

There are four promising themes for speculation:

  1. Is the employment data the best read on economic growth?
  2. Will the weak report influence Fed policy?
  3. Does Fed policy really matter?
  4. Will market perceptions be more important than any of the factual questions?

The super-bearish opinions will emphasize the weak economy, the Fed in a box (corner, rock and hard place or whatever) and the need to hike rates regardless of conditions.

The mainstream is expecting Chair Yellen to dial back, if only because of market perceptions. We will get our first clue about the Fed on Monday.

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

Indicator Snapshot 060416

 

The Featured Sources:

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

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). Monthly reports including both an economic overview the economy and employment. After each employment report Bob Dieli provides a complete, balanced, “no-spin” analysis. Here is a typical chart from this week’s report:

Dieli Employment Change

(Find out more in today’s conclusion).

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature the 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. His latest update features his unemployment rate recession indicator. A recession is unlikely “any time soon.”

Fig-8.-6-3-2016

 

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

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 and no cookie-cutter approach. 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.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 – The Year of the 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. (Please send any 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 our neutral market forecast. Felix is fully invested, and continues with fairly aggressive sectors. Most sectors remain in the penalty box. The (usually) more cautious Holmes is almost fully invested, with fifteen positions. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now. It is not a resounding endorsement of the overall market, but a vote for opportunistic trading.

Top Trading Advice

 

Adam H. Grimes has some great advice on trading a quiet market. So many traders go wrong in such times. Of his five points, I especially like the last:

Quiet markets are boring, but focus is rewarded. No one wants to talk about some market that is sitting in a 2% range for weeks, and the media quickly loses interest when markets go into consolidation. You, as a trader or investor, cannot. No one is going to do this work for you. It’s hard work to maintain focus when that focus is not rewarded today, tomorrow, or even next week, but you must do so. Know where the opportunities are, and monitor market conditions for shifts that might mark significant inflections. For some traders, a daily look at a handful of markets is enough, but other traders might consider setting alerts or using other screening tools.

Dr. Brett has another great contribution that most traders have never considered. The language we embrace to describe markets colors are thinking and prevents flexibility. He writes:

The traders I see making money are employing language differently to make sense of frequently-changing markets.  For example, several traders I know are trading shorter-term strategies and longer-term strategies and adjusting the weighting of those based upon how markets are moving.  A good example was yesterday’s trade in the ES futures.  We had early selling off the weak jobs number, but many sectors of the market displayed buying interest.  The advance-decline line was unusually strong, given the decline in the average, and we never hit a selling extreme of -800 or less in the NYSE TICK measure.  This was a useful tell that the selling was part of sector rotation, not part of a general bear/risk-off move.  Recognizing this made it much easier to take profits on short positions early in the day and not get whipsawed by the afternoon strength.

In a topic that has broad interest, Bloomberg’s Sheelah Kolhatkar asks why Phil Mickelson did not get busted for insider trading. When I was teaching new traders at the Chicago options exchange, one of my first classes was to bring in a legal expert on this topic. Information flowed wildly – in the rest rooms and elevators, but most of it was wrong or unhelpful. Meanwhile, if something worked, what was the risk?

Needless to say my companies and students never used such information and they all understood why. Traders need to know about this. Did you hear about the plumber who got a tip from a top executive? Free bathroom remodeling? Sheesh!

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, it would be Chuck Carnevale’s warning about buying over-valued stocks. He carefully points out how even good companies can be poor stock purchases if the price is too high. I cannot agree more. As part of our stock screening we always use Chuck’s tools, and you should, too! Here are some examples of good companies at bad prices.

426415-1464884091632117_origin

426415-14648840545287015_origin

 

The full article has more examples as well as some current “buy” ideas.

 

Stock Ideas

Here is an update on Morningstar’s ultimate stock pickers. These reflect “conviction buys” which are new or large positions from top managers. The information lags a little, but no one is “talking his book.”

4128

 

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, but my favorite this week is from Larry Siegel, the Gary P. Brinson Director of Research for the CFA Research Foundation. He takes on a difficult but important topic – the expected return from various asset classes. A recent study by the McKinsey Global Institute has attracted plenty of attention, mostly because of the downbeat forecasts. The range of factors is apparent from this fascinating deconstruction of all that goes into determining equity returns. It is taken from the original study and repeated by Siegel to assist in the analysis.

MGI decomposition

 

You need to read the entire article to understand this, but it is worth the effort. Here is his conclusion:

Investors who expect a miracle from the markets – who think that 3% or 5% savings rates will get them close to their goals or that 10% savings rates will assure them a luxurious future – will be disappointed. Those conditions never existed. One would have had to have perfect foresight – and a lot of money early in life – to buy at the bottom in 1982 and then never sell until the top in 2000 or 2007 or 2015, availing oneself of the full glory of the largest bull market in history.

But investors who save diligently, buy and hold diversified portfolios of stocks and bonds and focus on their very long-term goals will do fine. A bias toward equities is justified, given the exceedingly low expected returns on bonds. Even with growth as low as we’ve experienced over the disappointing period since the end of the global financial crisis, the equity risk premium implied by McKinsey’s forecasts is 4%, enough to justify an above-average allocation to equities. With higher growth rates, the equity risk premium implied by McKinsey’s forecasts is even higher: 4.5%.

 

Dividend Stocks

Is it time for a stress test?

Energy Stocks

Our best source on the economics of the energy markets is Prof. James Hamilton. His update this week is worth careful reading by anyone interested in oil prices or energy stocks. Since there has been such a high correlation between oil prices and U.S. stocks (the bogus economic proxy), we are all forced to be interested. This chart from his excellent article is worth special attention:

china_oil_imports_May_16

Watch out for….

The Brexit threat. Polls put the vote (June 23rd) at 50-50. The bookies make it 30% in favor. This is a threat worth watching, since good studies suggest a major hit to exports if it passes. (Econbrowser). Two questions remain:

  • How much of this is already anticipated?
  • How much will extend to the rest of the world?

Marc Chandler cites three political events before the vote.

Expect more on this topic next week.

Some net-lease REITs. Brad Thomas explains what to look for as well as three to avoid.

 

Final Thoughts

 

How much did Friday’s employment news change the fundamental picture of economic growth? Or the prospects for stocks?

Not very much.

There are three key points:

  1. Any single report is of marginal significance – even employment.

A single employment report is but one flawed indicator of what is happening. It carries such significance not because it is especially accurate, but because we would really like to know the answer!

[picking up from above] My exasperation hit a peak Friday morning when the pundit-in-chief complained about revisions in the employment report. I was astounded to realize how little he knew about how the information was collected and compiled. As Cramer himself would put it: “HE KNOWS NOTHING.” Why does he think Fed economists would have fewer revisions? Sure we can track a package across the county. Should we all wear a bar code? We have excellent data with an eight-month lag. Getting data monthly is difficult and costly. (Should have kept the mute on!)

There is a huge margin of error on the net job growth (+/- over 100K) as well as the various subcategories. This is sampling error — after all revisions. Some companies never respond to the survey. Historically the growth of new businesses replaces those that drop out – plus a little more. I have explained this many times, most recently here, but you never see it mentioned by the punditry. The temptation to discuss pseudo-facts is just too juicy.

There are several estimates of employment growth, including the ADP, that are just as good and perhaps even more accurate than the BLS approach.]

  1. The Fed understands point #1. They have 350 expert economists who do not need to pontificate on TV. They understand surveys, sampling, birth/death models, and alternative methodologies. They place much less emphasis on a single number than the market.
  2. Nevertheless, the Fed does not want to surprise markets. Many recent Fed decisions have reflected not the best information, but the Fed guess about the market perception of information.

Everyone expects that a June rate increase is off the table, and probably July as well. The exact timing does not really matter, but I still expect two hikes before the end of 2016.

The Biggest Investor Challenge

I am often asked what is the biggest challenge for investors. If you think about it, the answer is obvious. Staying invested despite the barrage of negative hype has been a daunting challenge for most. Staying the course requires confidence in your approach and your sources. There is no information more valuable than knowing where we are in the business cycle.

Everyone seems to be itching to make a “big” call about the market or a recession. This will make them famous and rich.

It is better to rely upon someone with a genuine, long-term record. Bob Dieli’s regular reports provide the explanations and data that will give you the confidence to stay invested while that is right – as well as plenty of warning when it is time to change course. It is a very valuable resource. After many months of cajoling Bob has agreed to offer my readers a one-month free trial and a discount on subscriptions. Please give it a try. The reports are witty as well as informative. You will swiftly learn why I am such a fan.

Weighing the Week Ahead: What is the Risk/Reward for Stocks?

This week’s economic calendar is loaded, and packed into a holiday-shortened week. There will also be plenty of FedSpeak, encouraging the favorite game of not just reporting data, but wondering how the Fed will see it.

When it comes time to put it all together, pundits will be asking:

What is the risk/reward tradeoff for stocks?

Last Week

The news was very good, and the market responded.

Theme Recap

In my last WTWA, I predicted that the pundits would be focused on the oil price rally and what it meant for investors in stocks. That was a good call, with the theme continuing through week’s end. Several sources even cited both the recent strength and the apparent ceiling at $50/barrel. As a bonus, the strong housing data revived the “springtime for housing” theme from two weeks ago. Despite the competition from election news, these were important stories. If you prepared in advance, you were better able to handle the news.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. He 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.

SPX-five-day

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 most important economic and market news was quite good.

The Good

  • Q1 GDP was revised higher, up 0.8% instead of 0.5. This is old news, but it does provide a slightly stronger base for the year. More importantly, the current data suggests that Q2 will be much stronger – some estimates now reaching 3 %.
  • Jobless claims declined again, to 268K. People are not losing jobs, especially when considering the higher working population. We also need job creation. Bespoke has the story, and a great chart.

     

052616-Initial-Claims-SA

  • Industrial production jumped 5.8%, the most in eighteen months. Utilities were behind much of the gain.
  • The Michigan sentiment index showed a surprising increase of 5.7 points, for the highest reading in nearly a year. Jill Mislinski provides a complete analysis and Doug Short’s chart. You can readily see that the index is back at healthy levels, topped only by the Y2K era.

Michigan-consumer-sentiment-index

 

  • Housing data showed real strength.
    • Pending home sales popped 5.1%. (Calculated Risk)
    • New homes sales had the best showing since 2008. Inventory is now down to 4.7 months. (Calculated Risk)

NHSApr2016

The Bad

  • April durable goods fell 0.8%, worse than expectations of a 0.3% decline. (BI).
  • Transportation “stunk in April” according to New Deal Democrat. It has certainly been the worst part of the economic story. Check out the full post for details. Steven Hansen at GEI has a thoughtful analysis suggesting that this was a “huge recession which never came.” Think about coal.
  • Puerto Rico debt measure is stalled in the Senate after progress in the House. This represents more than the specific issue. It is something of a litmus test for Speaker Ryan’s ability to negotiate. That is the real market significance.

     

The Ugly

The vulnerability of government technology. The multi-year pressure on government spending has had a definite effect on equipment. Upgrades that would be routine in business simply do not happen in government. It is a vicious cycle. The older the equipment and software get, the higher the maintenance costs. Barbara Kollmeyer has a good analysis of the problem, including this chart.

MW-EN838_gao226_20160526041302_NS

This problem is deeper than general obsolescence. The determined hackers are looking for vulnerable systems. There is a likely collision course, already seen in prior attacks.

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. Think of The Lone Ranger. This week’s award goes to Narayana Kocherlakota, former President of the Minneapolis Fed. Many of those who have moved on from a roles as official participants in Fed meetings are speaking out. This valuable information gives us an inside look. Sometimes the message is that we are making too many unjustified inferences. Kocherlakota writes:

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

It is possible that no information will be more important for investors over the next two years or so.

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 big four-day week for economic data. (Dare I say YUGE?) I highlight the most important items, helping us all to focus.

The “A” List

  • The employment report (F). Remains the biggest news of all.
  • ISM index (W). Great read on an important sector. Concurrent with some leading qualities.
  • Personal Income and spending (T). April data, but a continuing rebound here is important for economic expansion to continue.
  • Auto sales (W). A strong indicator of economic growth. F150 sales? Many believe this is linked to construction and small business.
  • Consumer confidence (T). This is the Conference Board version. It provides information on job creation and spending plans that you will not get elsewhere.
  • ADP private employment (Th). This independent read on private employment growth, using contemporaneous data, deserves more attention.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Fed Beige Book (W). The anecdotal report that will inform participants at the upcoming Fed meeting will not tell us much, but pundits will find something!
  • PCE prices (T). The Fed’s favorite inflation measure. Not much change expected.
  • Construction spending (T). Volatile April data is still relevant because of the importance of this sector.
  • ISM services (F). Not quite as important as manufacturing, but only because the data series is shorter. Will recent strength continue?
  • Trade balance (F). April data relevant for Q2 GDP calculation.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

Not much will be happening at the start of the week, with many slow to return from a long weekend. Expect volume to pick up.

There is also a full slate of Fed speakers, including Chair Yellen.

Next Week’s Theme

 

It is a big economic calendar and a holiday-shortened week. There will be a trifecta of questions:

  1. Economics. Will the recent data rebound continue?
  2. The Fed. Will strong data increase the pace and timing of rate increases?
  3. Stocks. How will stocks react? Will good news be good?

The pundits will circle around these topics. Even the pundit-in-chief seems to be shifting with the winds. They will analyze the data, emphasize how important Friday will be for the Fed, and wind up asking:

What is the risk/reward tradeoff for stocks?

 

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

 

Indicator Snapshot 052816

The Featured Sources:

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

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he observes that more people are using forward earnings, and many are thinking about 2017.

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). Monthly reports including both an economic overview the economy and employment.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature the 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.

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

Noteworthy this week:

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 and no cookie-cutter approach. 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.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 – The Year of the 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. (Please send any 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 our neutral market forecast. Felix is fully invested, and with more aggressive sectors. Most sectors remain in the penalty box. The (usually) more cautious Holmes is once again fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now.

Top Trading Advice

Dr. Brett Steenbarger emphasizes emotion-free trading. He writes:

The emotionally intelligent trader can prepare for frustration, fear, greed, and other seemingly disruptive states.  By anticipating them, rehearsing our response to them, and channeling their energy constructively, we turn our experience into a powerful trading asset.

Holmes is barking enthusiastic agreement, and Felix is nodding wisely!

12 good points from Paul Tudor Jones (via New Trader U). They are all worth considering, but my favorite is #9:

“Always think of your entry point as last night’s close.”

 

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, it would be the overall market outlook from David Templeton at HORAN Capital Advisors. He covers many of the themes I regard as most important, but readers will enjoy getting the message from different sources.

In particular, he deals with the common argument about good news: The Fed will raise rates. He writes as follows:

Historically though, the initial moves in rate increases by the Fed is pursued to get rates back to a more normal level. As a result, when interest rates are increased from a level below 5% stocks tend to rise. In short, below the 5% level there is a positive correlation between interest rates and stocks.

correlation rates market

Stock Ideas

Chuck Carnevale has a terrific follow-up to his prior article on Emerson Electric (EMR). Individual investors who do their own stock picking should read this carefully. Not only does he provide great analysis and advice about entry points, it illustrates what your research should cover.

Time to buy Europe? Jason Zweig (WSJ) recounts all of the bad news, as well as the depressed stock levels. Is it time to “buy low?”

And for income investors – always consider the dividend kings. Here are eighteen companies that have increased dividends for at least 50 years. If that level of income is enough, this kind of stock may be the answer. Philip Van Doorn (MarketWatch)

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, but my favorite this week is from Ben Carlson for his discussion of Social Security Benefits. Here are but two points from a great post. You should read it all.

  • Social Security is a more important part of retirement than many realize, covering more than half of the needs for most people.

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  • Waiting longer for benefits generally helps, if you are able to do it.

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The article also has some links to good sources. Your financial advisor should be considering the Social Security contribution when figuring out your retirement needs and asset allocation.

Older investors pick their biggest mistake – not starting early enough in saving for retirement.

Value Stocks

How about AbbVie as a retirement holding? Looking at the numbers shows value, but perhaps no immediate catalyst. Where others see “value trap” I see an opportunity for enhancing good dividend yield by selling near term calls. Take what the market is giving you!

Energy Stocks

There is not a specific recommendation here, but the information is important. I am watching it, and so should you. What companies begin to profit at various levels of oil prices? (The Daily Shot)

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Watch out for….

Safety stocks. Seth Masters asks, Are “Safety Stocks” Truly Safe? Many of the relevant sectors have been part of the recent quest for yield. With investors fearful about a weak economy – or even recession – something with a dividend yield looks great. If the economy improves, it is a different story, as this chart shows:

 

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Bonds. In the “man bites dog” department, even Bill Gross is going negative on bonds. Mr. Dow 5000 is still not recommending stocks.

 

Final Thoughts

 

The risk/reward debate includes many viewpoints, but the worries usually dominate.

  • These stories are more newsworthy, so they get higher ratings. Barry Ritholtz has a good article on “click bait.” One of his examples is the repeated story about George Soros buying puts. I have two different posts (here and here) showing the error of this approach, but the scary stories get the readership.

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  • The negative predictions call for extreme outcomes (market 50% over-valued – various sources, we are already in a recession – Peter Schiff’s claim this week, Europe and the rest of the world will crumble, or maybe it will be China. There is just enough plausibility in the arguments that many people are “scared witless” (TM OldProf euphemism) If you think the downside is 50% and the upside only 2%, what would you do?
  • The positive arguments are generally modest and restrained. Ed Yardeni (who also accurate downplayed the recession worries in January) sees a 10% upside for stocks in the next year. The Fast Money gang acted like he was crazy. “What needs to happen for that?” was the question. Not much, he explained. A little earnings growth, no recession, and a little inflation. It was a modest claim.
  • Politicians of all stripes find it useful to highlight dissatisfaction. This political approach is effective when running for election, but it is dangerous for investors. It is easy to think about societal ills rather than improving your investments. You cannot improve public policy by making poor investment decisions and losing your money!

For a change, why don’t we ask what could go right? (The Barron’s cover story this week is on the right track, repeating some of our main themes — but perhaps not analyzed as thoroughly. It is always helpful to have more voices helping investors).

  • The economy is not headed for recession, and actually shows promise on the big-purchase items like autos and homes.
  • Employment is good and improving.
  • Earnings may have troughed with the energy crash (apparently) behind us. Meanwhile, energy prices remain relatively low.
  • Interest rates remain low – this makes companies more profitable and stocks more attractive.
  • The dollar strength seems to have leveled off, helping the earnings of multi-national companies.
  • Economic and market cycles do not die of old age. A “mature” cycle has the same survival potential as a new one, despite the appealing metaphor of the doddering old person.

The market could easily gain 10% next year, and the year after that. Picking value stocks could increase your potential, since the economic skepticism has created recession pricing.

Most do not understand this key point: We could be having the same debate two years from now! Or even three.

And stocks could be 50% higher.

Weighing the Week Ahead: How Should Investors React to the Oil Price Rally?

This week’s economic calendar is pretty light. Market participants will be looking to an early getaway for the long weekend. While there will be plenty of entertaining FedSpeak, I expect a different topic to be at the fore. Pundits will be asking:

Should investors react to the oil price rally?

Last Week

The news was pretty good, but the stock market was not.

Theme Recap

In my last WTWA, I predicted that the punditry would be asking whether it was “springtime for housing”. That was the recurring topic as housing news was reported on several different days and garnered plenty of discussion. Competition came from the Fed Minutes, some dramatic earnings reports, and the election race.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. He 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.

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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 economic and market news, on balance, was pretty good.

The Good

  • Housing starts increased to a 1.172 annual rate, beating expectations. Calculated Risk has a complete analysis. I am especially interested in single-family building permits, a good leading indicator. Bob Dieli’s monthly economic report always updates this chart:

Dieli Building Permits

 

  • Existing home sales were up 5.45 million (SAAR), the top of the Calculated Risk range for a solid report. Bill writes:

    Note that January and February are usually the slowest months of the year and March and April are the beginning of the “selling season”.  This is a solid start to the year.

    EHSNSAApr2016

  • Jobless claims down ticked to 278K, in line with estimates and below the 300K level that some have been citing. (The four-week moving average was up slightly).
  • Industrial production rose by 0.7%. Eddy Elfenbein has a good report, noting that this interrupts the downtrend since November, 2014. He also points out the effect on the Atlanta Fed’s GDP forecast for Q2, now up to 2.8%
  • Sentiment remains very negative. Urban Carmel summarizes asset allocations and economic skepticism. Ben Eisen of the WSJ cites four stats, including the fund flows in the chart below. Schwab’s Liz Ann Sonders agrees. She notes only negative questions from both investors and advisors, “all almost bordering on Armageddon.”

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The Bad

  • The Philly Fed indexremained negative and essentially unchanged, -1.8 on the diffusion index. Employment improved dramatically, but remained marginally negative. The outlook fell a bit but remained strongly positive. There was little market reaction.
  • Fed minutes showed more chance for a June rate increase. Our go-to Fed expert, Tim Duy, sees a June hike as a bit less than 50-50 but July as quite possible. The Fed remains more confident about the economy than most market participants.
  • LA port traffic declined. Calculated Risk uses a rolling twelve-month average to control for seasonality. The decline was 0.7% for inbound traffic and 0.8% for outbound. Steven Hansen opines that this raises recession concerns.
  • Rail traffic “moves deeper into contraction”. Steven Hansen looks at a variety of rolling averages, including some analysis that adjusts for the declining coal shipments.

The Ugly

State and local pension funds. Chicago provides an example. A decision of the Illinois Supreme Court struck down an “overhaul” of the system, adding $11.5 billion to the deficit, now $18.6 billion. The fund covers 70,000 workers and in the absence of any changes, will run out of money in ten years. (Crain’s Chicago Business)

Noteworthy

Try this financial literacy quiz designed by economists from Wharton and George Washington. (via Shawn Langlois) I am confident that WTWA readers will do well. Keep in mind that less than 1/3 of the population could get all three questions right!

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. Think of The Lone Ranger. This week’s award goes jointly to Gene Epstein of Barron’s and New Deal Democrat of the Bonddad Blog and xe.com. Both take on the frequent current scary articles about the “flattening” yield curve, citing the yield difference between the ten-year and two year notes. That spread is currently 0.94 percentage points. Those on a mission often cherry-pick the part of the curve to analyze, and cry alarm whenever it gets a little smaller.

Epstein points out that until the curve actually inverts (a spread of less than zero) there is not a reliable recession indicator.

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NDD has a great article with plenty of charts. He calls out the “doomers” with this commentary and chart:

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

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I wish that more publications would recognize the Silver Bullet winners and writers like them. It is difficult to call out weak and biased posts. There is little reward for good and courageous analysis.

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. I highlight the most important items, helping us all to focus.

The “A” List

  • New home sales (T). Continuing strength in housing?
  • Durable goods (Th). Important April data. Continuing recent strength?
  • Initial claims (Th). The best concurrent indicator for employment trends.
  • Michigan sentiment (F). Best for job growth and prospective spending. Strength continuing?

The “B” List

  • Pending home sales (Th). Unlikely to match last month. Not as important as new sales, but a read on the market.
  • GDP second estimate for Q1 (F). This will get attention, but it is old news by now with Q2 more than half over.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

There is plenty of FedSpeak, including a Friday appearance by Chair Yellen. Things will be slowing down by Friday as some slip away early for a long weekend marking the unofficial start of summer.

Next Week’s Theme

 

It is a pretty light economic calendar. In addition to the daily dose of analysis by pseudo-experts on the Fed, I expect to see some serious discussion about energy prices. Will the oil rally continue? What does that imply for investors and traders?

Voting a tentative “No” is Dana Lyons, who cites technical resistance and concludes as follows:

Will the oil rally stop here? We have no idea – but we wouldn’t be surprised to see the rally get clogged up, at least temporarily.

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Oil & Energy Insider is also cautious but more bullish, mostly citing fundamentals. Their free edition includes this analysis:

Oil prices bounced around this week, flirting with $50 per barrel but stopping short of that key threshold. The major supply outages in Nigeria (now at 900,000 barrels per day) and Canada (more than 1 million barrels per day) continue to put upward pressure on oil prices as they are erasing the supply overhang. Still, much of that will be temporary. The EIA poured a bit of cold water on the rally this week, reporting a surprise uptick in oil stocks. At the same time, U.S. production continues to slowly erode. The markets are more confident than at any point in recent weeks that prices won’t crash back into the $30s, but more movement to the upside is not a given.

Their premium edition (which requires a subscription) is headlined Fundamentals Starting to Underpin Oil Price Rally. They cover a wide range of considerations, but include key questions: When might we expect Nigerian supply to rebound? Most investors would find their analysis quite helpful:

–    The Niger Delta Avengers have attacked pipelines and platforms in Nigeria, knocking 800,000 barrels per day offline.
–    Between 2006 and 2009 Nigeria suffered a similar level of attacks and outages, and a sweeping amnesty policy helped bring an end to the violence. The new President Muhammadu Buhari has taken a tougher line, ending patronage that existed in security contracts for many militia members, a move that has contributed to the resurgence in pipeline attacks.
–    Nigeria’s cash reserves are running low as its economy slows. Reserves have plunged from $49 billion in 2013 to $27 billion recently.
–    Eni (NYSE: E) suffered the latest attack this week. Fellow oil majors Royal Dutch Shell (NYSE: RDS.A) and Chevron (NYSE: CVX) have also seen their infrastructure taken out from explosions.
–    Nigeria’s oil production is at its lowest level since the 1980s. The attacks show no sign of letting up, and as of now the Nigerian government is unwilling to back down.

 

 

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

Indicator Snapshot 052016

The Featured Sources:

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

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he observes that more people are using forward earnings, and many are thinking about 2017.

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). Monthly reports including both an economic overview the economy and employment.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting approaches to asset allocation. This week Dwaine opened to the public one of his subscriber-only research reports. He notes that one of his recession indicators has moved up to 60%. He goes on to explain that he uses a group of six different methods as his preferred approach. He writes as follows:

Another way to look at the RFE is to average the current recession probability showing on each of its six model components, which is currently showing a 14.6% probability of recession. This model appears to have served well in the past, with zero false positives above readings of 0.20.

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Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods.

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

Noteworthy this week:

Hedge funds are using artificial intelligence to analyze the Fed minutes. Guess who can do it faster – you or them?

Peter F. Way reports on the hedging techniques of “big money” traders, identifying candidates with the best risk/reward balance. Apple?

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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 and no cookie-cutter approach. 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.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 – The Year of the 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. (Suggestions and questions welcome!)

 

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 our neutral market forecast. Felix is about 75% invested, and with less aggressive sectors. REITs and utilities have moved near the top of the list. The (usually) more cautious Holmes remains almost fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates.

Top Trading Advice

Dr. Brett Steenbarger has important advice about Seeing Beneath the Market Surface. He writes:

Markets move higher, markets move lower.  The question worth continually posing is, “Is the market getting stronger or weaker?”  This is a meaningful question because a market that moves higher can be getting weaker and a market that moves lower can be getting stronger.

Read the entire post as he explains how to apply this approach.

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, it would be this Forbes article by Brett Steenbarger (and not just because he has some kind words about WTWA, but thanks!) As a psychologist and trading coach he sees things missed by others and explains them very well. I share many of his themes, but often cannot communicate them as well. People need to be open to new ideas and unemotional in executing the plan.

Few can meet these tests.

Stock Ideas

Chuck Carnevale has a timely post on cyclical stocks. He shows how to use his tools to analyze valuation in this difficult sector. When can these stocks be right for dividend-oriented, conservative investors? Emerson Electric (EMR) is his illustration. If you agree with our experts that a recession is not imminent, cyclical stocks are a good place to shop.

How about Kroger? Hale Stewart makes this a good example of how to search for a good stock – find an interesting sector, a cheap stock, and a catalyst.

Retailers that might profit from the “Amazon effect.” (Philip Van Doorn) Hint: they need to change their business model.

Marc Gerstein has some interesting contrarian retail plays. Marc always uses some science in his method. Here he identifies desired characteristics, develops a screen, and looks for a catalyst. It is another article that goes beyond simply delivering stock ideas (although it does that). Stock screening meets Peter Lynch.

How about solar? If energy prices improve, solar stocks do as well. Travis Hoium has an interesting argument favoring First Solar (FSLR) over some alternatives.

Outlook

Why is it so attractive to be negative on your investments? One good answer lies in Morgan Housel’s explanation of volatility and how it can take investors off course. It is so easy to think about an account in terms of how far we are from the past high. In fact, that is the condition over 87% of the time. Each year includes a lot of big moves that seem small when you later look at the long-term stock chart. He uses 1998 as a year of major gains, but only if you were able to ride out the major swings. I like this chart showing time spend below the prior high:

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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 this special edition. There are always several great choices worth reading, but my favorite this week is from Carl Richards at Investment News. He suggests that a good financial advisor helps clients by turning off the news spigot. (If you do not use a financial advisor, I recommend that you turn it off anyway! You might make an exception for WTWA).

There’s a valuable role for us to play as real financial advisers, that of the human curator. Do our clients really need to spend hours sorting through their feeds and trying to decode the headlines or could we be doing that for them? What should they be paying attention to?

For instance, one friend shared with me that when he turned off the financial news spigot, he calculated that he saved two to three hours every night. Do the math and it ends up being a savings of 40 or so days each year.

Value Stocks

Time to buy again? They are cheaper than the broad market and that seemed to be the story last week.

Watch out for….

Boeing (BA). Barron’s warns that demand for fuel-efficient aircraft has declined.

Bonds and fund redemptions. If the ten-year note increases one percentage point, to something like 2.8%, you will immediately lose 9% on your investment. It would take a few years to make that up, even if rates moved no higher.

Investment big-shots using a platform to talk their book. Are they really there to help you? This is an interesting summary of recommendations at the recent SALT conference, which was breathlessly covered in the media. Most of the topics would require a lot of research, but the Sherwin-Williams (SHW) recommendation (You can’t buy paint online) caught my attention. It took about five seconds to discover the error of this assertion.

13F filings. Here is one example that highlights stocks from David Einhorn. This, and nearly everything written about 13F reports is misleading. This WSJ article headlining George Soros is especially misleading. I explained this carefully (for the second time) but no one cares. We can think of it as our secret!

Final Thoughts

Knowing economics helps to understand energy pricing, but the payoff for that knowledge has been delayed. In my most popular article ever on Seeking Alpha, I noted a few basic facts about energy including the relatively small gap between supply and demand. We are now observing the closing of that gap. It could (and will) continue in one of three ways:

  1. Reductions in supply through economic forces. U.S. producers responded, but most others have not – so far at least.
  2. Increases in demand through a growing economy. This is happening with record miles driven in the U.S. and many new consumers worldwide.
  3. External shocks, through weather, disasters, or war.

The same economic effects may well push against a price increase. The reduction in rig counts, for example, seems to have paused for the first time in eight weeks. Bespoke has one of their great charts using data from the primary source on drilling activity, the Baker-Hughes weekly report.

052016-Baker-Hughes

 

Even if $50/barrel represents an intermediate high for oil prices there are important favorable consequences:

  1. The savings to the consumer, compared to recent years, remains large;
  2. The fears about failing companies and job losses, exaggerated and localized, will be less of a story.;
  3. The concern about banks failing due to oil company bankruptcies will be reduced.

Current oil prices may represent a sweet spot both for the energy sector and the overall stock market.