Stock Valuation and Occam’s Razor

Among competing hypotheses, the one with the fewest assumptions should be selected.

William of Occam

 

The use of this principle is valuable, but not completely determinative in science.  It often has an important application in investing.

Let us consider two hypotheses.

  1. A method of valuing markets that relies upon backward-looking data, looks at replacement value, or depends upon some other fixed ratio. Put another way, all the most popular valuation metrics.
  2. A method that considers prospective earnings, expected inflation, and interest rates.

Method one has been wrong for many years.  In fact, it has been mostly incorrect for decades.  Method two has been on the right side of market moves, but still shows significant deviations.  What can we learn from Occam’s Razor?

Method One

Since this method has been mostly wrong, many explanations have been offered.  I think I left a few out, but you get the drift.

  1. Speculation
  2. Not recognizing “fundamental” risks – Euro collapse, China collapse, recession, Brexit, etc.
  3. Depending upon dubious earnings estimates
  4. Market is about to crash
  5. Method not good for market timing, but returns will be poor for the next 5, 7, 10, 12, ? years
  6. Fed intervention – money printing and pumping up the market via QE
  7. Plunge protection team
  8. European Central Banks
  9. Suckers’ Rally
  10. Myopia of the investment world – no efficient markets
  11. High Frequency Traders and Algorithms

Method Two

Since this method has been mostly right, little explanation is needed.  The expected increase in market prices and multiples is consistent with the theory.  It should continue for another 8-10% and further if forward earnings increase.

 

Question

 

Should investors accept the complex and ever-changing explanations for method one?  Or perhaps should they consider that the method itself is flawed?

 

Weighing the Week Ahead: Will an Earnings Surge Revive the Stock Rally?

Are you ready for some real news? How about corporate earnings? While there is some economic data on tap, the Q1 earnings season starts in earnest this week. With questions about economic strength, the dollar and the Fed in mind, pundits will be looking for fresh data. They will be asking:

Can resurgent corporate earnings revive the stock rally?

Last Week

Last week the news was heavy but generally neutral. Strong economic data caused celebration. The Fed minutes and concerns about tax reform were the biggest negatives.

Theme Recap

In my last WTWA I predicted special attention to the Trump-Xi meeting. That was a good call, with plenty of discussion all week. The talks did not yield much news, but there might be a lesson from that as well.

The Story in One Chart

I always start my personal review by looking at a weekly chart. While there was not much of an overall change this week, Wednesday was the exception. Stocks moved sharply higher after the ADP number and sold off sharply in the afternoon, perhaps because of reaction to the Fed minutes, perhaps because of tax reform prospects.

 

The News

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

This week’s news was neutral.

The Good

  • Construction spending rose 0.8%. Steven Hansen (GEI) is not convinced.
  • Rail traffic in March increased 7.3% (AAR).
  • ISM manufacturing maintained recent strength at 57.2. Scott Grannis offers this chart.

  • ADP private employment registered a change of 263K, handily beating expectations.

  • Weekly jobless claims dropped to 234K

 

The Bad

  • Tax reform prospects seemed to get worse at least that was the market take on Speaker Ryan’s press conference.
  • The Fed may be reducing its balance sheet. (Reuters). Fed expert Tim Duy thinks that balance sheet reduction will be gradual.
  • Auto sales were surprisingly weak. Calculated Risk concludes:

    This isn’t a huge concern – most likely vehicle sales will move sideways at near record levels. But the economic boost from increasing auto sales is probably over.

  • ISM services dropped to 55.2. This is still a strong level, of course, but any dip from a peak is drawing attention.
  • Non-farm payrolls registered a net increase of 98K, well below expectations. Doug Short has a nice chart pack, including this rolling average interpretation of non-farm payrolls.

 

The Ugly

Rising global threats including Syrian gas attacks, North Korean challenges, and more terrorist 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. No award this week, but nominations are always welcome. There are many bogus claims and charts out there!

The Week Ahead

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

The Calendar

We have a normal week for economic data, including releases on Friday when financial markets are closed.

The “A” List

  • Michigan Sentiment (T). Continued high readings and debate over “soft” data.
  • Retail sales (F). Will negative consumer news be confirmed?
  • Initial jobless claims (Th). Is the series edging up from record low levels?

The “B” List

  • JOLTS (T). February data. This is about labor market structure, not job growth!
  • PPI (Th). Still tame, with more of the same expected.
  • CPI (F). See PPI. The core increase is starting to approach the Fed’s target level.
  • Business inventories (F). Not much expected from this February data.
  • Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

The schedule is light on FedSpeak and many markets around the world are closed on Friday.

Next Week’s Theme

In a normal week for economic data the start of the Q1 earnings season will command attention. Geopolitics will grab some headlines, but market participants are eager to see if the recent stock market strength is supported by corporate earnings. The key question?

Will resurgent earnings revive the rally in stocks?

Each earnings season sees a revival of a familiar theme: Companies guide expectations lower. The final report is a “beat” compared to this lowered bar.

More objectively, observers can compare earnings to the prior year. The weak energy sector has been a drag on these comparisons, leading to an “earnings recession.” This name was attached to two consecutive quarters of decline. This quarter seems more promising. Earnings expert Brian Gilmartin does a sector-by-sector analysis, concluding that this quarter might see S&P 500 growth of 12-14%.

John Butters of FactSet notes that current expectations are an increase of 8.9%, but that “double-digit” growth is more likely. He looks at the history of “beat rates.”

 

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

Quant Corner

We follow some regular featured sources and the best other quant news from the week.

Risk Analysis

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

The Indicator Snapshot

 

 

The Featured Sources:

 

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

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

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

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

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. His most recent post notes that the expected growth rate in S&P earnings is now 8.41% — the highest level since October, 2014.

Doug Short: The World Markets Weekend Update (and much more). His Big Four chart is the single best method to monitor the key indicators used by the National Bureau of Economic Research in recession dating. The latest update now includes the employment data.

 

 

How to Use WTWA (especially important for new readers)

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix, Holmes, and Friends

We continue with a strongly bullish market forecast. All our models are now fully invested. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our five technical experts, and some rebuttal from a fundamental analyst (usually me, but sometimes a guest expert). We try to have fun, but there are always fresh ideas. Last week the group discussed how to find trading ideas in a quiet market. We were delighted to have expert commentary from Chuck Carnevale, founder of F.A.S.T. Graphs and a frequent source for WTWA. Check out the five stock ideas from our regular group, and especially Chuck’s reactions.

Top Trading Advice

 

Brett Steenbarger continues his stream of great posts. My favorite this week is his explanation of the real reason traders lose money. That should certainly attract universal interest! Here is a key takeaway:

There is only one source of making money in markets, and that is identifying recurring patterns in market behavior and exploiting those in a manner that provides solid reward relative to risk.  We marshal and attenuate various personality traits to identify and exploit those patterns.  Success comes, not from indulging our personalities, but from knowing which traits to draw upon and which to work around.  That is called wisdom.

Peter Coy has great advice for system traders: Beware of excessive back fitting of your data. If this seems too nerdy, you are probably making serious errors in developing your trading system.

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 Gary Belsky’s, Why We Think We’re Better Investors Than We Are. Here is a sample, comparing an unhappy lawyer with a disappointed investor:

Both people are highly likely to obsess over their sunk cost — law school tuition and time served for the lawyer, the original investment amount for the stock picker — in a nonconscious desire to justify their earlier decisions. Both are also very likely to fall prey to “loss aversion,” a key tenet of Prospect Theory, which tells us that humans typically respond to the loss of resources — be it time, effort, emotion, material goods or their proxy, i.e., money — more strongly than they react to a similar gain.

What differentiates the typical lawyer and average investor, however, is their justification for engaging in their activity. Lawyers are trained to do what they do, while the majority of investors are not. Ask a random player in a law firm’s basketball league whether he or she could compete with LeBron James, and the most common response will be laughter. Yet many of those lawyers would willingly compete with the billionaire investor Warren E. Buffett.

 

Stock Ideas

 

Barron’s has some undervalued energy stocks for consideration.

Our Stock Exchange always has some fresh ideas. There are ideas from five different approaches. Felix, who is most aligned with long-term traders, likes Sprint (S). You will enjoy the careful response of our guest expert, Chuck Carnevale, to that idea! The entire post has a good discussion.

Blue Harbinger has ten attractive ideas with 10% yields. It is a thorough analysis, and read the cautions carefully.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, this is a must-read. Even the more casual long-term investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. As usual, investors will find value in several of them, but my favorite is Jane Hwangbo’s 6 Things You Don’t Know About Money. The six points are interesting, as is this conclusion:

The point of money is to magnify you.

If you care about something, you get the opportunity to make more impact. If you love someone, you can give them more of what they need. You can share more. You can contribute more. You can invest in your future more.

You get more options.

In his regular column, Seeking Alpha Editor Gil Weinreich takes up an intriguing question – whether boomer retirements will cause a market crash. There is also a good discussion as well as links to other sources.

Value versus Growth

It is always interesting to see whether market sentiment is favoring value or growth. Blue Harbinger provides this interesting table.

Watch out for…

 

Kinder Morgan (KMI) and other pipelines. The operations are amazingly extensive.

The “toll road” analogy is also seductive for the pipeline companies. But that is only part of the story. Simply Safe Dividends has an excellent and thorough examination of the underlying finances, cost of capital, safety of the dividend, and the effect of changing energy prices.

 

Final Thoughts

 

There are several developing themes that require more elaboration than I can provide in WTWA. In such cases I often state my conclusions in advance – with more to come. Here are a few such ideas.

  • There are some lessons from the Trump-Xi meeting. Nothing bad happened. That may not seem newsworthy, but it is useful intelligence.
  • President Trump had his first test as Commander-in-Chief. He consulted experts and took their advice. Whether or not you agree with the decision, the process is better than we might have expected a few weeks ago.
  • The hard data, soft data meme is the latest way to find a source of market worry. The definition of the categories is not objective, nor is the analysis of the sources carefully done. This is definitely an agenda item.
  • The employment report is a single important example. The headline payroll report change was only about 100K. Despite repeated warnings that sampling error alone is +/- over 100K jobs, discussing smaller changes is great sport. The ADP report is a good independent source. Jobless claims are excellent. Wages are rising. The unemployment rate is declining. There is no reason to look for excuses (like the weather) for a weak number. But pundits must earn their pay!

Each earnings season I offer a challenge. I am still waiting for an answer. Those who do not trust earnings say that the estimates are too optimistic. They also say that (at the time of the report) they are too low. If both are true, there must be some point in time when the estimates are pretty accurate. John Butters provides this interesting table, looking only at the last-quarter effect.

 

If earnings growth continues this pattern it can do the following:

  1. Increase confidence in earnings estimates;
  2. Increase confidence in an improving economy;
  3. Provide the basis higher forward earnings;
  4. Support the idea of a higher PE multiple.

Eventually, whatever the other worries, it is all about earnings.

Stock Exchange: Finding Trading Ideas in a Low Volatility Market

Ted Williams was a terrific ball player, but he had one tactic that many found…questionable. He almost never swung at the first pitch.

Many short term traders and individual investors could take a lesson. The market has been dragging sideways for weeks. Volatility is low. There’s a great temptation to force in a few trades. It can be difficult to resist.

As we often discuss, successful investors have a system – and they stick to it. That is as true for periods of low volatility as it is for any other market phenomena. Ben Carlson covered this topic recently, calling it “the hardest question in portfolio management.” He opens with a quote by Jim O’Shaughnessy:

“If you don’t have the discipline to stick with your underlying strategy particularly when it’s not going in your favor, it’s nothing. It’s data on a page.”

If you want to match the Splendid Splinter,  you must take what the market is offering. Wait for the right pitch.

This week, we’re joined by Chuck Carnevale himself. Chuck is one of our favorite sources of market wisdom and stock ideas, with a heavy focus on long-term earnings trends, cash flow, and balance sheets.

Review

Our last Stock Exchange considered how to trade a market with a lot of headline risk. If you missed it, please check back and catch up on this important topic.

Market Tech Take

Last week we introduced our proprietary indicator, the market health index (MHI). This is a specialized combination of breadth and strength in our own trading universe. The index remains strong. For contrast, we are looking for alternative technical measures. What is your own favorite indicator?

 

Let’s turn to this week’s ideas.

This Week—Finding Trading Ideas in a Low Volatility Market

Holmes

Holmes: Proofpoint Price (PFPT) is my pick of the week. The price on this one has been shifting sideways for months, which creates an attractive buying opportunity.

PFPT pricing is down near the 200 day moving average, and the stock 12% off its all time highs. I’m confident we could see significant gains here over the short term.

Chuck: As a fundamental long-term oriented investor, I like good businesses.  Proofpoint is a young mid-cap company with a lot of debt and a weak earnings record.  But operating cash flows have historically been growing at enormous rates.  Based on cash flow growth, this company looks inexpensive for a high-growth stock. Free cash flow growth has been even better and the company also looks attractively valued based on this metric.

Holmes: I don’t know (or care) much about the mechanics of the business, but all that sure sounds encouraging! Jeff is usually harsher on us.

Chuck: Let’s not get ahead of ourselves. It would be hard to call this a prudent long-term investment.

Holmes: That’s fine by me. I’m only looking at the next few weeks.

Chuck: Well, at least you’re sticking with your method.

Holmes: It’s been working well for me so far.

Felix

I’m buying into a long-term position in Sprint (S). Much like last week’s pick, this is another one where the stock is up near its all-time highs. For that reason, I understand I might be criticized for jumping in here. It’s not my ideal situation; but for a long-term investor, this is what opportunity looks like right now. Let’s check the chart:

The trend lines on the 50 and 200 day moving averages  have been steadily rising for almost a year now. I certainly don’t expect the price to triple again anytime soon, but from my perspective this looks like a winner.

Chuck: Sprint reminds me of the old adage “price is what you pay – value is what you get.”  To me the price is high – but the value low.

Felix: Ouch. Isn’t there anything here you like?

Chuck: Not so much. As Kenny Rogers so aptly put it “You gotta know when to hold ’em, know when to fold ’em, know when to walk away, know when to run.”  As a fundamental value investor I believe that the “dealin’s done” on this one.

Oscar

Ted Williams is one of my favorites! I’ll help clarify your broader point: he always watched the first pitch, but he had a good reason for doing it. He wanted the most information he could get about a pitcher’s performance on a given day.

Here’s where the analogy breaks down. Once you’ve clicked through an order on your Trader Work Station, you’ve probably got the mechanics down. Naturally, I agree with the idea of waiting for the right pitch.

On to business, my pick this week is the Software Cloud and Computing sector. First Trust has an ETF for this, which captures the kind of growth and performance I expect.

For what people are calling a “sideways” market, this sector has been a clear outlier. These stocks are growing faster in 2017 than they did in 2016, and they’re doing it without a significant bump in November.

Chuck: Trying to find the best investments in cloud computing is a cloudy endeavor (pun intended).  You have pure growth stocks such as Amazon, Salesforce.com and Google.  In contrast you have stalwarts such as Microsoft, Oracle and IBM.

Oscar: That makes sense to me. How would you break these down?

Chuck: The trick here for fundamental investors is valuation.  IBM and Oracle are reasonable; Microsoft has gotten very pricey as has salesforce.com and Google.  Amazon has scant earnings but generates prodigious levels of cash flow.  To me, it’s tough to find a consistent investment theme in this sector.

Oscar: Point well taken. I have my own special mix of this sector, so I’m reasonably sure I can hit those value picks.

RoadRunner

(Commentary translated from various pecks, rapid movements and beeps).

I like Incyte (INCY), but only for the next 10-20 days. The pattern of growth is very attractive to me here. I can handle a brief lull if it’s capped off with a nice spike, and that’s exactly what we’re seeing here.

It may be a bit optimistic, but I’m anticipating that this most recent bump will bring us back to the $150 range.

Chuck: There are no fundamentals supporting this biotech company at all.  This is purely a hope and a dream speculation.  Maybe some of their pipeline will eventually bear fruit.  Nevertheless, the company has suffered losses for years but did begin earning a little money since 2015.

Road Runner: What if I’m approaching this like a short term trader? I might only be holding onto this position a few days.

Chuck: Earnings growth could accelerate in future years but not enough to support current levels.  This is a pure momentum play, a.k.a. a musical chairs stock.  Therefore, you better be sure to have a chair if and when the music stops.

Road Runner: Tough but fair.

Athena

Micron Technology (MU) is on a roll. The mid-march pop in price leads me to believe more short term gains could be significant. Is the price high? Sure. That’s my method, and I’m sticking to it.

Chuck: This stock is way too cyclical for my taste.  However, this might make it a short-term trader’s dream stock.

Athena: That’s the idea.

Chuck: Earnings go from losses to huge rates of change of earnings growth and stock prices tend to react over the short run.  I would consider this the classic sardine company that works like this.  I buy a can of sardines for $.50 and sell it to Oscar for $1.  He in turn sells it to Jeff who is hungry for $1.50.  Jeff opens the sardines and finds them rotten.  He complains to Oscar that he sold him rotten sardines.  Oscar then informs Jeff that he doesn’t understand sardines.  There are 2 kinds of sardines, Oscar says, there are eaten sardines and there are traden sardines.  I sold you traden sardines.

Athena: I think I just lost my appetite.

Conclusion

Despite the prevailing mood about the current market, there are plenty of opportunities for goal-oriented investors. The key, again, is to take what the market is giving you. Investors with a robust method should stick to it, even if it’s a bit harder to find new positions. Investors without a robust method probably shouldn’t be making any trades at all.

Chuck’s approach is value based, and that makes his recommendations extraordinarily consistent. Reading between the lines a bit, it’s clear that there’s some upside even in the companies he wouldn’t consider for his portfolio. What’s right for Felix and Oscar might not be a good fit for Holmes. There’s nothing wrong with that. After all, every batter has their own favorite pitch.

Stock Exchange Character Guide

Character Universe Style Average Holding Period Exit Method Risk Control
Felix NewArc Stocks Momentum 66 weeks Price target Macro and stops
Oscar “Empirical” Sectors Momentum Six weeks Rotation Stops
Athena NewArc Stocks Momentum One month Price target Stops
Holmes NewArc Stocks Dip-buying Mean reversion Six weeks Price target Macro and stops
RoadRunner NewArc Stocks Stocks at bottom of rising range Four weeks Time Time
Jeff Everything Value One month or long term Risk signals Recession risk, financial stress, Macro

Background on the Stock Exchange

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

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

Questions

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

Getting Updates

We have a new (free) service to subscribers to our Felix/Oscar update list. You can suggest three favorite stocks and sectors. We report regularly on the “favorite fifteen” in each category– stocks and sectors—as determined by readers. Sign up with email to “etf at newarc dot com”. Suggestions and comments are welcome. In the tables above, green is a “buy,” yellow a “hold,” and red a “sell.” Each category represents about 1/3 of the underlying universe. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Weighing the Week Ahead: What Can We Learn from the Trump-Xi Meeting?

We have a big economic calendar and potential Fed news. Those stories will take a back burner this week. My safest prediction is that we are about to see a new rash of China experts both in print media and on CNBC! These freshly-minted pundits will be asking:

What will the Trump-Xi meeting mean for the economy, and for stocks?

Last Week

Last week the news was mostly positive, but light. Markets continued the attention to the Trump Administration’s next policy steps – especially the chances for tax reform.

Theme Recap

In my last WTWA I predicted a discussion about the aftermath of the ACA repeal decision. That was a good call, as assorted pundits explained what the next policy moves might be. The more adventurous speculated about whether the Freedom caucus would block changes in the debt ceiling or tax reform. Some of that discussion will continue in the early part of next week.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. She notes the overall weekly gain of 0.80% and the quarter one increase of 5.5%. The biggest takeaway might be the general rebound from last week’s market reaction to the failure of the ACA repeal.

 

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

The News

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

This week’s news was slightly positive.

The Good

  • Hotel occupancy is strong. Calculated Risk reports interesting hard data from private sources. These are items you might not see elsewhere.

  • Household finances are on “solid ground” as explained by Scott Grannis. Debt levels as a percentage of disposable income are at 30-year lows. He provides an interesting chart of household leverage.

  • Serious delinquencies have declined to 1.19% (Fannie Mae via Calculated Risk). This is the lowest level in nine years.
  • Corporate profits remain strong, increasing 9.3% year-over-year in Q416. New Deal Democrat has a good account of the trends, why National Income and Profit Accounts (NIPA) come so late, and how he estimates this series in advance. Scott Grannis has a similar report which also shows the relationship between NIPA profits and stocks. It is dramatically different from the popular valuation charts.

  • Michigan consumer sentiment remained strong, increasing to 96.9. Jill Mislinski has the update. It includes an interesting excerpt from the Survey of Consumers chief economist, Richard Curtin. He notes that expectations and partisanship are influencing the outlook. This bears watching. Jill also has this fine chart.

  • Q4 GDP revisions edged a little higher than expected to 2.1%
  • Pending home sales increased 5.5%. CNBC’s Diana Olick has an interesting report, noting that sales would be much higher if there were more inventory. She has an interesting interview from Denver, where construction is 50% behind the pace needed. Builders blame the lack of labor, especially illegal immigrants frightened by recent policy changes. The builder interviewed stated that the jobs were not desirable for most U.S. workers.

    This report, if accurate and typical, has implications for homebuilders, Fed policy (labor market tightness), and immigration policy. You need to watch the video to see the key points.

 

The Bad

  • Personal consumption spending missed expectations. The increase was only 0.1% despite an income increase meeting expectations of 0.4% growth. Steven Hansen (GEI) has a thorough analysis with excellent tables and charts.
  • Jobless claims moved slightly lower, to 258K, but the four-week moving average moved higher. I am scoring this as “bad” because the series has moved a bit higher from the best levels. Scott Grannis helps us to keep this in perspective with this interesting chart of claims compared to the labor force.

The Ugly

U.S. Bridges. (No, not the recent North American Bridge Championship, where Bill Gates had a nice win. While that particular event was limited to players with fewer than 10,000 masterpoints, it still included many experts. It was a nice victory, and his best career result). Turning back to actual structures, the American Society of Civil Engineers (ASCE) notes that 40% of bridges are more than fifty years old. Over the next twenty-five years the U.S. is short of needed spending by about $3 trillion.

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week, but nominations are always welcome. There are many bogus claims and charts out there! I wrote about headline spinning last week, and the misleading recession forecasts that resulted. We should all encourage astute analysts to help on this front!

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 week for economic data, featuring the most important reports.

The “A” List

  • Employment report (F). Expectations are in the 180K range, down from last month’s 235K
  • ISM index (M). Continuing strength expected.
  • Auto sales (M). The concept of “peak auto” has some recent buzz, drawing attention to this private data.
  • ISM services (W). Wider scope than manufacturing, but a shorter history. Strength expected.
  • FOMC minutes (W). Will be scrutinized for hints about the pace of future rate hikes.
  • Initial jobless claims (Th). Is the series edging up from record low levels?

The “B” List

  • ADP employment change (W). A good independent read on job growth.
  • Construction spending (M). February data, but an important sector.
  • Factory orders (T). More February data of significance. Continuing strength expected.
  • Trade balance (T). Usually not a market mover, but will get extra attention this week.
  • Crude inventories (Th). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

While the schedule is not as heavy as last week, FedSpeak will be featured on several days.

The Thursday meeting between President Trump and China’s President Xi Jinping could be extremely important for economic policy and the markets.

Next Week’s Theme

This is a big week for economic data. We could usually expect daily analysis of the news, focusing on the Friday employment data. A secondary theme might be the emerging change in Fed policy, with speakers and the release of minutes on Wednesday.

Not this week! The visit of Xi Jinping and the meetings at Mar-a-Lago have significance extending beyond recent economic news. The commentary next week will raise the question:

What will the Trump-Xi meeting mean for the economy and stocks?

No one knows what will happen. The best we can do is collect relevant facts and decide what to watch for. Here is some key background.

  • Trump is advertising a “tough” meeting. Quartz suggests the reasons and key issues:

    He is sure to be coached by hardline China advisor Peter Navarro, who believes China is full of cheating thieves, intent on global domination. After Trump’s allegations that China had stolen jobs and a way of life from America’s middle class on the campaign trail, the stage seems set for a clash. Sensitive topics could include the trade imbalance, China’s over-production of steel, North Korea’s increasing militarization, and Beijing’s insistence that it control the South China Sea, in defiance of international law. American CEOs are worried that the wrong move could destabilize the relationship and harm the US economy.

  • Xi is the most powerful and popular Chinese leader in decades. He is dismantling the “collective leadership” approach. The Economist explains and questions whether this will lead to needed reforms. After describing his takeover of key committees and battle against corruption, the article focuses on his mission:

    All of this helps Mr Xi in his twofold mission. His first aim is to keep the economy growing fast enough to stave off unrest, while weaning it off an over-dependence on investment in property and infrastructure that threatens to mire it in debt. Mr Xi made a promising start last November, when he declared that market forces would play a decisive role (not even Deng had the courage to say that). There have since been encouraging moves, such as giving private companies bigger stakes in sectors that were once the exclusive preserve of state-owned enterprises, and selling shares in firms owned by local governments to private investors. Mr Xi has also started to overhaul the household-registration system, a legacy of the Mao era that makes it difficult for migrants from the countryside to settle permanently in cities. He has relaxed the one-child-per-couple policy, a Deng-era legacy that has led to widespread abuses.

  • Chinese strategy is to reach Trump through his family. The FT describes the background.

    China seems to have grasped that the best way to influence Mr Trump is via his family. Chinese diplomats have gone out of their way to court Mr Kushner and Ivanka Trump, who were their guests of honour at the Chinese new year celebration in February. China has also looked favourably on Mr Trump’s business. Since his inauguration it has approved dozens of pending trademark applications by The Trump Organization. The volume of applications to market Ivanka Trump’s brand in China has also soared. This week, Kushner Companies — the family property group from which Jared has stepped back — ended talks to sell a prime piece of Manhattan real estate on very favourable terms to Anbang, a Chinese company, after members of Congress alleged a conflict of interest.

  • Possible outcomes. The FT continues with the range of what we might expect.

    At one extreme, Mr Trump could threaten to carry out his campaign vow to impose a 45 per cent tariff on Chinese imports — a step that would provoke a global trade war and fall foul of the World Trade Organisation. That would produce a similar outcome to Mr Trump’s rancorous meeting with Angela Merkel last month, in which he presented her with a massive invoice for Germany’s defence costs. At the other extreme, Mr Xi could package a few Chinese investments into easily tweetable jobs announcements. Last year China invested a record $45bn in the US — mostly in real estate, finance and entertainment.

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

Quant Corner

We follow some regular featured sources and the best other quant news from the week.

Risk Analysis

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

The Indicator Snapshot

 

 

The Featured Sources:

 

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

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

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

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

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. His most recent post notes that the expected growth rate in S&P earnings is now 8.41% — the highest level since October, 2014.

Doug Short: The World Markets Weekend Update (and much more). His Big Four chart is the single best method to monitor the key indicators used by the National Bureau of Economic Research in recession dating. The latest update now includes the real income data.

Scott Grannis writes this week about the equity risk premium, which I currently score as “high.” This means that I find stocks to be much more attractive the bonds. Here is Scott’s chart of this relationship. The above-average value is IMHO the best gauge of market sentiment – still negative on stocks versus bonds.

 

How to Use WTWA (especially important for new readers)

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix, Holmes, and Friends

We continue with a strongly bullish market forecast. All our models are now fully invested. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our five technical experts, and some rebuttal from a fundamental analyst (usually me, but sometimes a guest expert). We try to have fun, but there are always fresh ideas. Last week the focus was on “Voodoo Chart Reading” inspired by Michael Kahn (see below).

Top Trading Advice

 

Like everyone else, I like reading about Jesse Livermore. He enjoys a reputation as a great trader despite multiple bankruptcies and a life ending in suicide. That certainly is one measure of success!

Joe Fahmy has a nice post highlighting Livermore trading rules from almost 80 years ago. Most still make plenty of sense. It would be a nice project for someone to analyze how these might be different under modern conditions. Out of the many rules I endorse, I especially like this one:

21. Few people ever make money on tips. Beware of inside information. If there was easy money lying around, no one would be forcing it into your pocket.

Brett Steenbarger remains at the top of trader “must-reads.” My favorite post this week is about trading resilience. Many traders do not recognize how negative factors can affect their work. You need the ability to bounce back.

Chartered Market Technician Michael Kahn uses the “Voodoo” word in discussing charts. He has a great post on what you can and cannot expect to learn from your chart study. I especially like his dismissal of the “death cross.”

First of all, the death cross occurs when the trend has already changed. That is the only way the math works, by the way, because the pattern is defined as the 50-day moving average crossing below the 200-day moving average. That cannot happen when prices are rising.

Anyway, in practice we often see the market bounce right as the cross happens. Why? Because typically it has been falling for a while already. Again, is has to be falling otherwise the short-term average cannot drop under the long-term average.

OK, Einsteins, I know we can make the math work with price spikes and outliers but roll with me here.

So, the market may be a bit oversold and it bounces. But overall the cross appeared because most likely something is wrong. Short of real voodoo telling us what’s what that is all we can hope from charts. They do not tell us what will happen. They are meant to give us clues as to what to do.

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Michael Kitces great article, The Evolution Of The Four Pillars For Retirement Income Portfolios.He presents an excellent history of retirement needs and alternatives. He also analyzes the consequences of each of the current choices. I especially like this element of the conclusion, an issue that we frequently discuss with clients:

In fact, arguably when thinking about a retirement portfolio, it’s better to think in terms of “retirement cash flows” than retirement income, as what constitutes “income” for investment purposes (interest and dividends, but not principal) is different than what constitutes “income” for tax purposes (as interest and dividends might be tax-free coming from a Roth, while principal may be fully taxable if withdrawn from a pre-tax retirement account).

Nice work, with many great points. Please read the entire post.

Stock Ideas

 

David Fish has updated the list of dividend champions, challengers, and contenders. This is always a good source of ideas. This week he features McGrath RentCorp (MGRC) and includes some analysis from Chuck Carnevale.

Chuck is back with a deep dive on United Parcel Service (UPS). The quantitative metrics are solid, so he takes on the key concern – the challenges in business to consumer deliveries. This is a typically first-rate analysis.

Brian Gilmartin’s earnings-driven analysis still favors energy stocks. Like everyone else, we will be paying even more attention to Brian next week as earnings season begins.

Barron’s agrees with the energy theme, and also features Under Armour (UA) and Lowes (LOW).

Our Stock Exchange always has some fresh ideas. There are ideas from five different approaches. Felix, who is most aligned with long-term traders, likes Wynn Resorts (WYNN). The most recent post provides descriptions of each model. You will probably identify with one of the characters, and your questions are welcomed.

Lee Jackson has five “safe stocks” if you think the “Trump magic” has worn off.

Yield Plays

Blue Harbinger has some dividend ideas in health care.

Wade D. Pfau does a nice job in describing bond ladders. I especially like the rolling ladder, which we offer as a complement to higher-yielding programs. Anyone interested in safe yield, with the potential to grow with the market, should read this post.

Emerging Europe?

Frank Holmes opines that the time has come.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, this is a must-read. Even the more casual long-term investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. As usual, investors will find value in several of them, but my favorite is this week’s best investment advice (see above). Other great posts included the question of whether you would prefer $1 million or $5000 per month for your retirement, and the pragmatic warning about making financial decisions on your smartphone.

 

In his regular column, Seeking Alpha Editor Gil Weinreich takes up yet another important topic – diversification and what is added by ETFs. He cites contributor Roger Nussbaum, who provides a balanced discussion of diversification, stock picking, concentrated portfolios, and recent strong opinions. A timely point for discussion.

 

Watch out for…

 

Costly but natural mistakes. Josh Brown cites data showing that investors significantly underperform market averages. Mostly this comes from psychological reactions, but some is also stock selection. The key chart is below. If you are lagging on your investment performance, please request (main at newarc dot com) my free report on the 12 Pitfalls for Individual Investors. It is a quick and easy test to see if you can profitably “fly solo.” Here is Josh’s chart:

Subprime auto. Steve Eisman warns. Barron’s also features a negative take on CarMax (KMX) for the same reason.

Good companies that are bad investments. Aswath Damodaran explains how to tell this difference. Here is the summary, which I strongly endorse!

Final Thoughts

 

A major change in leadership has everyone thirsting for information about possible policy changes. Stated positions from a candidate are not dependable. Those ideas might change once in office, or might prove infeasible. In the case of foreign policy, the range of possible results is especially wide. The President has a lot of flexibility, and many of the relationships have a personal quality.

This highlights the importance of this week’s Trump-Xi meeting. Like a top poker player, you should be looking for “tells” about true intentions, future policies, and the economic implications.

As is often the case, it is foolish to predict the specific outcome of these meetings. Readers sometimes expect a definitive answer to the week’s question in my “final thought.” That is not the mission of WTWA. I try to do two things:

  1. Explain what will be the focus in the coming week;
  2. Provide help with interpreting events.

It is important to recognize what you do not know, what is unknowable, and what is pure speculation. Pretending that you know a specific answer can be costly.

Given that setting, how can we prepare for this event? Most observers will be focused on specific policy implications. That is a mistake. I am interested in the following:

  • Overall tone and friendliness. I do not expect any golf! This will be an early test of how foreign leaders, aggressively criticized by Trump during the election campaign, respond to him as President.
  • Symbolic quality of the announced results. A tough line by the President? Some clear concessions by Xi?
  • Common ground. Will there be an emphasis on issues like North Korea?
  • Technical missteps. The China team consists of specialist on the specific issues – those who work only on these matters and have done so for years. The US team has dismissed the experts for a more general approach. Will this matter? Will it lead to blunders?

The most important consequence will be the implications for trade policy. One major viewpoint is that President Trump has engaged in tough talk to facilitate bargaining. The other is that he will instigate a trade war. Which is closer to the truth?

This week will provide the first hints. Stay tuned!

Headline Spin — Recession Forecasting is Back!

Investors have learned from both data and personal experience that business cycle peaks (popularly known as recessions) are associated with the most important stock declines. It is natural that any news about a possible recession gets extra attention. There are so many sentiment measures – surveys of different populations, including non-investors – that it is easy to find one that supports any viewpoint.

Since I have recently spoken with several intelligent, but worried investors, my own conclusion is that market worries and Trump angst are at a high point. Consider some evidence. Here is the headline page from a reputable source for professional managers.

 

The array of front page stories has nothing positive about U.S. equities. Here is a front-page story running yesterday on a social media page.

When you actually read the article, you cannot even find the “R” word! Economist Adam Posen, President of the Peterson Institute, is actually writing about an excessive boom (not mentioned in the headline) which would lead to the inevitable bust when the Fed over-reacts. Briefly put, he expects greater amplitude in business cycle, mostly because of deficits which his organization opposes. Posen has no record of successfully predicting recession. More importantly, his near-term prediction is for a boom.

Why the negative headline, with a worried trader looking at a declining chart?

Here is the next case, sent to me by a reader.

Fed rate hikes + low growth = recession, says stock-market strategist

 

This article reproduces an almost indecipherable chart that references three recessions in all of history that began after a Fed rate increase when economic growth was low. Of course, the article does not explain it that way. It seems inevitable. The author, a non-economist with no proven record of recession forecasting, does not even make these claims in his original post.

If it has historically taken 11 quarters to go fall from an economic growth rate of 3% into recession, then it will take just 2/3rds of that time at a rate of 2%, or 6 to 8 quarters at best. This is historically consistent with previous economic cycles, as shown in the table to the left, that suggests there is much less wiggle room between the first rate hike and the next recession than currently believed.

I hope the error in this pseudo-math is obvious to my astute readers.

And here is the conclusion, after explaining that all Fed rate-rising periods eventually lead to bear markets:

For now, the bullish trend is still in place and should be “consciously” honored. However, while it may seem that nothing can stop the markets current rise, it is crucial to remember that it is “only like this, until it is like that.” For those “asleep at the wheel,”there will be a heavy price to pay when the taillights turn red.

So to be clear, the author is bullish for the moment, but giving a warning. I guess he will be right either way.

And meanwhile, how does this recommendation compare to the headline in the original article – the one predicting a recession?

Is there another side to this?

If so, it must be infrequent and obscure. I invite readers to send examples. This cannot just be a bullish story with evidence, since that is not spinning. You need to find a bullish headline that is not supported by the underlying facts.

 

Why the disparity? The truth about recession chances – that we are almost certainly OK for the next year or so – is not an exciting story. Journalists never ask about the record or credentials of sources on technical stories.

Investor Protection

There are two ways investors can protect themselves:

  1. Plow through the entire story, the supporting links, and the bio for the original source. (That is what I do, of course). It helps to know how to spot real experts.
  2. Just ignore these stories – especially when the interview subject is not presented as holding specific and relevant skills and experience. This method will save a lot of time – and also plenty of money!

Actionable Investment Advice

The main educational theme is more significant and potentially profitable than any specific stock recommendation. For those needing a little help in following it through, late stage cyclicals, financials, and technology are all good choices. Bonds and utilities are not.

Weighing the Week Ahead: What Does the Health Care Decision Mean for Stocks?

The economic calendar is light, but it really would not matter. The defeat (via retreat) of the effort to replace Obamacare will dominate financial market stories this week. The pundits will be asking:

What does the health care decision mean for stocks?

Last Week

Last week the news was mostly positive, but irrelevant. Markets were focused on the Obamacare repeal decision.

Theme Recap

In my last WTWA (three weeks ago since my vacation included two weekends) I predicted a discussion about the expected change in Fed policy and the effect on stocks. That now seems like ancient history, but it was a pretty good theme for that week.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. She notes the overall loss of 1.24%, largest since last October. You can also clearly see the Friday fluctuations around the health care breaking news.

Given the time since our last post, let’s catch up with this longer-term chart.

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

The News

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

This week’s news was slightly negative.

The Good

  • Durable goods rose 1.7%.
  • Earnings growth remains solid. Energy has weighed down earnings over the last few years. The general assumption is that earnings estimates are too optimistic. FactSet reports that the expected y-o-y growth in Q1 is 9.1%. You probably do not see that data very often, unless you are wisely following Brian Gilmartin, who has been on top of this story for many months.
  • Rail traffic growth continues although the pace is a bit slower. Steven Hansen has the full story, including charts and analysis.
  • New home sales increased 6.1%. Calculated Risk, the go-to source on housing matters, calls this a solid report. Despite the 12.8% y-o-y increase, Bill notes the downward revisions to prior months. The key upcoming issue is whether builders will provide affordable housing.

 

The Bad

  • Jobless claims increased to 258,000.
  • Existing home sales dropped 3.0%. This was also a small miss of expectations. New Deal Democrat embraces the overall housing strength, calling this the “least important” housing indicator. Calculated Risk has an important summary about existing sales:

    To repeat: Two of the key reasons inventory is low: 1) A large number of single family home and condos were converted to rental units. In 2015, housing economist Tom Lawler estimated there were 17.5 million renter occupied single family homes in the U.S., up from 10.7 million in 2000. Many of these houses were purchased by investors, and rents have increased substantially, and the investors are not selling (even though prices have increased too). Most of these rental conversions were at the lower end, and that is limiting the supply for first time buyers. 2) Baby boomers are aging in place (people tend to downsize when they are 75 or 80, in another 10 to 20 years for the boomers). Instead we are seeing a surge in home improvement spending, and this is also limiting supply.

The Ugly

Hate groups in the U.S. are flourishing. GEI Editor John Lounsbury regularly includes articles that you might miss otherwise, including this important story.

 

 

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 Charlie Bilello, whom we also featured on Stock Exchange. This is double recognition that is unlikely to be repeated!

Why is this so important? Because so many are being “scared witless” (TM OldProf euphemism).

Most pundits, media, “smart money”, experts on valuation have been completely wrong for many years. If you have wisely stuck with the fundamentals, you are called part of a “sucker’s rally.”

For some years, the top “fear indicator” has been VIX. No matter that few understand how it is calculated. The VIX has remained low, despite the insistence of many that risk is high. Instead of accepting the results of an indicator embraced for many years, the true believers take the only course possible: Find a new indicator!

Many of them have seized upon SKEW, which shows that the risk of a crash has never been higher. Bilello’s analysis pushes deeper, asking the excellent question of how predictive SKEW has been in the past.

The conclusion is that widely-perceived fear, whether in regular options or tail risk, does not predict a severe decline.

What does? A business cycle peak (AKA a recession). That is the reason for our careful monitoring of that 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 rather light week for economic data.

The “A” List

  • Consumer confidence (T). This is the Conference Board version. Will the amazing strength continue?
  • Michigan sentiment (F). The Michigan version, which includes a continuing panel in the sample, is important.
  • Personal income and spending (F). Until and unless more business spending kicks in, consumers are crucial.
  • Initial jobless claims (Th). The series seems to be flattening at record low levels.

The “B” List

  • PCE prices (F). The favored Fed measure is approaching the 2% target.
  • Chicago PMI (F). Best of the regional indicators gets special attention as a hint about the ISM report.
  • Wholesale inventories (T). Advance Feb data. Desired or undesired? That is always the question.
  • Crude inventories (Th). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

The Fed Speakers Bureaus have been busy. Expect a daily dose of FedSpeak.

Next Week’s Theme

There is little in the way of scheduled fresh news. The health care vote came at the end of the day on Friday. It will be open season for the punditry. Speculating about the President, the legislative agenda, the Speaker, and the market provides plenty of grist. The commentary next week will raise the question:

What does the failure of the Obamacare repeal mean for stocks?

Once again, there is a hidden question which will be the focus for most – the impact on the Trump agenda. While health care is important, the market strength is more related to tax issues and infrastructure spending. Here are the key viewpoints:

  1. The defeat weakens the President and signals lower chances for the economic agenda.
  2. Getting this issue out of the way permits more rapid attention to corporate tax reform.

These issues are most important to those who believe that the post-election rally is all about Trump. More observers are joining me in crediting the stock strength to resolving the election uncertainty and overall economic improvement. Scott Grannis has a helpful chart.

Even the usually sour Barron’s lead column says that an improved global economy accounts for about half of the U.S. stock rally.

Those who focus on the economic fundamentals (nice piece by a semi-anonymous blogger with whom I have corresponded) and corporate earnings emphasize a base of continued modest growth. Improvements in tax policy are an upside kicker. Eddy Elfenbein has his usual incisive and clear explanation of the history of the “Trump trade.”

The single best analysis I saw was from Dan Clifton of Strategas Research Partners. This video is packed with information, so watch it twice and take notes!

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

Quant Corner

We follow some regular featured sources and the best other quant news from the week.

Risk Analysis

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

The Indicator Snapshot

 

 

The Featured Sources:

 

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

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

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

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

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. His most recent post notes that the expected growth rate in S&P earnings is now 8.41% — the highest level since October, 2014.

Doug Short: The World Markets Weekend Update (and much more). His Big Four chart is the single best method to monitor the key indicators used by the National Bureau of Economic Research in recession dating. The latest update now includes most of the February data.

How to Use WTWA (especially important for new readers)

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix, Holmes, and Friends

We continue with a strongly bullish market forecast. All our models are now fully invested. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our five technical experts, and some rebuttal from a fundamental analyst (usually me, but sometimes some guest experts). We try to have fun, but there are always fresh ideas. Last week the focus was on dealing with news-driven risk.

Top Trading Advice

 

Be careful in your backtesting! Sean McLaughlin understands the issues and provides practical advice.

Brett Steenbarger identifies seven training resources for developing traders, including helpful links.

Are you too confident about your skill at technical analysis? Price Action Lab shows how cognitive bias can lead you astray, including some great examples.

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 Chris Kacher’s popular and insightful chart, spread widely by Sue Chang. The various soft times in market history are considered. My own conclusion is that you had better have a good reason to fight the trend.

Stock Ideas

 

Deep value in a solar stock? Andrew Bary of Barron’s features SolarEdge Technologies (SEDG), citing a possible 40% upside. He quotes my friend Bob Marcin, who is very fussy about deep value, noting that the company “makes a category-killer product for a secular growth industry.”

Chuck Carnevale considers the implications of rising interest rates for stocks. His wide-ranging analysis, which you should read carefully, looks at historical macro effects as well as analyzing individual stocks like Johnson and Johnson (JNJ), McDonalds (MCD), and other important names.

Josh Brown explains why homebuilders are strong in the face of rising interest rates.

Our Stock Exchange always has some fresh ideas. There are ideas from five different approaches. Our momentum newest member, Road Runner, trades upward-sloping channels, seeking attractive entry points. This week’s idea is Netflix (NFLX). You will probably identify with one of the characters, and your questions are welcomed.

Yield Plays

Blue Harbinger does a deep dive into dividend aristocrats. He begins with the membership of the SPDR Dividend Index (SDY) and then moves to his likes and dislikes. It is an excellent and thorough piece. In a somewhat more speculative vein, Mark has a provocative analysis of CVR Energy (CVI), including Carl Icahn’s involvement and possible link to his role as a Trump advisor.

Simply Safe Dividends provides an absolutely first-rate analysis of the potential for utility stocks. There is a good analysis of the likely impact of higher interest rates, and how to pick companies that will hold up the best. Especially interesting is the argument for keeping some utilities in your portfolio no matter what you expect on interest rates.

Some REITs might be fine, even when rates are rising. Here are ideas from Salvatore Bruno.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, this is a must-read. Even the more casual long-term investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. As usual, investors will find value in several of them, but my favorite is the practical tax-time advice on what records you can safely discard. More abstract but very powerful is this discussion of the trade-off between financial assets and human capital.

In his regular column, Seeking Alpha Editor Gil Weinreich raises an important question: Can even the rich afford to retire? He cites several great sources as well as some possible solutions. My advisor colleagues should join me in making this a regular read, but it is usually helpful for DIY investors as well.

If you have been stock on the sidelines, evaluating possible worries, you might want to read my (free) short paper on the top investor pitfalls. It is a good test of whether you can successfully fly solo. Send a request to main at newarc dot com.

 

Watch out for…

 

Companies with “suspicious earnings.” Rupert Hargreaves explains the warning signs and provides some starting ideas.

Final Thoughts

 

Astute and intelligent investors closely follow the news. That will be a special challenge in the week ahead. Most of what you read about the health care decision will be worse than unhelpful. It will steer you astray.

Most sources will discuss what the health care defeat means for Trump or for the Republicans. That type of story is easy to write and invites readers to join in the speculation. The financial outlets might do a little better with some ideas about the impact on tax reform.

The implications for investors demand more sophisticated analysis. This was a test of two things:

  1. The intransigence of the Freedom Caucus
  2. The GOP leadership and the President’s ability to craft a compromise.

If a “layup change” like Obamacare repeal cannot be done within the Republican party, the entire agenda will require some compromise with Democrats.

This affects both the probability of success and the nature of the resulting policies. This conclusion is much more important for investors than the specifics of the health care legislation. It is also more sophisticated than knee-jerk commentary on the change in the “Trump agenda.”

 

A Conclusion for Investors

I know from my travels and discussions that there is a high degree of market concern right now. Part of it is uncertainty about Trump policies (from investors of both parties), and a general sense that the rally is extended and markets are “high.”

This type of concern is exactly why we must invest based upon data, not emotion.

None of our indicators currently warn about the end of this business cycle. Business cycles do not have an expiration date. They do not die of old age. (Yardeni). These are emotional ideas that feel right, but lack empirical support.

There is plenty of “upside risk.” Earnings growth is improving, even in the environment of modest growth. The recent market strength could go on for years without any policy changes. If some of the Trump agenda (probably with Democratic support) becomes law, it could mean a spike in both economic growth and profits. We already see improved business and consumer confidence.

Stock Exchange: Trading in a Time of High, News-Driven Risk

Many seem convinced that market risk is elevated – perhaps at an all-time high. I know this from contacts on my vacation, where I see many high-net worth people, messages from my clients (an intelligent and cool-headed lot), and even some objective measures of angst. Whether it is uncertainty about the new President and policy, revisiting issues about valuation, or concern about foreign challenges – it is a popular time to be worried.

Charlie Bilello of Pension Partners looks at SKEW. While VIX has not generated warning levels, SKEW suggests an all-time high in crash risk.

 

Is this really important for trading? It is an excellent question for our experts.

Review

Our last Stock Exchange considered the role of valuation in trading. Deep value expert Robert Marcin provided some great observations. I thank him, and urge you to follow his regular observations at Scutify.

 

This Week—How Traders Can Cope with News-Driven Risk

We have a new participant this week – Road Runner. This beeping bird has a very specialized approach, but one that should be a favorite with traders. RR looks for stocks in an uptrend, identifies the trading range within that trend, and buys at the bottom. His holding period is only two weeks.

After extensive testing, we have invited him to join the group.

Road Runner

(Commentary translated from various pecks, rapid movements and beeps).

R: Look at Netflix (NFLX).

This sustained price growth provides a solid working range. I might look to buy around the 50-day moving average price, and sell just over $145. It’s not the world’s biggest gain, but it’s a great fit for my trading style.

J: Are you worried about a market crash?

RR: My holding period is only ten business days. Major selling takes me out of everything. My method requires finding some attractive stocks with uptrends.

Athena

My methods do not show any new choices. I look for short-term momentum picks with a solid base. The current market does not fit my style.

J: Is this a reflection of very high risk?

A: Not necessarily. The market has been pretty flat. It is less likely to find new short-term momentum opportunities.

J: Are you doing anything about headline risk and your current positions?

A: Only my normal measures. I will take note of alarming moves in the wrong direction, including both price and volume. Even a Goddess cannot anticipate what tomorrow’s tweet might bring. I am reactive, not anticipatory.

Felix

I will once again emphasize answers to reader questions. Here is the most recent list.

J: I did not see the list last week. What happened?

F: A small omission. Sorry.

J: When I am on vacation, this group is supposed to conduct business as usual. No dallying.

F: We were all working.

J: Do you have any new recommendations for us this week.

F: No, but that is no surprise given the market conditions.

J: OK, but please try to do better next week.

F: I have a question. Does adding the bird to the team mean that the rest of us will earn less?

J: Road Runner will have to earn his birdseed. It has no effect on you if you maintain your current performance.

 

 

 

 

 

 

 

 

Oscar

It’s no secret that the semiconductor sector (SOXX) is on a tear. Just look at this chart. The price looks like it’s ready to soar over the ivy at Wrigley field.

Usually it’s Athena who winds up taking flak for buying on a high. My approach is similar in that I don’t intend to hold onto this sector for very long. All I’m looking for is another 2-4 weeks of sustained growth, which seems likely at this point. In my program, I’m holding individual stocks within this sector. That opens opportunities for additional pops that might register as a small blip on the group as a whole.

J: Are you doing anything special about risk?

O: You mean my final round picks of Kansas and North Carolina?

J: No! Not your March Madness bracket. I mean the risk of a market crash.

O: There is no such indication in the data. If the situation changes, I will close positions and move on.

I also have my regular answers to reader questions about sectors.

J: Readers seem to be wondering about one of your favorite groups, chip stocks.

O: They are on the right track.

J: I see that you like regional banks (KRE), which had a tough week.

O: The sector is still strong.

J: The news emphasized lower used car prices. The reaction seemed overdone.

 

 

 

 

 

Holmes

CF Industries Holdings (CF) is my rebound pick of the week.

We’re well off of the all-time highs, with a flat 200 day moving average and a 50-day moving average that’s starting to trend downward. In my mind, that opens a big opportunity. If the stock climbs to its mid-February prices, I could exit this position with an increase of more than 15%.

J: Are you worried about a market crash?

H: No. My high-level indicators are quiet. Smaller moves are great for my dip-buying strategy.

H: One more thing – is that beeping bird really part of the group?

J: Yes. Some questioned the addition of a dog, so don’t complain. RR will be the last addition.

 

Conclusion

Markets always have news-driven risk. If you refuse to trade because of scary headlines, you should look for a new business.

A widespread perception of risk need not be accurate. And don’t be fooled by headlines calling it the “smart money.” Returning to Charlie Bilello’s fine analysis of SKEW, he demonstrates that it is not really a good predictor of large downside risk.

His powerful conclusion emphasizes that an indicator based upon perception may not reflect reality. This may seem obvious, but I doubt that many are aware of the underlying elements of SKEW.

Here are some key takeaways about news-driven risk and trading:

  1. Headline risk may be exaggerated – perhaps by a lot.
  2. Do not abandon your strategy and miss opportunities without confirming danger for your specific method.
  3. For some trading approaches, perceived risk may represent opportunity.
  4. If you are trading momentum, you should have a solid exit strategy. This is more than just a mechanical stop.

We welcome comments, suggestions, and followers for each character. Even Jeff. I try to have fun once a week in writing this, and I hope you get a chuckle or two from reading it. Here is how to join in.

Background on the Stock Exchange

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

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

Questions

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

Getting Updates

We have a new (free) service to subscribers to our Felix/Oscar update list. You can suggest three favorite stocks and sectors. We report regularly on the “favorite fifteen” in each category– stocks and sectors—as determined by readers. Sign up with email to “etf at newarc dot com”. Suggestions and comments are welcome. In the tables above, green is a “buy,” yellow a “hold,” and red a “sell.” Each category represents about 1/3 of the underlying universe. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Weighing the Week Ahead: Will a More Aggressive Fed Derail the Stock Rally?

The economic calendar is light until the Friday employment report. Most of the punditry are still digesting the more aggressive talk in the recent speeches from Fed participants. With many observers expecting a correction and looking for a catalyst, pundits will be asking:

Will a more aggressive Fed derail the rally in stocks?

Personal Notes

I have a vacation coming in a couple of weeks. I will not write WTWA next weekend, and possibly not the weekend after that. I will still be following the markets and email. I will join in if it seems needed. The Stock Exchange group is supposed to keep working.

Last Week

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

Theme Recap

In my last WTWA I predicted a discussion about whether stock prices had lost touch with reality. That was a good guess. There was plenty of talk about market valuation. Those bearish also questioned the lack of specifics in the Presidential Address to Congress – which had a greater immediate effect that the annual Buffett letter.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. She notes yet another record close based on the week’s gain of 0.67%. We can also see the gap opening after the Presidential Address to Congress.

The rally story is even clearer in this chart, when begins before the election.

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

The News

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

This week’s news was mostly positive.

The Good

  • Durable goods orders increased 1.8% after last month’s decline. Most of the increase was from the volatile transportation sector, but it was still a welcome boost.
  • Earnings news was positive. Brian Gilmartin emphasizes the favorable trend in estimate revisions.FactSet reports that the earnings and revenue beat rates are slightly lower, but outlook is stronger. Here is an interesting chart of surprises by sector.

  • Investor sentiment turned more bearish. The AAII reports that sentiment is within historic ranges, but off recent highs. This is unusual given past behavior in a rising market. I score it as “good” since most regard it as a contrary indicator.
  • Mortgage delinquency rate falls below 1%, the lowest since June, 2008. (Calculated Risk).
  • ISM Non-Manufacturing rose to 57.6 (from 56.5). The employment index also moved higher. February was stronger than January.
  • ISM manufacturing increased to 57.7 beating expectations and showing a solid increase over last month’s 56.1. The Chicago regional survey was also very strong.
  • Rail traffic in February was 4.2% higher than a year ago. Steven Hansen takes the look at the data we have come to expect, including various moving averages and trends. Read the whole post, but this chart captures some key points, especially the improvement over the last two years.

  • Consumer confidence spiked to 114.8, a post-recession high. Briefing.com covers this series.

  • Initial jobless claims rose slightly on the week, but dropped to the lowest level since 1973 on the widely-followed four-week moving average. (Calculated Risk).
  • President Trump’s speech was very well-received. Most preview articles mistakenly emphasized the need for specifics. Commentators right after the speech did the same. My own preview did not provide advice on what to go out and trade right after the speech. Instead, I drew upon experience and the current policy environment to highlight the key element – the potential for compromise. This chart shows the dramatic shift in this Trump presentation, more like SOTU speeches than nearly anything else he has done. (The Upshot)

 

The Bad

  • Construction spending fell 1%.
  • Money supply is drifting to the neutral range – possibly even tilting negative. (New Deal Democrat). Despite complaints about Fed policy, this is a possible economic drag.
  • Pending home sales fell 2.8% and December was revised lower.
  • Debt Limit will be reached in mid-March. Even the extraordinary efforts will be exhausted in September or October. Will this play out any better with a GOP President and Congress? Douglas A. McIntyre has a good story on this issue.

The Ugly

My concern about hacking and threats to the Internet’s weak spots continues. Rick Paulas’s article is not about events from last week, but is just as relevant. Perhaps even more so with the Barron’s cover story on robots.

The article explains that even rather unsophisticated attacks can work on the 6.4 billion Internet of Things devices in use. Little is being done to protect on this front.

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week. Nominations are welcome. Potential award winners can find daily inspiration at several websites!
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 moderate week for economic data, featuring the employment report on Friday.

The “A” List

  • Employment situation (F). Despite +/- 100K sampling error and multiple revisions, this is seen as most important data
  • ADP private employment (W). Good independent alternative to the BLS numbers
  • Initial jobless claims (Th). Not the same time period as the Friday report.

The “B” List

  • Trade balance (T). Attracting more interest in the Trump era
  • Wholesale inventories (W). Desired or undesired? That is always the question.
  • Factory orders (M). January data. Modest gain expected.
  • Crude inventories (Th). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

FedSpeak will be light and earnings season is ending. Employment will be the big story.

Next Week’s Theme

 

The punditry, especially those who explain the stronger stock market as enthusiasm for Trump policies, is even more amazed than a week ago. To them it seemed that the lack of specifics in Tuesday’s Trump speech should have provided a dose of reality.

Many will now turn to the most common explanation for strong stocks, the ever-popular Fed theory. With several speeches emphasizing that the March FOMC meeting is “in play” for an increase, interest rate markets are adjusting to the probability of three rate hikes in 2017.

Much of the commentary next week will raise the question:

Will a more aggressive Fed spark a stock market correction?

Some might add “finally”!

The question actually has two parts:

  1. Will the Fed increase rates at a pace greater than expectations?
  2. Will this lead to a correction?

Friday’s employment report will have special significance for those with these fears. It will be the final and most important piece of evidence for the FOMC decision.

Both questions have a bullish and bearish side.

  1. An increased pace of Fed rate hikes was the consensus at week’s end. (Bloomberg). Leading Fed observer Prof. Tim Duy’s careful look at the important Dudley speech (before Yellen) was not so decisive.
  2. Bears invoke the hoary adage, “three steps and a stumble.” (David Rosenberg). As you review the evidence, you might consider the starting point for interest rates, as well as the yield curve. More constructively, Neal Frankle analyzes the frequency (often) and severity (moderate) of corrections.

 

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

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

 

The Featured Sources:

 

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

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

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

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

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. His most recent post notes that the expected growth rate in S&P earnings is now 8.41% — the highest level since October, 2014.

Doug Short: The World Markets Weekend Update (and much more). His Big Four chart is the single best method to monitor the key indicators used by the National Bureau of Economic Research in recession dating.

How to Use WTWA (especially important for new readers)

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. All our models are now fully invested. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our four technical experts, and some rebuttal from a fundamental analyst (usually me, but some noted guests experts are coming). We try to have fun, but there are always fresh ideas. Last week the focus was on trading an overbought market. The week before we considered sector rotation strategies, with a recent example from Oscar.

Top Trading Advice

 

Morgan Housel draws upon Ed Thorp’s work to discuss the advantages and dangers of trading with a small edge.

I agree. Every busted card-counter starts with the statement: “The deck got really good”.

Brett Steenbarger has so many strong entries that picking a favorite is a challenge. Here is one I especially liked from last week – reading the market’s psychology. Hint: Do not impose your own preconceptions on what is really happening.

In case you were unable to attend Brett’s master class in NY, SMB’s Bella has a summary of key takeaways. I especially like #6. The successful trader finds more than one way to win. Check out the five “inspirations” as well.

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 once again be Warren Buffett’s annual letter to his investors. It is full of wit and humor – and plenty of great insights. Last week I recommended his annual letter to investors. For those who (mistakenly) did not take the time to read it, you can now check out the “Cliff Notes.”

  • Methodology and screening expert Marc Gerstein applies Buffett principles. Check out his interesting list emphasizing book value.
  • Twenty-eight highlights from Exploring Markets. I especially like this one: When a person with money meets a person with experience, the one with experience ends up with the money and the one with money leaves with experience.
  • Ed Yardeni explains why the oft-cited “Buffett Rule” gets complicated when interest rates are so low. It is why Mr. B regards stocks as cheap.
  • Gil Weinreich has a list of great quotes with his own comments added.

Stock Ideas

 

Chuck Carnevale does his typical comprehensive analysis of j2 Global (JCOM). It includes business model analysis, the important stats, education on how to analyze, and much more. Even if this particular stock does not trip your trigger, you will learn from the article.

Our Stock Exchange always has some fresh ideas. There is usually something from four different approaches. Our momentum trading model, Athena, highlighted Principal Financial Group (PFG). You will probably identify with one of the characters, and your questions are welcomed.

Bottom Fishing

There are some high dividend stocks – often a sign of danger. Are these dividends safe?

Frontier Communications (FTR) yields 14%. Stone Fox Capitalanalyzes the risk.

Target (TGT) declined 12% after announcing poor earnings and a weak outlook. Simply Safe Dividends believes that the yield of 4%+ is probably safe, but a significant increase next year is unlikely.

How about Snap?

A fashionable IPO always attracts attention. In the absence of actual earnings data, everyone is free to spin a story. Initial trading was very positive. Does that mean that investors should consider buying it at market prices? (Those who get an allocation at the offering price have already made a bundle – depending upon when they sell).

Valuation guru Prof Aswath Damodaran provides the careful look we would expect from a top expert. While his final range is wide (and includes current prices) the overall conclusion is not promising. If you are attracted to the stock because you like the concept or company, you should look at this post.

MarketWatch reports that most analysts have stock targets below the $17 IPO price.

 

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, this is a must-read. Even the more casual long-term investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. As usual, investors will find value in several of them, but my favorite is the discussion of ten things you must know about personal finance. It is important to get fundamental decisions right before launching your investment program.

In a similar personal finance emphasis, Seeking Alpha Editor Gil Weinreich cites the top four savings ideas from BlackRock’s clients.

If you have been struggling with your own decisions, you might want to read my (free) short paper on the top investor pitfalls. It is a good test of whether you can successfully fly solo. Send a request to main at newarc dot com.

 

Watch out for…

 

Scam season. One person gets you in the back yard to discuss landscaping, while the other is inside your home, stealing. The IRS does not take payments through credit cards or gift cards. If it seems in the slightest bit suspicious, check it out. The elderly are frequently targeted.

Final Thoughts

 

Your investment conclusions are strongly influenced by your preconceptions and current position. Last week I had an especially good summary of the two main themes. If it matters, Warren Buffett went on TV the day after I wrote this, expressing a similar opinion about stock valuations.

  • Stock values are attractive
    • Emphasis on earnings expectations and forecasts
    • Belief in relative valuations – comparing stock expected performance, with bonds, real estate, gold, etc.
    • Confidence that a recession is not imminent.
  • Stocks are over-valued
    • Emphasis on trailing earnings
    • Analysis based partially on 19th century data
    • Belief that valuation is absolute. A sector’s value is independent of the alternatives
    • Focus on headline risk – uncertainty, world events, etc.

Your choice of world view controls how you interpret fresh news, and your key investment decisions. If you are getting it wrong, you need an epiphany!

The market is rising despite the lack of specifics in the Trump plan and the realization that there will be delays in his proposals – even if he can sell them to Congress. The reason is straightforward:

The economy has been getting better in the post-election period. Dr. Ed Yardeni, declares that The Recession Is Over. He is thinking globally, noting that worldwide improvement cannot be linked to the U.S. election.

Charles Lieberman reviews the entire array of factors, including what to worry about.

Briefing.com’s excellent Big Picture column (worth a paid subscription) explores the possible causal relationships. Here is a key chart.

The Fed rate increases will be consistent with a stronger economy, an environment that implies solid growth in earnings. Scott Grannis explains why higher rates are not a threat in the current market:

It’s very likely we’re still in the early stages of more of the same. Interest rates are going to be rising, probably by more than the market currently expects, because the outlook for the economy is improving and inflation is at the high end of the Fed’s target range, yet interest rates are still relatively low because of the market’s willingness to pay up for safety—and that won’t persist for much longer. Stocks are going to be buoyed by improving earnings and the prospect of stronger economic growth. Interest rates will be moving higher because of stronger growth—higher rates are not yet a threat to growth. The Fed is still a long way from raising rates by enough to threaten growth. If the FOMC hikes rates in two weeks it won’t be a tightening, it will be a sensible reaction to stronger growth and improved confidence.

Worries?

Sure. If the Fed gets behind on inflation and accelerates rate increases, even though the economy is sluggish, it will be an early sign of an impending recession. I am watching this closely, and so should you.

Meanwhile, do not be scared witless (TM OldProf euphemism).

Stock Exchange: How to Trade an Overbought Market

For the last three weeks, the term “overbought” has been frequently used to describe the overall market as well as many specific stocks. What does this really mean?

It has a dangerous sound, and that is indeed the common message. A stock, or a sector, or the overall market has rallied more than expected over an extended time.  What does that mean for traders?  Or for investors?

It is an excellent question for our experts.

Review

Our last Stock Exchange focused on trading sector rotations, Oscar’s regular mission. There was an excellent discussion. It provides special value when readers engage with our crew of “technical analysts.”

To encourage this discussion and diversity we will have some visiting experts for the next two weeks:

  • Brian Gilmartin of Trinity Asset Management, a leading expert on corporate earnings and fundamental analysis reported at his blog, Fundamentalis.
  • Robert Marcin of Defiance Asset Management. Bob is an oft-quoted legend, a deep value manager, and a curmudgeon par excellence.  While I often do not agree with him, I always listen carefully in our discussions on Scutify.  You will enjoy the banter and can keep your own scorecard.

Today’s Theme

An extended stock move is often described as overbought or oversold.  For most observers, an overbought stock or market is poised for a selloffSome technical analysts measure this in terms of relative strength measures (RSI).

How important is this warning sign?

Pension Partners warns of an “optical illusion,” citing multiple prior examples and then considering the current NASDAQ 100.  Look at the interesting evidence in the entire article leading to this conclusion:

If one is going to predict anything based on extreme overbought levels (and I would advise against doing so), it would be further gains. I realize that doesn’t conform to the prevailing narrative of “overbought is always bearish,” but the truth in markets rarely does.

Chris Ciovacco has a nice chart pack of prior overbought conditions.  The mixed results are a warning to anyone thinking about trading on this approach – despite the recent somber warnings from the NYSE floor via Art Cashin.

What do our Stock Exchange experts think about overbought markets?  We will hear them out and, as usual, I will conclude with a brief observation about the key points. I will begin with Athena, who specializes in short-term momentum trades.

This Week—Trading an Overbought Market.

Athena

My approach is to find winners and ride the gains.  Fundamental analysts are skeptical of momentum, but trend-following is one of the strongest historical methods.  The “trend is your friend” is not just a cliché. Principal Financial Group (PFG) is a great example; it has been on tear for a month. That is enough to put it on my radar. The sharp increases may be off-putting to some, but they are mistaken.  The trend line is strong. I’m looking for an increase of 2-3% over the next 2-4 weeks.

J:  Are you concerned that the stock might be overbought?

A: In my evaluation methods, the price action is a sign of strength.

J:  At what point would a major gain worry you?

A:  I like stocks that are showing strength, but I am ruthless when it comes time to get out.

J: So, you do not worry about overbought conditions on the entry?

A:  Some of the best trades come when an “overbought” stock gets more overbought.

J:  For a welcome change, your choice is also attractive on a value basis.

A:  Value?  What does that mean?

J:  You can see it in the fine chart from F.A.S.T graphs.  Let us turn to Felix, who also follows a momentum strategy.

Felix

I will once again begin with my responses to reader votes for the favorites list.

My list provides rankings within each zone, as well as the basics about buy, hold, and sell.  The list includes the most recent reader questions as well as former requests where my rating has moved.

J: AMD is still on top?

F: It leads the reader list, but not my own.

J:  I have had some questions about that.  Readers want to know your own top picks.

F: If I talked about that here, I would be revealing what I recommend for your clients.

J: That is a problem.  I want to be helpful to readers, but emphasizing that it should be a start for their own research. We did have a couple of questions last week.  What do you think about reader Jim Irving’s questions about CRX and CXRX, which he identifies as debt-laden drug companies?

F:  He is right to be concerned.  CRX is on my sell list and CXRX is a very weak hold.  I wish that more readers would submit such questions.  I need my incentive bonus to kick in.

J:  Do you have anything fresh for us this week?

F:  Nothing new, since my focus is longer than the others.  Let me take up a holding that some are worried about, NVIDIA Corporation (NVDA).  This was one of my long-term picks in early December of 2016. We’ve had two major spikes in price since then, followed by decline in February. Those with a short-term mindset are worried.  Since I’m interested in holding out for the long haul, I haven’t been preoccupied by the dips. I’m up about 10% here after nearly a full quarter in the position – nothing to sneeze at!

J: Would you call this an “overbought” stock?

F:  Not on my time frame.  The definition of overbought should adjust to your investment purpose.

 

Oscar

We haven’t hit March Madness yet, so I am mostly thinking spring training.  For many teams the question is whether to play big ball or small ball. In small ball baseball, players trade the long odds on huge plays in favor of more manageable base hits.  Sometimes the small ball approach generates more runs and winning baseball.

On that theme, I’m looking closely at the Russell 2000 Index (IWM). Small caps and large caps performed very differently in 2016. Large caps were generally in favor due to their relatively low volatility and risk. However, I see potential for growth in the small caps over the next several weeks. From the looks of the chart, I’m probably not alone!

 

J:  Are you worried that small cap stocks might be overbought?

O: What I see is strength?

J:  What if the small-cap sector fades?

O:  As I always do, I’ll dump it and move to what is working.  I always like to have my money working.

J:  Does that mean that you are getting ready for March Madness?

O:  That is where a longshot can really work.

J:  I suppose we are going to hear more on that subject.

O:  You can count on it!

J:  Do you have your updated sector ratings?

O: Yes.  I monitor about 40 sectors and hold positions in the top three.  $IWM is a new holding.  It is not on the list because no readers asked about it.

 

Holmes

This week I’m buying YELP, an internet content & information provider in the U.S. (34.66)

Although it traded at 97 in 2014, I have no illusions that is going back there. Instead I like this stock because it’s showing some resilience at 32.5 level. Trading down to 32.5 in late October this stock rebounded all the way 42.5 before getting pounded again down towards the 32.5 price, BUT, it didn’t get there before turning up. So now we have a stop, (32.5), and a price target 42, with a current price of 34.66, I like the risk/reward this setup provides. Plus, I like the name, it reminds me of my pack when I was a young pup.

J:  Are you worried about overbought stocks.

H:  Never!  I let others chase the recent winners.  I find strong stocks experiencing a temporary setback.  I don’t need to worry about “overbought” market conditions.

Conclusion

The term “overbought” can mean many different things.  Effective trading systems use recent trends and technical indicators in quite different ways.  No single method has a monopoly on success.  Drawing upon expert systems, let’s highlight three key conclusions.

  1. Overbought need not spell danger. Overbought stocks and sectors often get even more overbought.  This might even be the best part of the move, augmented by short covering.
  2. You must gauge your reaction and stops to your price target, loss tolerance, and time frame.
  3. Your system must fit your trading personality, as illustrated by our four models.

If you like selling the rips and buying the dips, do not take a momentum approach.  Check out our post on dip-buying.  If you are contrarian and flexible, consider this week’s advice about various ways to deal with momentum.

We welcome comments, suggestions, and followers for each character.  Even Jeff.  I try to have fun once a week in writing this, and I hope you get a chuckle or two from reading it. Here is how to join in.

Background on the Stock Exchange

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

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

Questions

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

Getting Updates

We have a new (free) service to subscribers to our Felix/Oscar update list.  You can suggest three favorite stocks and sectors.  We report regularly on the “favorite fifteen” in each category– stocks and sectors—as determined by readers.  Sign up with email to “etf at newarc dot com”.  Suggestions and comments are welcome.  In the tables below, green is a “buy,” yellow a “hold,” and red a “sell.”  Each category represents about 1/3 of the underlying universe.  Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Trump’s Address to Congress: A Preview for Investors

A Presidential address to Congress is an important occasion. In the first year of a term, it is called just that. In later years, it will be called the State of the Union Address. The circumstances, ceremony, and protocol are the same. I have been watching these speeches for decades, first as a political science and public policy professor and more recently as an investment manager. The combination of these perspectives helps me identify the most important aspects of these events.

Background

The first such speech is especially important as a clue about the new relationship between the executive and legislative branches of government. I previewed Obama in 2009. In 2008 I suggested ideas for the Bush team, predicting that you would not hear that speech. I was (unfortunately) correct in that prediction. My suggestions would have helped to stabilize markets before the 2008 crisis.

The Trump Address

The simple term “address” is quite different from the standard approach of the President. His Inaugural Address is our only example. Most people, including most of the punditry, will be looking for the wrong things. The key points include both style and substance. In the conclusion, I will explain more about why the style is important. Here is your Trump Speech Checklist:

  • Initial entry. The Doorkeeper of the House will announce his arrival. A normal entry includes sustained and respectful cheering and a slow, hand-shaking pace up the aisle. It will be our first clue about mutual respect, and especially the President’s respect for Congressional traditions.
  • Trump’s target audience. In these speeches, there is always tension between playing to the room or to the TV audience. Trump’s style generally emphasizes the audience in front of him and is fueled by feedback from that audience. Most people do not understand how challenging it can be to remain focused on the larger television audience instead of what you see right in front of you.
  • Specific policy statements. Do not expect fresh news. He has already commented on most key issues, but without any real legislation. This is almost a polar opposite of the early days of Obama – early legislative success, but lingering doubt about what was to come next.
  • Signals of cooperation – in both directions. Will the President embrace the power and authority of Congress, seeking their cooperation? Will he realize that support from Democrats will be needed on some issues? And will the Congressional audience reciprocate and appreciate any such overtures?
  • Demonstration of political savvy. Recent statements suggest that the new administration has learned about the necessities of Congressional politics, and the implied order of policy actions. Any such signals will get a favorable reception on both sides of the aisle.
  • Channeling the Great Communicator. Since the Reagan era it has been typical for Presidents to salt the audience with special guests who will be recognized. Most importantly, this humanizes the need for policy proposals. Putting a face on problems is powerful symbolism. Rumor has it that Democrats will have their own guests, but that is not likely to matter.

Conclusion

The media will have various criteria for determining the success of this address. Polls will give us another take.

For investors, we can look for information on two key subjects:

  1. Compromise. The market does not want years of fighting over key policies. Think back to the election night reversal in stock futures after the President-elect made a conciliatory speech. Investors want certainty (meaning compromise) more than any specific policy.
  2. Timing. Most of the punditry has not done well in identifying “Trump stocks.” That is not surprising. This job requires a sector analysis of policies, needed cooperation, timing, and analysis of affected stocks. I created and described a Trump matrix, which continues to build with each new piece of information.

This preview is not as much fun as a beer-drinking bingo card of likely statements, but it will help you to focus on what is important.

If you really want to own the right market sectors and stocks, you need a firm grasp on the likely policy changes.