Stock Exchange: Can Humans Compete with High Frequency Traders?

Many individual investors have been frustrated by the growing prominence of High Frequency Trading. Complicated algorithms can process new information and react in fractions of a second. It sounds intimidating, and in some sense, it is. Individual Investors would be poorly suited for direct competition.

Instead, stick to what the market is giving you. The connections made by these programs are often spurious – totally unrelated to the fundamentals of a given business. This is intentional. After all, they’re after a quick buck rather than a long-term investment.

For that reason, a stock being walloped for frivolous story in the 24-hour news cycle may present an attractive buying opportunity. It all comes down to the individual investor’s process and commitment to their goals.

To help give us perspective this week, we’re bringing in earnings expert Brian Gilmartin. Since 1995, Brian has managed Trinity Asset Management. You can find his regular writings on Fundamentalis.

This Week—Holmes sniffs out a deal

It can be tempting to make a trading decision based on a glance at its recent chart. Unfortunately, a stock that has underperformed in recent days might be providing a big opportunity. Holmes uses a mix of advanced trading techniques and technical analysis to avoid significant drawdowns. When he chases after a down stock, it’s because he sees some serious upside. Let’s see what he’s up to this week:

Holmes

Holmes: This week I’m buying  Jack-in-the-Box (Jack) a restaurant chain in the U.S. (95.98).

It’s not easy finding stocks that fit the exact criteria I’m looking for. I try to find stocks that have been trending higher, then have broken down below that trend, and have started to base a for reasonable period of time.

This gives me a good entry with limited downside risk and upside gains that may get back to the previous levels before the most recent debacle. I like risk/reward ratios of 2:1 or better.  With Jack, my downside is 93.70(Stop), my upside is 106, risking $2.28 to make $10.02. Woof Woof!

Brian: a comp miss sent the stock down to its 200-day moving average after February ’17 comp’s for JACK as the industry that the “low-end” consumer has taken a breather. Forward earnings and revenue estimates are a little weaker following the February ’17 miss, but JACK is trading at 20(x) expected ’17 earnings for expected 17% growth. Even if EPS growth slips to 15% or even low teens the stock is cheap on a PEG (P.E to growth) basis.

Holmes: Glad to hear you approve! Jeff is usually a bit harsher.

Brian: It’s not a bad pick, depending on how long you’re holding onto this one.

Holmes: My usual target is about 4-6 weeks, though I wouldn’t hesitate to unload this if another downturn became apparent.

Brian: Solid reasoning – for a talking dog, at least…

Oscar

Oscar: My big pick this week is the China Large-Cap ETF (FXI).

We’re in the midst of March Madness, so let’s call this pick a rebound. Not in the classic sense: that’s better suited for FXI’s behavior through early January.

Still, I made this my pick on 2/9 and hung with it for a couple of weeks. Now that we’ve seen another drop, I’m ready to jump off the bleachers and get back in the game.

Brian: BRIC’s and Emerging Markets have traded well since the bottom in Q1 ’16. FXI is the safer asset class in a crowded China ETF market. As someone who was never a fan of China as a strategic or even tactical asset allocation recipient, Emerging Market ETF’s might be a better risk / reward. The ETF is scraping along its 200-day moving average.

Oscar: So, you like this one too?

Brian: I’ve always thought China was like playing the US stock market in the late 1800’s – it is the Wild Wild West of outcomes, as a Communist country tries to centrally plan a free-market economy.

Oscar: It’s a risk I’m willing to take!

Felix

Felix:

Continental Resources (CLR) is my next long position.

The decline here has been sustained and significant, which I find attractive. At $43.22, there is definitely potential for the stock to improve near previous highs above the $55 mark. I could hang onto this one for months.

Brian: Continental took a beating on Wednesday as crude oil fell 5%. The Energy sector is a battleground sector as crude gyrates around $50 per barrel and CLR is leveraged to the price of crude. The stock is oversold and trading below its 200-day moving average.

Felix: I agree the stock is oversold, but I don’t like the sound of that “battleground.” How do I know when I’ve hit a proper valuation here?

Brian: Tell me what crude oil will do and you can figure out what CLR will do.

Felix: Uh oh.

Athena

Athena: I understand my methods are often met with skepticism. That’s why I like to pause now and then and reflect on some small successes. Let’s review my recent foray into Advanced Micro Devices (AMD).

I recommended this stock back on 2/9/17, just after a huge spike in price. Put lightly, this was not my most-loved pick. That was fine by me. Because I had the right time frame in mind, I was able to collect a tidy sum and close out this position near the end of the month.

Brian: A semiconductor company that was a serial capital destroyer for most of its life and long an “also-ran” to Intel, AMD had an impressive string of “earnings beats” and raises in 2016. On the other hand, the valuation is stretched with the Street looking for $0.07 and $0.26 thus AMD is trading at 50(x) next year’s earnings.

Athena: Would you say something like this might be due for another pop in the near future? How hot is this trend?

Brian: The semiconductor space looks good both technically and fundamentally, and AMD is a resurgent laggard in the space.

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. Each week features a different expert or stock.

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).

Conclusion

The growing establishment of High Frequency Trading algorithms has changed the investment landscape. However, that doesn’t spell doom for the individual investor. Overreactions to trivial matters, like a POTUS tweet, can actually create bargain opportunities. Keep these ideas in mind:

  • Do not compete directly by trying to react more quickly to news.
  • Find a method that differs in time frame.
  • Do not use stops that become limit orders.  A random move can take you out of a position at a poor price.
  • If possible, use the HFT algorithms to your advantage.  If a stock is solid, consider buying dips by having some standing buy orders.

Take what the market is giving you.

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

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

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

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

1/3/16

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

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

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

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

2/7/16

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

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

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

3/5/16

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

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

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

3/20/16

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

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

3/26/16

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

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

4/3/16

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

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

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

4/10/16

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

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

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

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

But Harris has thoughts on this, too:

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

4/17/16

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

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

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

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

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

4/23/16

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

5/8/16

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

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

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

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

5/21/16

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

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

5/29/16

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

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

6/12/16

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

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

Conclusion – Part One

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

Weighing the Week Ahead: Should We Expect September Mourning?

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

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

Last Week

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

Theme Recap

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

The Story in One Chart

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

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

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

Please Watch…

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

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

The News

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

The Good

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

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

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

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

 

The Bad

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

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

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

The Ugly

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

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s award goes to Ben Carlson, who takes on the apparently compelling statistical link between the Fed and stock performance. Since 2008 more than half of the increase in the market comes on days of FOMC meetings. He notes that this argument was featured in the WSJ, but it shows up in various places.

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

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

 

The Week Ahead

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

The Calendar

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

The “A” List

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

The “B” List

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

 

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

Next Week’s Theme

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

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

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

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

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

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

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

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

The Featured Sources:

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

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

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

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

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

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

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

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli’s enhanced aggregate spread, considering when it might first give a recession signal. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score. This week, as he always does after an employment report, Georg updated his unemployment-based recession indicator. No recession is indicated.

How to Use WTWA

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

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

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

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Holmes – the top artificial intelligence techniques in action.
  • Why 2016 could be the Year for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions or suggestions for new topics.)

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

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

Top Trading Advice

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

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

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

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

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

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

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

Insight for Investors

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

Best of the Week

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

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

And also this one….

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

Stock Ideas

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

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

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

Energy

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

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

Personal Finance

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

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

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

Market Outlook

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

Strategy

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

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

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

 

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

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

Final Thoughts

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

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

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

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

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

Weighing the Week Ahead: What’s Up with Housing?

Once again, this week’s economic calendar is very light. There will be plenty of political news and daily doses of FedSpeak. Despite the political stories, I expect the punditry to be asking:

What is happening with housing?

Prior Theme Recap

In my last WTWA (two weeks ago) I predicted a focus on the US Presidential election and the possible implications for financial markets. That was a good guess, with these stories remaining at the forefront of news through two weeks, not just one. Last week included the expected news about the Fed even though the expected news was no real policy change! Doug Short notes the post-Fed rally, as you can see from his excellent weekly chart. (With the ever-increasing effects from foreign markets, you should also add Doug’s World Markets Weekend Update to your reading list).

SPX-five-day

Doug’s update also provides multi-year context. See his full post for more excellent charts and analysis.

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.

This Week’s Theme

The economic calendar is light and the U.S. has a four-day trading week. The President’s trip to Cuba and South America will make news, but probably not financial news. Daily servings of speeches from Fed participants will provide plenty of material for those who always see that subject as most important.

Despite this competition, I expect attention to the role of the housing market in the current economy. Employment remains strong. Auto sales are solid. Retail sales are good. Business investment and housing remain the biggest economic question marks. At one point both were a real drag on economic growth. More recently the effect has been flat rather than negative. With some key data released this week, I expect pundits to be asking: What’s up with housing.

 

Background

Calculated Risk is the “go to source on housing” according to Paul Krugman. For those who are not fans of Krugman, I have said the same thing many timesJ Bill called both the top of the housing market in 2006 and the bottom in early 2012. Very few can claim that distinction. His blog has become a top source for coverage of economic news, earning widespread respect. We should be paying attention to his perspective this week.

Viewpoints

Those bearish on the housing market (and often on the economy and stocks in general) frequently cite the following points:

  • Increasing housing prices strain the affordability for new buyers;
  • Increasing interest rates also hurt affordability;
  • Many homeowners are underwater on mortgages and cannot sell or buy;
  • Demand is lower because of millennials staying at home or choosing to rent;
  • Homes held in foreclosure proceedings or by speculators provide low-priced competition;
  • Home sales are low because there is insufficient supply.

Those who are bullish observe the following:

  • Interest rates remain at historically low levels, helping affordability;
  • The price rebound has helped many to build home equity;
  • We can expect increasing purchases from young people;
  • The foreclosure and speculative sales are less significant than a few years ago;
  • Increased home prices enable some to sell – trading up or even sideways to take new jobs.

As always, I have my own opinion in the conclusion. But first, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:

  1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially – no politics.
  2. It is better than expectations.

The Good

There was some good news last week, but it was only marginally positive.

  • The Fed Decision was – as usual – unpopular with many, but was celebrated by markets. There was no policy change, but the guidance suggested a slower pace of future rate increases. Those who believe that the Fed has no tools left might want to read former chair Bernanke’s latest blog post. (He has some favorable observations about negative interest rates).
  • Retail sales missed expectations a bit on the headline, but beat on the core rate. See this week’s Silver Bullet award for more detail.
  • Inflation data moved toward a more normal range. The core rate has been about 2%.
  • Housing starts climbed. The single family annualized rate was 822K, the best since November, 2007. (Bloomberg)
  • Jobless claims remained low at 365K. Staying in this range means that relative few are losing jobs, but we still need job creation.
  • JOLTS data showed continued strength in job openings and the quit rate. (BI)

The Bad

Some of the news was negative.

  • Housing permits missed expectations dropping 3.1% (Bloomberg).
  • Industrial production fell 0.5%.
  • Michigan sentiment weakened to 90.0 falling from 91.7 in February and missing expectations. Many observers noted that the level was still strong, but I watch this indicator carefully.

3-20-2016 12-00-38 AM

The Ugly

Wild conspiracy rumors. When you read something like this it is best to turn the page. Large-scale conspiracies of central bankers, plunge protectors, or the like have no basis in fact. Too many people would know and find it politically or financially tempting to tell their story. These rumors are most frequently lame explanations by people who have been wrong in their market forecasts. They have to blame someone! Respected media sources should not report such “news” and we should not read it.

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts.  Think of The Lone Ranger. This week’s award goes to two sources, taking on the same topic but using different approaches. The standard media take is that retail sales have been weak, with little evidence of impact from lower gasoline prices.

Todd Sullivan

brings us another post from “Davidson,” who provides consistently fine analysis. (It would be good to see more of him). He notes that many sources confuse nominal and real data showing the chart and the table below:

 

Screen-Shot-2016-03-15-at-2.07.51-PM-581x420

3-19-2016 8-06-09 PM

Here is the key takeaway:

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

 

Our co-winner is Steven Hansen of Global Economic Intersection. He prefers rolling averages of unadjusted data, as shown here:

 

z retail1

 

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. Beginning last week I made some changes in our regular table, separating three different ways of considering risk. For valuation I report the equity risk premium. This is the difference between what we expect stocks to earn in the next twelve months and the return from the ten-year Treasury note. I have found this approach to be an effective method for measuring market perception of stock risk. This is now easier to monitor because of the excellent work of Brian Gilmartin, whose analysis of the Thomson-Reuters data is our principal source for forward earnings.

Our economic risk indicators have not changed.

In our monitoring of market technical risk, I am now using our new model, “Holmes”. Holmes is a friendly watchdog in the same tradition as Oscar and Felix, but with a stronger emphasis on asset protection. We have found that the overall market indication is very helpful for those investing or trading individual stocks. The score ranges from 1 to 5, with 5 representing a high warning level. The 2-4 range is acceptable for stock trading, with various levels of caution.

The new approach improves trading results by taking some profits during good times and getting out of the market when technical risk is high. This is not market timing as we normally think of it. It is not an effort to pick tops and bottoms and it does not go short.

Interested readers can get the program description as part of our new package of free reports, including information on risk control and value investing. (Send requests to info at newarc dot com).

In my continuing effort to provide an effective investor summary of the most important economic data I have added Georg Vrba’s Business Cycle Index, which we have frequently cited in this space. In contrast to the ECRI “black box” approach, Georg provides a full description of the model and the components.

For more information on each source, check here.

indicator snapshot 031916

Recent Expert Commentary on Recession Odds and Market Trends

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured “C Score.”

Georg Vrba: provides an array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal. He gets a similar result with the twenty-week forward look from the Business Cycle Indicator, updated weekly and now part of our featured indicators.

Doug Short: Provides an array of important economic updates including the best charts around. One of these is monitoring the ECRI’s business cycle analysis, as his associate Jill Mislinski does in this week’s update. His Big Four update is the single best visual update of the indicators used in official recession dating. You can see each element and the aggregate, along with a table of the data. The full article is loaded with charts and analysis.

dshort big four

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting systems. These include approaches helpful in both economic and market timing. He has been very accurate in helping people to stay on the right side of the market.

Dwaine has introduced a new indicator, using only the timeliest data and a distinct improvement over the ECRI approach. Read the entire post for details and a number of interesting charts.

Bill McBride is still not even on recession watch.

The Week Ahead

We have a huge week for economic data. While I highlight the most important items, you can get an excellent comprehensive listing at Investing.com. You can filter for country, type of report, and other factors.

The “A List” includes the following:

  • New home sales (W). Key element of economic health and growth.
  • Existing home sales (M). Signals overall market health, while less important for construction.
  • Initial Claims (Th). A lot of attention to the recent volatility in the best concurrent news on employment trends.

The “B List” includes the following:

  • Durable goods orders (Th). Volatile but important data.
  • FHFA housing prices (T). Different segment from the more popular Shiller method, but interesting.
  • Crude oil inventories (W). Attracting a lot more attention these days.
  • GDP third estimate (F). Old news, no change expected, and announced when the markets are closed.

The election stories will still attract attention. We have FedSpeak every day.

 

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a “one size fits all” approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

WTWA often suggests a different course of action depending upon your objectives and time frames.

Insight for Traders

We continue both the neutral market forecast, and the bearish lean. Felix is still 100% invested, catching much of the rebound. The more cautious Holmes avoided the downdraft, but has only signaled a few buys in the last two weeks. For more information about Felix, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix and Oscar’s weekly ratings updates via email to etf at newarc dot com. They appear almost every day at Scutify (follow here). I am trying to figure out a method to share some additional updates from Holmes, our new portfolio watchdog. (You learn more about Holmes by writing to info at newarc dot com.

Dr. Brett explains that many traders are “playing the wrong game.” This happens when you work with a system that does not really fit your skills. I have known many traders who struggle for years in this type of situation.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. Major market declines occur after business cycle peaks, sparked by severely declining earnings. Our methods are focused on limiting this risk. Start with our Tips for Individual Investors and follow the links.

We also have a page (recently updated) summarizing many of the current investor fears. If you read something scary, this is a good place to do some fact checking. Pick a topic and give it a try.

Many individual investors will also appreciate our two new free reports on Managing Risk and Value Investing. (Write to info at newarc dot com).

Other Advice

Here is our collection of great investor advice for this week.

If I had to pick a single most important source for investors to read, it would be Morgan Housel’s post, You May Be A Better Investor Than You Think. He notes that many people unrealistically focus on certain index benchmarks. It is more realistic to look at your own goals. The average investor, either active or passive, doesn’t earn a return even close to the benchmark.

 

For an investor to earn the returns of the benchmark, they would have to own it continuously, for years on end, without touching shares and reinvesting all dividends. They’d have to sit patiently when markets plunged, never selling out of fear, never needing the cash to fund retirement or a house, and never paying an advisor for advice.

How many investors actually behave that way? Few. Nothing close to the average investor.

Take the Vanguard 500 fund. It’s the closest thing we have to a tradable benchmark – an S&P 500 fund with a negligible fee.

The fund has an average annual return of 6.3% over the last 10 years. But the average investor in the Vanguard 500 fund earned 4.4% a year. The difference is due to money coming into the fund when the market is high and selling when it’s low.

Despite this, you may be doing a lot better than other investors who are making bad picks or trying to time the market.

 

Stock and Fund Ideas

Dividend stocks. Morningstar reports the top 10 dividend stocks held by their “ultimate stock pickers.” It is an interesting methodology. We own several names on the list and several others are on our watch list for our enhanced yield program.

Taking a look at emerging markets? (I am). Sovereign Man notes that Singapore is one of the richest countries, but has one of the cheapest stock markets.

How about energy bonds instead of stocks? David Bianco contributed this idea to BI’s periodic feature on the most important charts. Many are worth checking out (and thanks to reader CS for reminding me about this).

david-bianco-and-team-deutsche-bank

 

Energy Prices

The International Energy Agency suggests that lower oil production may have created a bottom in prices. The dollar has stabilized and even drifted a bit lower.

Prof. Jeremy Siegel notes that both of these factors might lead to upside surprises in earnings in the coming year – perhaps an increase of 15%.

Watch out for….

Utility stocks. These have been leaders over the last year, driven by momentum rather than fundamentals. Even Felix has owned the group for brief stretches. Value managers see the stocks as significantly overvalued, and it could get much worse if interest rates rise. (The Capital Spectator)

“Smart Beta.” Bailey McCann writes that many such funds are slightly disguised chasers of performance.

Bonds. It does not take much of an increase in rates to wipe out an entire year of returns. (The FT). AAA corporate bonds in Europe just had the worst twelve months since 1999. The chart tells the story:

cffe8eb6-ec36-11e5-bb79-2303682345c8.img

 

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. There are several great posts, but I especially liked Kyle Moore’s discussion of why investors might benefit from professional advice. After citing examples from various fields, he writes:

What the do-it-yourself approach cannot provide is an objective third party who asks the questions you’ve never considered. This third party, whether golf coach or financial advisor, should be someone who can help you determine your goals, provide a clear path toward those goals, and keep you accountable in your efforts to achieve them.

 

Final Thoughts

Following Calculated Risk helps you track some indicators that you do not see elsewhere. How about “detached annual lot deliveries.”

w704

In this post he cites Metrostudy chief economist Brad Hunter, who says that the bullish trend in the lot delivery indicator shows up in several important markets.

I also like the fact that NAHB confidence remains strong. The builders might have some insight into their own business.

Finally, the housing bears seem to have an ever-changing story. Low prices were bad, but so are higher prices. The market was going to be flooded with foreclosure sales. Now there is too little inventory.

It is always best to focus on the major trends rather than short-term blips. The potential for a significant economic contribution in housing is there. The possible drag on the economy seems limited.

Housing could be the sector that gives the economic cycle a further push.

[I am long some homebuilders both personally and for clients].

Weighing the Week Ahead: Will there be a January effect?

After two weeks of slow, holiday-shortened trading, the A-Teams will (gradually) get back to work. Despite the importance of the data on this week’s schedule, I expect a different sort of fixation on the calendar. We can expect widespread discussion of the question:

Will we see a January effect?

 

Prior Theme Recap

In my last WTWA I predicted that the slow news and trading environment would lead to a pundit parade, with plenty of forecasts for the new year. This was pretty accurate, including some carry over from our prior week’s question about Santa. Things were looking up until the last two days of the year disappointed. You can see this clearly from Doug Short’s weekly chart. His full post also includes analysis for the full year. (With the ever-increasing effects from foreign markets, you should also add Doug’s World Markets Weekend Update to your reading list).

SPX-five-day

 

Doug’s update also provides multi-year context. See his full post for more excellent charts and analysis.

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.

This Week’s Theme

There are plenty of important data releases this week, including the most important. At most other times this would stimulate spirited discussion about the economy. At the start of the year there is a very different dynamic. Perhaps because it is simpler to think about, everyone loves the focus on the start of the new year. I expect most observers to be asking –

Will we see a January effect?

I did not say “the” January effect, since the calendar-based prognoses have broadened to include the following:

  1. The original January effect saw losers sold near the end of the year to harvest the tax losses. After 30 days, many repurchase, causing a January rebound.
  2. Some investors wait until January to sell winners, delaying the tax effect. Reportedly (Art Cashin) others sell winning names short during the last two days of the trading year, anticipating the tax trade.
  3. Many believe that as goes January, so goes the year.
  4. Some believe that as goes the first trading day, so goes January and the year.
  5. Some will focus on the Presidential election year.
  6. And a few will stick to the data.

As always, I have my own opinion in the conclusion. But first, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:

  1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially – no politics.
  2. It is better than expectations.

The Good

Despite the negative result for stocks, there was some good news last week.

blogger-image--1496232610

  • Consumer confidence from the Conference Board registered 96.5, beating expectations by a few points. Doug Short has the story, including data showing the historical significance of the indicator.

DShort Conference Board

The Bad

Some of the economic data was disappointing.

  • Initial jobless claims increased to 287K. See Calculated Risk for analysis and a helpful chart.
  • Rail traffic weakness continues. Steven Hansen of GEI says it is “sliding into recession.”
  • The Chicago PMI was only 42.9, missing expectations by seven points and signaling continuing contraction in Midwest manufacturing. Detailed analysis from Steven Hansen of GEI (who was definitely working last week!)
  • Pending home sales declined by 0.9%. Too little inventory once again gets the blame. Hmm.

The Ugly

My intention was to skip this topic over the holidays, despite the many candidates. Then I saw a famous bear’s list of “possible” predictions for 2016. The list was heavy on terrorism ideas and even included a possible injury to Warren Buffett. To me, this went beyond the bounds of good fun. It also serves to keep investors scared witless (TM OldProf Euphemism). The question of how terrorism affects investing is difficult, and not a subject for light-hearted speculation – especially when it includes specific ideas of what attacks might be the worst.

Mrs. OldProf advises me that I should not name and link to this source – who is notoriously thin-skinned. You can find it easily if you really want, but I am not recommending it. The post just hit me the wrong way. I suppose that others might like it.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts.  Think of The Lone Ranger. This week’s award goes to Matt Busigin, who explains that US Recession Callers Are Embarrassing Themselves. Here is his lead paragraph, worth keeping in mind on Monday when the ISM data come out:

 

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

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

 

Please also see our review of last year’s winners. You will find the summary fun to read, featuring advice which remains timely.

A Well-Deserved Remembrance

If we had been doing the Silver Bullet in those days, we certainly would have recognized “Tanta” who wrote anonymously for Calculated Risk before her death in 2008. Joe Weisenthal and Tracy Alloway have a nice interview on the subject with Bill McBride.

Noteworthy

How would you do as Fed Chair? Could you get reappointed after four years? Give it a try with this enjoyable game.

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. Beginning last week I made some changes in our regular table, separating three different ways of considering risk. For valuation I report the equity risk premium. This is the difference between what we expect stocks to earn in the next twelve months and the return from the ten-year Treasury note. I have found this approach to be an effective method for measuring market perception of stock risk. This is now easier to monitor because of the excellent work of Brian Gilmartin, whose analysis of the Thomson-Reuters data is our principal source for forward earnings.

Our economic risk indicators have not changed.

In our monitoring of market technical risk, I am using our “new” Oscar model. I put “new” in quotes because Oscar is in the same tradition as Felix and the product of extensive testing. We have found that the overall market indication is more helpful for those investing or trading individual stocks. The score ranges from 1 to 5, with 5 representing a high warning level. The 2-4 range is acceptable for stock trading, with various levels of caution.

Oscar improves trading results by taking some profits during good times and getting out of the market when technical risk is high. This is not market timing as we normally think of it, since it is not an effort to pick tops and bottoms and it does not go short. Instead, Oscar identifies and limits risk. (More to come about Oscar).

I considered continuing to report the Felix updates, but I already have a distinction between long and short-term methods. I want to minimize confusion. Those who want this information can subscribe to our weekly Felix updates.

In my continuing effort to provide an effective investor summary of the most important economic data I have added Georg Vrba’s Business Cycle Index, which we have frequently cited in this space. In contrast to the ECRI “black box” approach, Georg provides a full description of the model and the components.

For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured “C Score.”

Doug Short: Provides an array of important economic updates including the best charts around. One of these is monitoring the ECRI’s business cycle analysis, as his associate Jill Mislinski does in this week’s update. His Big Four update is the single best visual update of the indicators used in official recession dating. You can see each element and the aggregate, along with a table of the data. The full article is loaded with charts and analysis.

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting systems. These include approaches helpful in both economic and market timing. He has been very accurate in helping people to stay on the right side of the market.

Georg Vrba: provides an array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal. He gets a similar result with the twenty-week forward look from the Business Cycle Indicator, updated weekly and now part of our featured indicators.

Check out Georg’s new mutual fund analysis tool. You can easily see how your fund has done on this fee-adjusted ratings scale.

Monitoring earnings trends is a crucial step in making sound investment decisions. Brian Gilmartin has an excellent review of the last several years, as well as a look at the year ahead.

The Week Ahead

This is a big week for economic data, including several of the most important reports, as well as some catching up from the holidays. While I highlight the most important items, you can get an excellent comprehensive listing at Investing.com. You can filter for country, type of report, and other factors.

The “A List” includes the following:

  • Employment report (F). Still viewed as the single most important data point.
  • ADP private employment (W). A strong alternative to the official report, using a different method.
  • ISM Index (M). Of special interest given the recent softness in manufacturing and the Chicago PMI.
  • Auto sales (T). Continuing strength in this important non-government read?
  • Initial claims (Th). Fastest and most accurate update on job losses.
  • FOMC minutes (W). Even with a unanimous vote and a press conference, we can expect careful scrutiny in the search for added information.

The “B List” includes the following:

  • ISM services index (W). Less widely followed than manufacturing because it is newer – actually covers more of the economy.
  • Construction spending (M). November data, but still interesting.
  • Factory orders (W). Also November data, with weaker results expected.
  • Trade balance (W). November data with significance for Q4 GDP.
  • Wholesale inventories (F). Also November data with implications for GDP.
  • Crude oil inventories (W). Continued focus on oil prices keeps this report in the spotlight.

It will be a light week for speechifying, but there will be some action at the American Economic Association’s annual meeting, held in SF this year. Regional Fed President John Williams will be on a panel.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a “one size fits all” approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Oscar continues both the neutral market forecast, and the bearish lean. We are about 35% invested in this program. There are often plenty of good investments, even in an expected flat market. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix and Oscar’s weekly ratings updates via email to etf at newarc dot com. They appear almost every day at Scutify (follow here).

Dr. Brett Steenbarger has two great pieces this week.

 

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. Major market declines occur after business cycle peaks, sparked by severely declining earnings. Our methods are focused on limiting this risk. Start with our Tips for Individual Investors and follow the links.

We also have a page (just updated!) summarizing many of the current investor fears. If you read something scary, this is a good place to do some fact checking. Pick a topic and give it a try.

Other Advice

Here is our collection of great investor advice for this week.

If I had to pick a single most important source, it would be it would be the annual economic summary from Calculated Risk. Most investors find it challenging to link news about the economy to their own portfolios. Chuck Carnevale has provided great evidence that “earnings determine market price.” I have repeatedly shown that economic growth is strongly linked to earnings, with recessions the biggest risk. Bill McBride tells you what to watch for in 2016 – a very helpful list. A recent interview with Peter Lynch underscores this point. His advice has been widely summarized as investing in what you know. He notes that this is not enough.

 

What’s wrong with the popular-wisdom version of his ideology, which is usually cited as “invest in what you know”? It leaves out the role of serious fundamental stock research. “People buy a stock and they know nothing about it,” he says. “That’s gambling and it’s not good.”

 

Stock and Fund Ideas

Chuck Carnevale has ten undervalued dividend champions, with complete analysis and explanations. Here is one that we like, enhancing the nice yield with the sale of short-term calls.

426415-14508078108688552-Chuck-Carnevale

Value investors should note that even Mr. Buffett had a tough year, the worst since 2009. Great methods do not always work within a twelve-month period.

A guide to contrarian investing in 2016. (Luke Kawa/Bloomberg)

 

Lessons from 2015

 

You can get in short form – pithy and witty entries — with Josh Brown’s annual list. He asks many contributors to comment on what they learned. I always give some thought to this question, but it is difficult. I thought I had a good entry, but it didn’t beat this response:

 

Scott Redler (T3 Live): Uber, the world’s largest taxi company, owns no vehicles. Facebook, the world’s most popular media owner, creates no content. Alibaba, the most valuable retailer, has no inventory. And Airbnb, the world’s largest accommodation provider, owns no real estate

Michael Johnston has a categorized list of 50 favorite posts from a variety of authors. You can use the descriptions to find the most interesting for your own needs.

 

Watch out for….

 

Market Forecasts. It is pretty easy to find a long list of failures in the forecasting business, especially if there is no attention to error bands or the general volatility of the series in question. But what should you do? Even a buy-and-hold investor is making an implicit assumption about the general market trend. Cullen Roche has, as we would expect, a very pragmatic viewpoint on the subject. You will find it helpful in navigating the noise.

 

And also …. Market history in headlines for the last decade. This is a great illustration of the difficulty in calling the twists and turns of events. (Morgan Housel)

 

Hotel stocks. Does Airbnb represent a real threat?

 

Oil price forecasts. A history to consider. Check out some of the big-time calls versus this chart:

 

fp1228_oil_c_jr

 

 

 

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. There are several great links, but I especially liked Monevator’s advice on How to Lose Money in 2016. There are seven great points, but the first will give you the idea:

1. Sign up to some bearish investing websites

Good investing starts with a long-term businesslike mindset, so to really invest badly, it’s vital you start rotting your thinking without delay.

Where better to begin than by overdosing on some of the doom and gloom newsletters that have been predicting Financial Armageddon since, well, the start of the last bull market?

They’ll have you swapping your carefully chosen funds and shares for baked beans and survival kits in no time.

Ideally find one that offers occasional tips on Russian gold miners, Panamanian oil explorers and the like.

That way you’ll get twice the bang for your buck.

Final Thoughts

If we are to believe in a calendar effect, we need to see two things:

  1. Some logical reason behind the action. Deadlines for tax effects qualify, so it is something to think about.
  2. A reason that the effect has not been fully anticipated – already “discounted” by the market. In general, this sort of regular opportunity lasts only until it is widely known.

Count me in with the final group, de-emphasizing January and following the data. The calendar data are weak, and do not cover enough history.

This illustrates our most persistent theme from last year:

If you want to be a trader, you need to outguess what everyone else is thinking about. We do some of that.

If you are an investor you can rely upon your own assessment, taking what the market is giving you.

Eventually stock prices depend upon earnings which depend upon economic growth. Leading economist Brad DeLong illustrates why growth continues, but has been sluggish.

6a00e551f08003883401b7c7fe0e6a970b

[long EMR versus short calls]

2015 in Review: Hi-Yo, Silver!

1388287952-0For years, it’s been a staple of our Weighing the Week Ahead series to recognize analysts who go above and beyond in their coverage of the issues. We congratulate these writers with the Silver Bullet Award – named in honor of the Lone Ranger, who lived by a strict code: “…that all things change but truth, and that truth alone, lives on forever.”

In 2015, we gave out the Silver Bullet Award 21 times – the most ever in a single year. Despite the constant fearmongering from some bloggers and media personalities, more and more people are providing individual investors with the tools they need to make informed decisions. Our winners are summarized below. Readers may also want to check into our 2013 and 2014 compilations, as many of the same issues persist to this day.

Have any thoughts or predictions on what will dominate news cycles in 2016? Know of a great analyst flying below our radar? Feel free to post in the comments with any suggestions or nominations.

 

 

January 4, 2015

Our first Silver Bullet of the year went to RL at Slope of Hope for his examination of charting “techniques” in the post 2008 recovery.

RL notes:

What can we conclude from all the above? Well, first of all that making long-term trend predictions is not recommended, no-one knows what is awaiting for us in the future. Bull or Bear Market, inflation or deflation, you name it. What we can do, is to predict market trend extensions with statistical analysis, comparing past trends and current trends and that is in fact what we do with our RL models. We do not know if the market can go to 3000 in the next few years, it’s possible if all of a sudden a lot of investors, after staying on the sidelines since 2009, decide to join this 5 years long rally (how about that for a “confirmation signal”?). What we do know (based on our statistical models) is that the market is overbought right now, and it has been rising ~500 points in the last 2 years, although the strongest rise was in 2013, and in 2014 the speed of advance was a little bit slower (maybe a sign that the rally is faltering?).

In our view, this strong pace is not sustainable in the long term and some correction inevitably will come, although it does not have necessarily to be a 3-years Bear Market, it may be a 3 months correction, or a quick crash followed by a recovery, etc. What we can do is to gauge the market trend extension from a TIME and PRICE point of view with our model and this is an honest method to gauge the short and medium-term market direction

March 1, 2015

Nicholas Colas and Jessica Rabe of Convergex took on Jeff Gundlach’s assertion that equities have never risen for seven years in a row since 1871. With due respect to Mr. Gundlach, the authors primarily took issue with the dataset (courtesy of Robert Shiller) he had used to draw his conclusion. Colas and Rabe write:

“Gundlach used a well-known dataset from Robert Shiller for his findings, but it is not suitable for calculating calendar-year returns since it does not capture exact month-end levels. The S&P 500 actually rallied for eight consecutive years from 1982 to 1989 based on price returns and total returns. The index was also up for nine straight years from 1991 to 1999 using total returns. Therefore, the S&P 500 may have a few more years to run before breaking any records, but volatility will likely rise as well…Whether the stock market finishes the year in positive territory is anyone’s guess, but it wouldn’t be unprecedented.”

April 5, 2015

Barry Ritholtz dug up an old Onion article, as an analogue for what passes as analysis in the financial blogosphere. Readers may be reminded of Sidd Finch.

“Given this line’s long history of jaggedness, we really should take a wait-and-see approach,”Fortune magazine associate editor Charles Reames said. “And even if this important line continues its upward pointiness, we must remember that there are other shapes, colors, numbers, and lines to consider when judging the health of the economy.”

Reames also warned that the upward angle of the line, which most analysts agreed was approximately 80 degrees, may have been exaggerated by the way the graph was drawn.

“The stuff that’s written along the bottom of the graph is all squished together, making the line look a lot more impressive than it is,” Reames said. “Had that same stuff been spread out more, the line would have looked a lot less steep.”

April 11, 2015

Bill McBride (AKA Calculated Risk) ended 2014 by asking himself ten questions about the state of the economy. His quarterly reviews helped to measure economic progress over time, in line with his expectations. This innovative approach to interpreting data earned Bill our Silver Bullet Award.

“At the end of last year Bill made a series of ten forecasts about the economy with a full post on each. He provided a three-month update this week. While early in the year, I found it quite impressive. It is more measured than the optimistic economic predictions and much better than those always seeing the worst from any report. See for yourself, and you will understand why I emphasize this source each week. If you are interested in economic growth, housing, employment, the Fed, or oil prices there is something for you.”

April 19, 2015

Ed Dolan’s thorough deconstruction of ShadowStats is one of our favorite blog posts from 2015. From the way he picks his target, to his measurement of the data – his post reads like a step-by-step guide to winning a Silver Bullet. We found this excerpt particularly interesting:

“As mentioned above, Williams’ ShadowStats inflation series incorporates an additional 2.0 percentage point correction to reflect methodological changes that are not captured in the CPI-U-RS series. I would like to examine that number more carefully in a future post, but for the sake of discussion, we can let it stand. If so, it appears to me that, based entirely on Williams’ own data, methods, and assumptions, the adjustment for the ShadowStats inflation series should be about 2.45 percentage points below CPI-U, rather than the 7 percentage points he uses.

In my view, Williams alternative measure of inflation would be more convincing if he were to make this correction. It would also be less likely to feed the anti-government paranoia of some of his followers, who allege that the BLS is falsifies source data and manipulates reported indicators in the way that Argentina and some other countries appear to do.

It is worth noting that Williams himself makes no such claim. He is a fierce critic of BLS methodology, but he acknowledges that the agency follows its own published methods. He argues that the BLS has adopted methods that produce low inflation indicators, but not for motives of short-term partisan politics. Rather, he sees the choice of methodology as driven by a longstanding, bipartisan desire to reduce the cost of Social Security and other inflation-indexed transfer payments. It would be hard to deny that he is at least partly right about that motivation.”

April 26, 2015

The “what if?” question plagues individual investors and fantasy football fans alike. While the sports fans can afford to indulge in flights of fancy, investors probably shouldn’t. David Fabian won the Silver Bullet for writing to this effect very effectively:

Lastly, I think it’s important for investors to forget the “if/then” narrative that seems to be a psychological barrier to living in the present and investing for the future.

If the Fed had never….

If big banks had never….

If stock buybacks had never….

Stop worrying about what the world might look like if those things had never happened, because they did and we are where we are. Focus on the present and the things that you can control in order to get the most out of your investment portfolio.

June 08, 2015

We frequently warn individual investors to keep their politics and their investments separate. Morgan Housel earned himself a Silver Bullet by illustrating this with a clear, relatable example. The market has seen significant gains since 2008. If you’ve been sitting on the sidelines, you’ve missed some big opportunities.

Take these two statements:

“11 million jobs have been created since 2009. The stock market has tripled. The unemployment rate nearly cut in half.  The U.S. economy has enjoyed a strong recovery under President Obama.”

“The recovery since 2009 has been one of the weakest on record. The national debt has ballooned. Wages are stagnant. Millions of Americans have given up looking for work. The economy has been a disappointment under President Obama.

Both of these statements are true. They are both history. Which one is right?

It’s a weird question, because history is supposed to be objective. There’s only supposed to be one “right.”

But that’s almost never the case, especially when an emotional topic like your opinion of the president is included. Everyone chooses the version of history that fits what they want to believe, which tends to be a reflection of how they were raised, which is different for everybody. We do this with the economy, the stock market, politics — everything.

It can make history dangerous. What starts as an honest attempt to objectively study the past quickly becomes a field day of confirming your existing beliefs.

June 13, 2015

Regular readers know that we like to carefully scrutinize mainstream financial media. Needless to say, we got a kick out of Cullen Roche’s colorful guidelines for financial journalists. They’re all well worth reading, but our favorites are quoted below.

I.  The Stop Scaring People Rule. Scaremongering is not to be tolerated except during the middle of a financial crisis or nuclear war. Writing scary articles for the sake of conjuring emotionally driven page views is not a legitimate business model and is generally counterproductive.

III. The Crash Call Rule. That pundit who comes on TV predicting financial Armageddon every week is not a “guru” and is directly contributing to poor financial decisions. Please refrain from interviewing him regularly. Also, see Rule I.

IX. The Bubble in Bubbles Rule. If you feel the need to use the word “bubble” please reconsider. This word is only allowed to be used by a select few financial experts (Robert Shiller, Robert Shiller & Robert Shiller).  If you are not one of the names listed in the previous sentence please do not use this terminology.

June 20, 2015

Declining profit margins are a prime target for perma bears in the blogosphere. You’d think after an “expert” calls nine of the last three recessions, this one would go away – but we’ve been fighting it for years. Pierre Lapointe received the Silver Bullet for taking on the crowd.

“It can take a long time before contracting margins begin to hurt stock prices,” Lapointe and colleagues Alex Bellefleur and Francois Boutin-Dufresne wrote in a report yesterday. They cited the 1982-1987 bull market, which took place even though earnings as a percentage of GDP were among the lowest since World War II.

“It isn’t at all clear that margins will contract further from here,” they wrote. “They could stabiglize and remain near current levels for some time. This wouldn’t be a disastrous scenario for equities.”

July 04, 2015

Beyond errors in the investment world, we like to caution our readers to think carefully about all kinds of data. Math Professor Jordan Ellenberg, of the University of Wisconsin-Madison, provided a fascinating article about the misuses of numbers. We gave him the Silver Bullet based on his conclusion:

All these mistakes have one thing in common: They don’t involve any actual falsehoods. Still, despite their literal truth, they manage to mislead. It is as if you said, “Geraldo Rivera has been married twice.” Yes—but this statistic leaves out 60% of his wives.

In the era of data journalism, truth is not enough. We need people in the newsroom who can check not only a number’s value but also its meaning. Unless we can ensure that, we’re going to be reading a lot of data-driven stories that are true in every particular—but still wrong.

July 18, 2015

Zero Hedge is one of the least credible yet oft-cited websites sucking up oxygen in the financial blogosphere. Their supporters are apparently pervasive, which is why we had to give Fabius Maximus a Silver Bullet for his thorough deconstruction. The full article is of course excellent: his commentary ranges from exposing half-truths, conspiracy-mongering, selective use of data, and outright deception.

ZH is an ugly version of Wal-Mart or Amazon. It would be sad but insignificant if ZH was exceptional. But ZH is a model of successful web publishing, probably taking mindshare from mainstream providers of economic and market insights. I see websites using its methods proliferating in other fields. For example, geopolitics has become dominated by sites that provide a continuous stream of threat inflation as ludicrous as the worst of ZH.

July 26, 2015

On a lighter note, we greatly appreciated a video done by Jimmy Atkinson at Dividend Reference. His guide to useless (but entertaining) stock market indicators comes with an important lesson attached. Below is one example particularly relevant to hockey fans in the Chicago area.

August 02, 2015

Michael Batnick won a Silver Bullet this year when he abated growing fears about market tops. His careful analysis (backed up by solid data) is a huge asset for individual investors looking for edge.

Conventional wisdom goes that prior to market tops, the major averages become more reliant on just a handful of stocks to lead the rally. When stocks are making new highs, it’s important to look at breadth indicators because indices can pull a nasty trick of masking what is actually happening to the majority of stocks. For instance, the S&P 500 is up 2.3% YTD, however, the average S&P 500 stock is down 0.7%.

Observers with a mission fail to note that divergences often resolve to the upside. Here is an interesting table, showing both frequency and the range of gains.

August 22, 2015

We at “A Dash” applaud anyone willing to challenge the so-called conventional wisdom. We gave Barry Ritholtz a Silver Bullet this year for taking on the Death Cross.

…yesterday’s decline triggered the dreaded Death Cross, as the index’s 50-day moving average crossed below the 200-day moving average. The other major indexes haven’t yet succumbed to the Death Cross horror, though the S&P 500 is heading in that direction.

In a research note late yesterday, Bespoke Investment Group observed that this was the first time this has happened since Dec. 30th, 2011, or in 903 trading days. They also note the modest statistical significance of the Death Cross. Looking at the past 100 years, they wrote that “the index has tended to bounce back more often than not.” Shorter term (one to three months), however, these crosses have been followed by modest declines in the index.

How modest? The average decline is 0.17 percent during the next month and 1.52 percent the next three months. By comparison, Bespoke notes, during the past 100 years the Dow averages a 0.62 percent gain during all one-month periods and a 1.82 percent rise during all three-month periods.

In an e-mail I asked Justin Walters of Bespoke to expand on the details. He wrote: “Most of the time these crosses don’t mean much of anything. This one the forward performance numbers are a little more negative than we would expect to see over the next one and three months, but it’s basically 50/50 whether we go higher or lower.”

August 30, 2015

Our final award of the year went to Michael Batnick and Todd Sullivan (citing “Davidson) for two separate articles on the same theme. Both illustrate the danger in the way the Shiller CAPE ratio is presented to investors. Batnick notes:

When Shiller says 15-16 is where CAPE has typically been, what he really means is this is what the average has been. However, what he fails to mention is that over the past 25 years, the CAPE ratio has been above its historical average 95% of the time. Stocks have been below their historical average just 16 out of the last 309 months. Since that time, the total return on the S&P 500 is over 925%.

Sullivan shows that the profit estimates in the data are flawed because of accounting changes. He shows that large and completely implausible changes in “earnings” were actually the result of the FAS 157 rules.

Conclusion

As always, you can feel free to contact us with recommendations for future Silver Bullet prize winners at any time. Whenever someone takes interest in defending a thankless but essential cause, we hope you’ll find them here.  Have a Happy New Year and a profitable 2016.

Weighing the Week Ahead: What are the lessons from the market turmoil?

Dramatic events reset agendas. People re-evaluate probabilities about what is possible as well as the personal implications. Because the recent market story is so big and so fresh the week will start with the punditry asking:

What are the lessons from the market turmoil?

 

Prior Theme Recap

In my last WTWA I predicted that everyone would be asking whether the recent market decline was the start of something big. Monday’s 1000 point opening decline in the Dow underscored the theme. The next day the story continued with a failed rally. At that point, few would have guessed that the market would finish in the plus column for the week.

As he does each week, Doug Short’s recap explains this dramatic story and his great weekly snapshot lets you see it at a glance. With the ever-increasing effects from foreign markets, you should also add Doug’s World Markets Weekend Update to your reading list.

 

SPX-five-day

As Doug notes, the rebound stalled at the end of the week. CNBC quit running the “Markets in Turmoil” special report and went back to reruns of American Greed. Attention then turned to my secondary theme – the early reports from the Fed conclave at Jackson Hole.

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 try it at home.

Last week some advance planning was especially important. There was little time to react intelligently.

This Week’s Theme

Big events refocus attention and redefine the public agenda. They change our minds about what is possible, what is likely, and what to worry about. This week will start with more discussion about the meaning of the market turmoil and what, if anything, individual investors should do about it. The question for each producer or editor in financial media will be:

What are the lessons from the market turmoil?

It is a fertile topic and worth exploring. It should keep interest piqued until late in the week when the jobs report and Fed implications regain center stage.

So what were the lessons?

The Viewpoints

What you “learned” from the market turmoil seems to vary based upon your starting viewpoint. See Josh Brown’s recap of editorial cartoonist’s take on the market, including this one:

EngleB20150827_low

 

The conclusions once again cover a wide spectrum, with authorities lining up on all sides. Here are contrasting takes on several different topics.

On the Overall Economic and Market Health

  • Steep declines revealed the inherent weakness in the economy, stock valuations, and Fed policy. Worldwide weakness will drag developed countries into a global recession. Central banks will have no bullets left. The selloff and rebound provided a big warning to the wise.
  • The “correction” was over. That is what we have all been waiting for. Economic growth and the stock market rally can resume.

On China

  • We can now see how important the weakness in the Chinese economy really is. (Typical piece on this theme from Bloomberg, also running a bearish cover this week).
  • The Chinese threat has been examined and the effects analyzed. The impact is limited.

On the Fed

  • The Fed can finally see the error of its ways, but really has nowhere to turn.
  • The Fed is ready to move, but acknowledging some concern about worldwide markets.

On Personal Finance

  • It is time to sell. Major investors who had hedges in place last week showed significant profits while everyone else was crushed.
  • The volatility did not matter if you held firm. Hedges were difficult to cash in.

As always, I have my own ideas in today’s conclusion. But first, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

 

Last Week’s Data

Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:

  1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially – no politics.
  2. It is better than expectations.

The Good

There was some good economic news, especially GDP revisions.

  • GDP revisions were strong, raising the bar for expectations. The change was so great that the “old news” had a market effect. Scott Grannis notes that recent growth of 2.7% is significantly better than the former trend of 2.2%. Despite this, it is still $2.8 trillion per year below trend. Few are thinking about the effects of a return to trend, not to mention an overshoot.

Grannis GDP

  • Consumer confidence is very strong according to the Conference Board survey. The Michigan survey was a slight miss, but see below.
  • New home sales show a solid y-o-y gain of more than 21%, despite showing a slight miss for the month. Calculated Risk has the full story, including this chart:

NHS20142015July2015

  • Sentiment on many fronts
    • Negative among short-term market timers (Mark Hulbert highlights this contrarian indicator)

MW-DT143_nasdaq_20150827092321_ZH

  • The best market timers, by contrast, are bullish. (Also from Mark Hulbert). They have an equity exposure 84% higher than the worst performers in Hulbert’s database.
  • Insider buying was at the highest level since 2011 (Bloomberg)

The Bad

There was also some negative data last week.

  • Personal income and spending. Income was OK, but spending slightly missed the seasonally-adjusted expectations. Steven Hansen at GEI provides the complete picture, with a slightly more optimistic take on year-over-year data.
  • Pending home sales showed a slight miss, while still gaining 5% on a year-over-year basis. (Calculated Risk).
  • Michigan sentiment disappointed slightly and declined. Given the stock market decline, those in charge of the survey thought the results held up pretty well. This one was especially interesting because the data represent later polling than the Conference Board report. NY Fed President Bill Dudley noted this in answers to questions following a speech. Fed observers seem to be watching this closely. As always, Doug Short (and Jill Mislinski) have the full story including both analysis and plenty of charts. It is useful to look at both the Conference Board and Michigan surveys, which usually show a high correlation.

dshort michigan sentiment

dshort conference board

The Ugly

The ugly award this week goes to the performance of many financial markets. Many reasons are being offered, making this a subject for a full post someday. For now, let us note the following:

  1. The “rule 48” process of opening stocks did not generate valid prices. Customers doing market sell orders lost 20% or more on major stocks.
  2. ETF pricing was unfair, according to fair value based on underlying holdings. (ETF.com)
  3. Options markets were extremely wide, including prices that were “below parity” and therefore impossibly unfair.
  4. Popular hedging products like the VIX did not even have quotes until the market had regained more than 50% of the early losses. (Options expert Adam Warner)
  5. Some online trading sites were not responding.
  6. Systems overheated, creating a “glitch.” (Reuters)

The products and rules have become more complicated. This has permitted more products and increased revenue for the exchanges. It may not have improved opportunities or fairness for individual investors.

Quite frankly, the best thing that the individual investor could do during the turmoil was beware, and maybe stand back. Buy orders were OK, but that was not the mission of most traders on Monday morning.

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts.  Think of The Lone Ranger.

This week’s award goes, for separate articles on a theme, to Michael Batnick and Todd Sullivan (citing “Davidson). Both illustrate the danger in the way the Shiller CAPE ratio is presented to investors. Batnick notes:

When Shiller says 15-16 is where CAPE has typically been, what he really means is this is what the average has been. However, what he fails to mention is that over the past 25 years, the CAPE ratio has been above its historical average 95% of the time. Stocks have been below their historical average just 16 out of the last 309 months. Since that time, the total return on the S&P 500 is over 925%.

Sullivan shows that the profit estimates in the data are flawed because of accounting changes. He shows that large and completely implausible changes in “earnings” were actually the result of the FAS 157 rules.

Noteworthy

As a professor I made it a point to review and update illustrations and references in pop culture, but it was a swiftly-moving target. Beloit College provides a “mindset” list highlighting the experience of incoming freshmen. If you are forty or older, I guarantee that this will make you feel even older. The list has 50 entries. A few of my favorites?

  • Incoming students have always had Google.
  • They have never licked a postage stamp.
  • They have grown up treating Wi-Fi as an entitlement.
  • The announcement of someone being the “first woman” to hold a position has only impressed their parents.

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured “C Score.”

Georg Vrba: An array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal. He gets a similar result from the Business Cycle Indicator. Georg continues to develop new tools for market analysis and timing, including a combination of models to do gradual shifting to and from the S&P 500.

Doug Short: Provides an array of important economic updates including the best charts around. One of these is monitoring the ECRI’s business cycle analysis. Jill Mislinski has joined Doug’s team and provides this week’s update.

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting systems. These include approaches helpful in both economic and market timing. He has been very accurate in helping people to stay on the right side of the market.

Dwaine has a new signal from his Stock Market Health Diffusion Index, something he calls a high alert. At the moment, it is just an alert, but it bears watching. (We note the similarity to Felix’s conclusion this week).

 

The Week Ahead

It is very big week for economic data.

The “A List” includes the following:

  • Employment report (F). Most important remaining data before the September FOMC decision.
  • ISM index (T). Private data with both concurrent and leading qualities.
  • ADP employment (W). A good independent read on the changes in private sector jobs.
  • Auto sales (T). Surge is a sign of consumer strength. Pickup trucks indicate construction strength.
  • Construction spending (T). July data, but an important sector.
  • ISM services (Th). Gets less attention than the manufacturing survey, but actually covers more of the economy.
  • Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.

The “B List” includes the following:

  • Beige book (W). Anecdotal data used in the Fed decision process. This sometimes gets a lot of attention.
  • Chicago PMI (M). Most important of the regional surveys.
  • Trade balance (Th). July data of special relevance for Q3 GDP and evaluating effects of dollar strength.
  • Factory orders (W). July data and a volatile series.
  • Crude oil inventories (W). Current interest in energy keeps this on the list of items to watch.

While the Jackson Hole conference is over, there is plenty of FedSpeak on tap. Expect wide-ranging opinions.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a “one size fits all” approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has switched to “neutral,” but is almost completely out of the market. The confidence in this three-week forecast remains extremely low with nearly all sectors in the penalty box. Felix withdraws from the market when volatility gets very high. It is simply not a good environment for the model. I noted reports that many system-oriented trading firms have temporarily suspended trading. There is nothing wrong with waiting for better conditions. The inverse funds, bonds, and gold recently moved up the rankings, but are mostly in the penalty box. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com. Felix appears almost every day at Scutify (follow him here).

See this week’s “Ugly” section for more on trading challenges.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. Major market declines occur after business cycle peaks, sparked by severely declining earnings. Our methods are focused on limiting this risk. Start with our Tips for Individual Investors and follow the links.

We also have a page summarizing many of the current investor fears. If you read something scary, this is a good place to do some fact checking.

Other Advice

Here is our collection of great investor advice for this week.

If I had to pick a single most important article, it would be this article from Morgan Housel, explaining the results and challenges for individual investors. First, the results.

Morgan-Housel-Bad-Investors-3

Please read the entire post. A key theme is that investors blame performance on the wrong things – the market cheated them, etc., when it is mostly their own poor market timing.

 

Stock Ideas

Energy –Back in Focus On several occasions I have explained why “energy” should not all be traded like an oil futures contract. Joshua Kennon does a very good job on this topic, backed up with data and charts. A key point is that the oil majors must operate on a longer time frame than the quarterly report. You acquire reserves when it is possible to do so, not when compelled, for example. It is a long post, but well worth reading. Here is a key point, familiar to regular WTWA readers:

For the oil majors (as opposed to the pure plays, which are a different story), that’s not the whole picture.  It is entirely possible for a trader or hedge fund manager to say oil stocks are overpriced at the moment, calling for them to decline and a long-term investor to say that oil stocks are undervalued at the moment, preaching you should use your funds to load up on them.  That seems almost nonsensical; a paradox.  Nevertheless, it’s true when you understand one fundamental fact: When you buy a share of the oil majors outright, paying for it in cash and locking it away, you are being paid to absorb volatility over multi-year periods.

For this reason we frequently have one of the big integrated oil companies as part of our Enhanced Yield portfolio, capturing both dividends and income from selling calls, with the expectance of gradual long-term growth.

Commodity guru Jim Rogers sees a potential rebound.

Dividend strategies. Please read this excellent comprehensive guide. Is it enough to cash your regular payments, ignoring the stock price? Or should you focus on total return? Rob Martorana’s absolutely first-rate article is written for the community of investment advisors, but it is not a secret. Individual investors will appreciate the advice.

 

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. As always, there are several great links, but I especially liked this article from Monevator on the need for a plan. Does this sound familiar?

When markets fall, some panic and consider selling. That’s natural.

Others act brave, rub their hands, and boast about it being time to buy – to be greedy when others are fearful.

That sentiment is right, and they can sound like bold geniuses.

But how long were they sat in cash, waiting for the moment to get back in?

If you buy equities when they drop 10% but you missed the previous 50% rally, you’re not being greedy when others are fearful.

Not in the bigger picture.

You’re actually being timid when others are stoically betting on the long-term propensity of stock markets to rise over the long-term.

And you’re probably going to be left poorer compared to someone who is less cunning but more pragmatic.

The price they pay for their long-term gains is not feeling as smug as you when the market does swoon. They have to take their lumps.

 

Fed Outlook

As I suggested last week, we have the key news from Jackson Hole in time for WTWA, but not in time for Friday’s trading. Fed Vice-Chair Stanley Fischer granted a CNBC interview on Friday which seemed to cover many of the key points from his Saturday keynote speech. The speech was a little hawkish, but I do not expect a major market reaction to this on Monday. Sam Ro at Business Insider has good coverage along with key charts from the speech.

Here are some key takeaways:

  1. As of a few weeks ago, the Fed was probably ready to act in September;
  2. The Fed rates economic strength significantly higher than do the various financial markets;
  3. Market volatility is not the determining factor in a delay, but it is a consideration;
  4. The Fed sees the current low levels of inflation as a “one off” effect of lower energy prices and dollar strength;
  5. The Fed will not wait until after there is more inflation before starting the process of withdrawing accommodation; and finally
  6. The process of normalizing rates will be gradual – perhaps very gradual.

And of course, Fed expert Tim Duy’s take. And finally, a member-by-member scorecard (Steve Goldstein).

China Outlook

With so much attention on China, U.S. investors need to understand the implications for their portfolio. Everyone is trying to figure out which sources are reliable and how serious slowing growth is for the rest of the world. Sound? Or not sound? Dueling professors look at different data. It is all interesting. And keep in mind, from a Nobel Prize Winner, that the Chinese stock market does not give a good read on the economy.

At the peak of concern last week I provided a summary of What Investors Must Know about China. China expert Nicholas Lardy reached similar conclusions in a NYT op-ed piece published the same day.

The New York Times is highlighting “zombie factories” with a dramatic slide show. In sharp contrast, Templeton’s Mark Mobius, perhaps the most respected source on international investing sees jammed malls and expensive purchases. (Mobius’s frequent flyer miles make the George Clooney character seem like a piker!) Mobius provides some investing ideas along with this interesting thought:

A lot of attention has been given to slowing gross domestic product (GDP) growth in China. It bears repeating—China’s growth rate may be slowing, but one of the things that gets lost in translation is that while the percentage increases in the economy are indeed slowing down, but the actual dollar amounts are going up. When China’s economy was growing at 10% in 2010, about US$844 billion was added to the economy, but with growth at 7.7% in 2013, US$986 billion was added.2 I would also emphasize that 7% growth is nothing to sneeze at, either, given the size of China’s economy. It should not be a shock to see growth slow.

Watch out for…

Long-short equity funds, which have now lagged for more than a decade. (Eqira).

 

Final Thought

The past week was a great test for many investors. If you were prepared and had confidence in your plan, all was well. If you were calling audibles, you were likely to go wrong.

My own take on the lessons?

The China concern is over-rated, both because the economy is not as bad as advertised and because the US does not compete so much on exports. I expect companies that benefit from cheaper Chinese goods to show better profits.

The energy market is showing a little strength. The benefits of lower prices will start to show up for some companies, and the eventual market price will be OK for suppliers. There are opportunities here.

The Fed is more accurate on the economic prospects than the financial punditry. It is much better than the commodities market, which has (once again) dramatically over-estimated the probability of a recession. Falling oil prices have never predicted an economic downturn. (GaveKal).

The market timers who “predicted” the selling may not have done as well as advertised. Think about the following (all examples I read in major media):

  • Some of them have been waiting for this for many months, paying put premiums throughout
  • Claims of profits on Monday were not “locked in” gains, but on paper. Much of this was gone by Friday. (Example).
  • Many of the big bears saw Monday and Tuesday as verification of their theories about the market being 50% over-valued. They were not selling their puts. They were waiting for more or rolling positions.
  • Those who tried to cash in struggled because of illiquidity or unfair pricing in markets.

If you think it is wise to have protection in place, this week’s experience helps to see how difficult it can be to manage your hedges.

Those who read and considered this section last week may have escaped without major losses, and maybe with some gains in the market turmoil. I hope so.

Let me turn to this week’s investment thought.

Investment Conclusion

I still do not know whether we have a real near-term market bottom in place. (Neither does anyone else). I was right about retail panic last week.

I continue to see the trader/investor difference as crucial. I expect continued economic strength in the U.S. and improvement in Europe. While watching China and energy closely, the focus on commodity prices as an economic indicator is mistaken. I expect the Fed to start raising rates. It will have little impact on most sectors, but will help financials.

As a result, I find good opportunities, as follows:

  • Financials, especially regional banks, from rising rates
  • Technology, since skepticism about the dollar is overdone
  • Energy, since the dollar will not grow at the same pace, the economy is better than expected, and geopolitical risks are showing up
  • Health care – especially stocks with little or no China exposure

Weighing the Week Ahead: The Start of an Earnings Recession?

Despite a full slate of economic news and data, I expect earnings season to command special attention in the week ahead. For the first time since the Great Recession it is possible that corporate earnings will contract for two consecutive quarters. With the media penchant for colorful characterizations, I expect this to be a dominant theme as we all consider next week’s earnings reports.

Is this the start of an “earnings recession”?

Prior Theme Recap

In my last WTWA I predicted that attention would center on the apparently growing potential for a correction in stocks. That was the right question at the week’s start, with a carryover effect from the prior Friday’s employment report. With stocks not trading and futures down on the employment news, everyone knew the week would have a bad start.

This was the big theme on CNBC and MarketWatch on Monday and Tuesday. There were more recession calls. Michael Batnick has a nice post on how quickly the market shrugged off the employment news and the general irrelevance of short-term economic data.

When became clear that this story was not playing out, producers, editors, and writers switched to the Apple watch and the GE restructuring. The question of whether a correction was looming was timely, and for now, the answer seems to be “no.”

Feel free to join in my exercise in thinking about the upcoming theme. 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.

This Week’s Theme

There is plenty of economic data this week, including some major reports. More important will be the first big week of corporate earnings. If you are not familiar with the term, “earnings recession,” then get ready. You will hear it a lot, especially if there is weakness in early reports.

An earnings recession describes a circumstance where corporate earnings decline for two consecutive quarters, somewhat analogous to the commonplace (but flawed) definition of a recession as two consecutive quarters of negative growth. While earnings season is always important, this one has special significance. After a quarter of softer economic data, everyone wants to know what effect there was on profits. Look for pundits to be asking:

Is this the start of an earnings recession?

The Viewpoints

The viewpoints cover the typical wide range.

  • An earnings recession is likely and important. (Akin Oyedele at BI summarizes the Bank of America take).
  • A quarter of lower earnings is likely, as the result of energy stocks, weather, and a stronger dollar – all temporary.
  • An earnings recession is possible, but unimportant. (Paul Vigna – WSJ)
  • No way! Earnings will eke out a small gain despite the temporary effects. Brian Belski says “Bunk.” He cites the delayed benefits from lower energy prices and the lower bar set by estimate reductions.

Stefan Cheplick reports on the decline in estimates, including this helpful chart:

tumblr_nmijxijARG1tk131bo1_1280

 

As always, I have my own ideas in today’s conclusion. But first, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:

  1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially – no politics.
  2. It is better than expectations.

The Good

There was mostly good news last week.

  • Initial jobless claims. 281K slightly beat expectations and took the closely-watched four-week moving average to the lowest level since 2000. (Calculated Risk)

WeeklyClaimsApr92015

 

  • Job openings are increasing. So is the quit rate, a sign of employee confidence. I was an early fan of the JOLTs report, which many sources still do not use effectively. I am delighted to see that Doug Short has started coverage of this series. He has several charts, but this one combines important elements and allows you to see the quit rate.

Dshort JOLTS

 

  • Mortgage applications rise suggesting more home buyers. Diana Olick (CNBC) notes that overall levels are still low:

    Despite the increase in applications, mortgage application volume is still considerably lower than historical norms, and especially low today, given pent-up housing demand. Some argue that credit availability is still too tight, which is keeping potential buyers on the sidelines.

  • The Fed plans shallow rate increases according to NY Fed President Bill Dudley. His comments helped to set the tone for the week.
  • Global PMI is stronger, something that might be surprising to many. (Contra: IMF global growth forecasts via the FT). Ed Yardeni has analysis and this chart:

Yardeni Global PMI

 

C&I Loans 99-

 

The Bad

There was not much bad news. Feel free to add anything I missed in the comments.

  • ISM services registered a slight miss, but the 56.5 reading is still very solid.
  • Rail traffic remains weak, unchanged on a year-over-year basis. Steven Hansen provides analysis as well as this interesting table showing a “weak growth cycle”:

GEI Rail Traffic

 

  • High frequency indicators show weakness, especially anything where the US is connected to the world economy. New Deal Democrat has his weekly update. This is a granular update including items you might otherwise miss. I read it every week to round out a comprehensive view of the data.

The Ugly

Teens and smartphones. 25% spend almost all waking hours online, mostly on social media. (Pew data via PBS). There is a fundamental question about productivity and access to information – potentially very good, but perhaps with unexpected consequences.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts.  Think of The Lone Ranger.

This week’s award goes to Bill McBride known better as “Calculated Risk.” Bill started with a blog focused on housing, but expanded to comprehensive economic commentary. He earned the respect of the economic and financial communities.

At the end of last year Bill made a series of ten forecasts about the economy with a full post on each. He provided a three-month update this week. While early in the year, I found it quite impressive. It is more measured than the optimistic economic predictions and much better than those always seeing the worst from any report. See for yourself, and you will understand why I emphasize this source each week. If you are interested in economic growth, housing, employment, the Fed, or oil prices there is something for you.

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured “C Score.”

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (three years after their recession call), you should be reading this carefully. Doug has the latest interviews as well as discussion. Also see Doug’s Big Four summary of key indicators.

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting market indicators. He recently noted an increase in his combined measure of economic stress, although the levels are still not yet worrisome. Recently Dwaine introduced a valuation model that is much more sophisticated than the popular Shiller CAPE method. It also provides a much less worrisome conclusion, 13.7% returns through the end of 2016.

Georg Vrba: has developed an array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal. He gets a similar result from the Business Cycle Indicator. Georg continues to develop new tools for market analysis and timing, including a combination of models to do gradual shifting to and from the S&P 500. I am following his results and methods with great interest. You should, too.

EconomPic shows why we should all spend time on the macro picture as part of the long-term investment process.

spcompgdp

 

The Capital Spectator updates some quantitative methods for spotting bubbles. This is a refreshing alternative to the sources that see all bubbles, all the time, in nearly every market. He notes 0.95 as a key point on one indicator, charted below. We remain well short of this risk level. Another featured approach is even more sanguine about the low bear market probability.

adf.bubble.sp500.2015-04-081

 

The Week Ahead

It will be a big week for economic data.

The “A List” includes the following:

  • Retail sales (T). Are consumers buying or saving?
  • Building permits and housing starts (Th). Remains a key hope for fueling the economic rebound.
  • Michigan sentiment (F). Combines information on job creation and spending.
  • Beige book (W). Anecdotal evidence for each Fed district provides color for the next FOMC meeting.
  • Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.
  • Leading indicators (F). Despite changes over the years, still viewed by many as significant for economic prospects.

The “B List” includes the following:

  • PPI (T). Inflation measures are still a minor influence on markets. Someday this will change, but not yet.
  • CPI (F). See PPI (above).
  • Crude oil inventories (W). Maintains recent interest and importance.
  • Business inventories (T). February data but some relevance for Q1 GDP.

There is a little FedSpeak at mid-week, but I expect earnings news to take center stage.

There are some regional Fed surveys, but these rarely have a major market influence.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a “one size fits all” approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix continued a bullish stance for the three-week market forecast. The confidence in the forecast is now a bit stronger, reflected by the percentage of sectors in the penalty box. Our current position remains fully invested in three leading sectors. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

Do you want to make some options trades during earnings season? Savvy traders understand that the OTM options can be more expensive than those close to “the money.” You are wiser to use implied volatility for pricing rather than the dollar price. You can buy cheaper deltas. (If what I am writing does not make sense, you are not ready to trade options). Steven M. Sears of Barron’s cites the Goldman derivative desk.

Make sure you are not trading “too big.” Adam H. Grimes tells a familiar story in an effective fashion. Using simulated data for a trader with significant edge, he shows how easy it is to blow out from excessive size. You might also enjoy my 2007 post on this theme, where I recount some blackjack exploits of famous expert Ken Uston.

Felix did not enter the hedge fund manager contest at Scutify.com ($20,000 in cash and prizes), but he is making a daily appearance to mention a top sector. Check in yourself to get some ideas and join in the discussion.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. Major market declines occur after business cycle peaks, sparked by severely declining earnings. Our methods are focused on limiting this risk. Start with our Tips for Individual Investors and follow the links.

We also have a page summarizing many of the current investor fears. If you read something scary, this is a good place to do some fact checking.

Other Advice

Here is our collection of great investor advice for this week:

Featured Commentary

If I were to recommend a single source this week, it would be David Rosenberg (via Sam Ro at BI). He has a great analysis of the theme that nearly everyone is getting wrong – the length of the business and stock cycle. This is a familiar topic for readers of “A Dash” but it looks like Rosenberg might be a lonely bull at the Mauldin Conference!

The problems with the economy and the stock market don’t start with the first rate hike, but rather the last one — it is that last one that inverts the yield curve that bites and by then it is too late.

The stock market typically rolls over in less than a year and the economy shifts to recession three to four months after that — but dating the process from the first rate hike to the start of the recession is three years, on average.

So even if the Fed were to begin tightening as early as September, the historical record would suggest that the next downturn would not start until the third quarter of 2018 and the stock market won’t begin to price in until late the spring of that year at the earliest.

BlackRock’s Global Chief Investment Strategist, Russ Koesterich, has a similar view — the rally can continue for at least another year.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor, even if busy, should join with a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. This week he has an emphasis on practical advice, including this disturbing chart about saving:

Savers_0315

 

And also this important advice for millennials – the best things to do first, via Vanguard.

Stock Ideas

Time to sell GE says Avi Salzman. (Barron’s)

Energy stocks may soon be attractive. I always enjoy posts by “Davidson” often brought to us by Todd Sullivan. This one explains the seasonality and fundamentals of the energy market with a view toward a return to $90/barrel for oil. Even a hint of that would move energy stocks. This is a nice analysis of speculative trading versus fundamentals.

Low Yield Environment

The lack of dependable yield raises many issues and alternatives. Here are some ideas from this week’s commentaries.

  • Do not double down. Just because yields are lower does not mean that you should take more risk. Ben Carlson has some ideas.
  • Watch out for “liquid alts.” A promise of something for nothing? (WSJ)
  • Or maybe not. (The Sovereign Investor)
  • Or get educated. Alts Democratized is a comprehensive look which I am reading from cover to cover. For most people it could be a reference book. Skip to Chapter 18 for an idea of the overall fund selection process.
  • Watch out for bonds. A modest increase in rates could generate a double-digit loss. (Philip Van Doorn at MarketWatch).

 

Methods

Trading less is good. (Jason Zweig at the WSJ).

As Warren Buffett wrote in 1991, “the stock market serves as a relocation center at which money is moved from the active to the patient.”

Did you know that Ben Graham changed his methods with each revision of his classic book? Morgan Housel has a fascinating post explaining why those of us following the value approach should be constantly updating our methods.

Market Overview

Everyone with a bearish outlook cites the “Buffett Indicator” to show the overall stock market capitalization relative to GDP. Mr. Buffett mentioned this about fifteen years ago and it has been a popular method of scaring investors witless (TM OldProf) for the last several years. There are many reasons why it might not be so useful right now — a below-trend economy, more earnings from abroad, extremely low inflation and interest rates – so you might want to ask Mr. B about his current thoughts. I asked on Twitter and I also invite readers to send a citation for any recent statement of his applying the indicator to the post-recession market. Meanwhile, he told CNN that he likes stocks and does not see a bubble.

Eddy Elfenbein has updated his comparison of stocks and bonds, helping to illustrate why most serious investors and managers continue to find stocks more attractive.

image1468

 

Final Thought

The combination of the “R word” with earnings is a great way to put investors on edge and increase viewership and page views. Who would care if you just said that a combination of factors was sending earnings slightly lower? What is the fun in that?

As we look at individual stock reports, we will all pay attention to the outlook for future sales and earnings. Watch to see how frequently anyone talks about Tobin’s Q or the CAPE ratio for a stock. When it comes to individual stocks, we all try to look ahead, to see what current trends are doing with that company’s prospects.

We now can consider the work of hundreds of analysts, looking more deeply at companies than we can. I recommend getting as much information from this as possible. Do you suppose that Ben Graham, if he were alive and writing a new edition, would ignore this information?

If you look more closely at the “squiggle chart” in the introduction – the one that purports to show wildly optimistic estimates by analysts – you might see something useful. Try picking a point that is the start of the year for each estimate – not the two-year period used on the squiggles. You will see that the estimates are not bad for a one-year period, something that I reported in this post. Analysts got much better in the post Sarbanes-Oxley era.

We need objective data about past earnings and a willingness to consider forward earnings. My main source for this useful data series is Brian Gilmartin, who has also taken a careful look at the effect of oil price cuts. He expects earnings ex-energy to be up 5-6%, an important comparison. He also notes that Q4 earnings growth ex-energy was 9%, virtually unreported in the media.

The year-over-year growth rate for forward earnings has once again turned positive. We can and should be on the watch for a true recession – the source of major earnings declines. The talk about an “earnings recession” should not be a source of worry.

Weighing the Week Ahead: Time for the “January Effect”?

The pros are back from vacation and ready for a new year of punditry!

While there is a normal flow of news and a full trading week, I expect the financial media to focus on the New Year. That means an emphasis on slogans and seasonality.

Trader lore views January as including special predictive powers:

Will there be a January Effect?

Prior Theme Recap

In my pre-holiday WTWA I predicted that the quest for content would be filled “by forecasts of any and all flavors.” That was very accurate, partly because there was little competing news and light trading.

Feel free to join in my exercise in thinking about the upcoming theme. 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.

This Week’s Theme

While there is plenty of news on tap this week, those pundits who were on vacation still need to have their say. There is plenty of market lore about January, so it will be a highlight of discussions – at least until Friday’s employment report. Many will be asking:

Is it time for a strong seasonal rally in stocks?

There is plenty of trader lore about January.

  • January is seasonally strong, especially after a good year. Josh Brown reports Merrill Lynch research going back to 1929.
  • As goes January, so goes the year. Also the first week forecasts the whole month. And even the first day forecasts the week. (Sober Look).
  • It is a year ending in “5.” Dana Lyons charts the data (below). He also analyzes the four instances where there was a big drop on the last day of the year, noting that this is probably not meaningful. At least he points this out, as opposed to those who talk about the two prior times QE ended!

tumblr_nhgjgwPUZX1smq3o4o1_1280

  • It is the third year of a Presidential term. And the seventh year of a Presidential administration. (WSJ).
  • The January Effect follows December’s tax loss selling. (See Zacks).

     

As always, I have some ideas about this question in today’s conclusion. But first, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:

  1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially – no politics.
  2. It is better than expectations.

The Good

There was not much news over the holidays. On balance it was mildly disappointing.

  • The Keystone Pipeline remains first on the GOP Senate agenda. While there is still the threat of a Presidential veto, I expect a successful bipartisan coalition and compromise. This will be an early test of whether compromises can be forged and legislation passed in this Congress. My environmentalist friends should note that I am not citing this as desirable public policy. I am merely sticking to my rules concerning what is “market friendly”.
  • Hotel occupancy remains strong. (See Calculated Risk).
  • Rail traffic remains strong. Todd Sullivan explains why this is a solid indicator.

Screen-Shot-2014-12-29-at-11.02.51-AM-624x336

  • High frequency indicators remain positive. New Deal Democrat has the important weekly report.

The Bad

The bad news was pretty minor, although most items were a bit soft.

  • Financial crisis risk is not much lower than it was in 2007-09 according to Boston Fed President Rosengren. Ben Leubsdorf at Real Time Economics describes the rationale, citing money-market funds, broker-dealers, and short-term funding.
  • Canada? I thought we were worried about Europe, China, and the emerging markets. Sober Look warns about how low oil prices affect Canada’s economy
  • Greece. After two tries there is still not a new government in place. There is concern about Greece, but also about the implications for the Eurozone and the potential impact on the world economy. Brookings offers a balanced view of the prospects.
  • The auto bailout tab is in at $9 billion if you count the interest payments or $16 billion if you do not. This is on an investment of about $80 billion – 25 by Bush and 55 by Obama. Early estimates were for a loss of about $44 billion. We will never know what would have happened without the bailout, especially since the government would have been on the hook for some of the pensions.
  • Insider trading at BP as well as various bank currency desks. Bloomberg explains.
  • Construction spending shows weakness. (See Steven Hansen at GEI).
  • Jobless claims have drifted a bit higher, both on the weekly numbers and the four-week average. It has been a small weekly amount, but it is worth noting. Doug Short’s chart puts it all in context and they accompanying post provides excellent analysis of the underlying trends.

dshort employment claims

  • ISM manufacturing declined and missed expectations at 55.5. This level is still consistent with real GDP of 4.1% according to the ISM analysis, but that seems to have been a bit high in recent years. Calculated Risk has the story and notes the West Coast dock slowdown as a factor.

ISMDec2014

 

The Ugly

Jailed journalists in China (Felix Richter via GEI).

chartoftheday_3081_China_has_the_most_jailed_journalists_worldwide__n

Increased trade and economic ties generally increase cooperation and make the world safer. It has now been 42 years since Nixon’s famous trip to China and even longer since the Ping-Pong diplomacy. The world is very interested in China, its markets, and its economic data. Building confidence remains a challenge.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts.  Think of The Lone Ranger. This week’s award goes to RL at Slope of Hope for an interesting look at how normal charting techniques have not worked well in the recent rally.

Multi-Year-Chart-SPX_2

Fans of the Silver Bullet can check out our annual review of award winners, just in case you missed one. Most investors have been bamboozled by one or more of these stories, so an annual review can be helpful.

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

Georg Vrba: has developed an array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal. Georg’s BCI index also shows no recession in sight. Georg continues to develop new tools for market analysis and timing. Some investors will be interested in his recommendations for dynamic asset allocation of Vanguard funds. Georg has a new method for TIAA-CREF asset allocation. He has added a method for Vanguard Dividend Growth Funds. I am following his results and methods with great interest. You should, too.

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured “C Score.”

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting market indicators.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (three years after their recession call), you should be reading this carefully. Doug has the latest interviews as well as discussion. Also see Doug’s Big Four summary of key indicators.

James Hamilton, our go-to expert on oil prices, has a first-rate analysis. This chart of the global supply curve is an important part of the story, but just a taste. You need to read this post carefully.

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The Week Ahead

It is a full trading week with plenty of news.

The “A List” includes the following:

  • Employment report (F). Last month’s gain will be difficult to match.
  • FOMC minutes (W). The market seems to make something out of nothing whenever there is news from the Fed, so watch for signs that the official statement could be given a new spin.
  • Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.
  • Auto sales (M). Important concurrent economic read from non-government data.

The “B List” includes the following:

  • ISM services index (T). Good read on an important economic sector.
  • ADP private payrolls (W). Solid independent approach to measuring employment change.
  • Trade balance (W). Important component for Q4 GDP.
  • Factory orders (T). November data.

The calendar for Fed speechmaking is active, featuring both hawks and doves. The Consumer Electronics Show may provide some news.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a “one size fits all” approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Since our last WTWA post, Felix shifted from neutral to bullish. There is still a high level of uncertainty reflected by the extremely high percentage of sectors in the penalty box. There has also been some rapid changes in the top sectors, even in a relatively quiet market. Our current position is fully invested in three leading sectors. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

There is bottom-fishing with fund flows in energy ETFs. Jim Polson at Bloomberg picks up the story. Felix did also!

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. Major market declines occur after business cycle peaks, sparked by severely declining earnings. Our methods are focused on limiting this risk. We have updated our ideas on current ideas for investors.

We aim for a light-hearted approach in our “Hot and Not” review of the past year, but there is still a lot of investment truth. If you missed it, please take a look.

Other Advice

Here is our collection of great investor advice for this week:

Best Lessons

Josh Brown’s annual review of “What I learned” brings out pithy ideas from his many sources. I always enjoy reading the list and I always learn something. You will, too, because it combines humor and education. There is no good way to summarize this, so please read and enjoy. Here is one favorite:

“Sam Ro: if you ask, most stock market bears will tell you they’re not net short.”

Watch also for these 14 famous but meaningless phrases that pundits use to appear smart. Henry Blodget has the story. They are all so good that it is tough to pick a favorite.

 

Stock Ideas

Eddy Elfenbein, CNN/Money’s best buy-and-hold blogger, is out with his eagerly awaited choices for 2015. Eddy locks in the choices for a full year. This post amplifies the preliminary version (cited in our last WTWA) and provides more discussion. There are always great ideas, and you have the choice of selling during the year – if you dare!

Thirteen ideas from David Rosenberg. In contrast to the “bad news” above, he likes Canada.

 

Yield Plays

Robert Martorana is writing to an audience of investment managers, but you can listen in! He carefully describes the possible role of convertible bonds—very helpful.

Investors continue the quest for yield and Barron’s has some ideas. Jack Hough’s cover story reports on the alternatives in the table below. Don’t stop there. The recommendations are more nuanced. There is also a nice accounting of what worked and didn’t last year.

ON-BH809_CovYie_G_20150102221537

Sticking to a Winning Strategy

Michael Batnick reviews some winning strategies and the related drawdowns, noting the challenges of staying with the program. “Finding a strategy that can beat the market over a reasonable period of time is relatively easy. It’s sticking to it that is the challenge.”

Warren Buffett’s Berkshire Hathaway stock had a great year – up 28%. Betting on Buffett is an easy choice if you understand that you should focus on methods. Those chasing past performance would have instead emphasized the prior five years, where the stock trailed the S&P 500.

BRK.B Prior to 2014

Mark Hulbert sounds the same theme, with plenty of charts and examples. “Past performance is about to lead you astray – in a huge way.”

Psychology and Time Frames

Traders jump on a theme, but get bored quickly. Josh Brown is an expert on both traders and investors, often explaining how brokers sell their wares. This week he uses Cuba as an example, writing as follows:

The closed-end fund is down 35% over the last week and has given back most of the gains from the announcement. I’ve seen this kind of thing play out approximately one million times. I’d been on the wrong side of these plenty of times in the early part of my brokerage career as the sexiest stories in the market were always the easiest to sell to investors. Unfortunately, they’re often the stories that are the least likely to have staying power once the hype dies down.

Did you get caught holding the bag on Cuba? Consider hiring a professional to manage your money or lessening the amount of event-driven trades you take each year.

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Similarly, Sam Ro at BI on how market timing attempts are costly for most investors.

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Investment Scams

The hits just keep on coming! When you see a fund that is too good to be true, beware! Stephen Gandel at Fortune warns about such a fund. Every investor is seeking something that looks like a CD but pays 8% per year. Understanding the risk/reward balance is challenging for most.

Final Thought

I am not a big fan of seasonal effects unless there is a logical underlying reason. The Presidential cycle logic rests upon taking unpopular actions early in the term while emphasizing economic stimulus later. That does not have much relevance in the current environment.

The January tax loss effect is more persuasive, especially in years where there are some clear losers to sell. That was true in many sectors this year.

What are my market predictions for 2015? My own annual preview article will be out this week. I will not make a specific market forecast, but I will examine trends that I think offer the best risk/reward balance. I remain constructive on stocks since we are still in the middle part of the business cycle. I will also try, as I do in my weekly posts, to distinguish between investors and traders.

The Misleading Story about George Soros

A seriously flawed story about George Soros got a lot of media coverage today.  In the midst of options expiration and breaking news from Ukraine, this story might not seem very important.

It was big enough to earn a play from all of the major news sources and a feature on CNBC.

No one got the story right!

I am not going to list all of the errors.  If anyone had exposed the problem they would be in line for my Silver Bullet award!  Instead, everyone seems to have lamely tagged along with some anonymous sources.  I hope no investors traded on this “information.”

The Basic Claim

The news story was that George Soros, one of the most successful investors in history, had made a big bet on the market moving lower.  That the bet was much larger than in past filings (up over 600%!!).  That what he had risked was the equivalent of 17% of his fund.  Etc.

The Reality

None of these claims can be supported from the actual filing.  Here are the problems.  Those that should be obvious to anyone:

  • The information need not be filed for 45 days.  In the era of high frequency trading, this is ancient history.
  • There is no way to determine whether the positions are hedges against other holdings, nor to evaluate the relative size.

These items might require an options professional, but there are plenty of them around who would be happy to comment:

  •  The reports are based upon “notional value.”  This is a calculation of the number of option contracts multiplied by 100 and by the value of the underlying security.
  • The notional value does not represent how much was spent on the option, so using it to show the percentage of the portfolio invested is completely inaccurate.
  • The report does not show which strike price was used.  If buying puts, you could buy some that were 10% or more out of the money (tail risk?) and the notional value would be the same as if you bought puts that were deep in the money.
  • Put another way, the report does not show the “delta” of the options — how much the options change in price given a change in the underlying security.
  • The 13F filing does not require disclosure of short positions, including short puts.  Short puts are actually a long position, so you can see the confusion.  The reported options could be part of a complex spread — and probably are.  The spread might not even represent short deltas.  We simply do not know.

To summarize:  Soros might have a boatload of cheap tail risk puts.  He might have a put spread, including one that might actually lean long.  He could have some kind of volatility play, since he reports both long calls and puts.  He might have taken the entire position off weeks ago.

Do we really care about this?  You probably should not be influenced by George Soros’s position from 45 days ago, but it gets played as a big story.

What has gone wrong?

Our news sources completely failed on this story.  What went wrong?

Budget cuts?  Summer vacations?  A shorter news cycle?

Whatever the reason, the mainstream media sources are rushing to publish questionable information and conclusions.  I suppose there are a few investors out there who made a decision based upon what George Soros was doing.  Some sources said this was evidence that “the big one” was at hand.

And of course, the government is no help.  The required filings are well-intentioned, but do not provide even the most basic information required to discern the actual position of these managers.

I always try to make a constructive suggestion.  Requiring the actual holdings — strike prices, both long and short — would allow readers of the filing to evaluate the position as of the stated date.  That is the best the government can do.  Trying to put a number on the position value is a moving target that changes with time and price.  Leaving out the short positions turns the exercise into a joke.

Misleading information is worse than nothing at all!