Headline Spin — Recession Forecasting is Back!

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

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

 

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

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

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

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

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

 

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

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

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

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

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

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

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

Is there another side to this?

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

 

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

Investor Protection

There are two ways investors can protect themselves:

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

Actionable Investment Advice

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

Weighing the Week Ahead: New Year, New Highs, and a New List of Worries

There is a normal dose of economic data this week, but we are entering a quiet, pre-holiday period. As the rally faltered a bit, the Dow 20K talk yielded to a discussion of what could go wrong. I expect this discussion to continue in the coming week, and perhaps the next one as well. The punditry will be asking:

What can derail the rally?

Last Week

In a reversal from the last month, most of the economic news was soft. There was little apparent market effect.

Theme Recap

In my last WTWA, I predicted a week-long fixation on the Dow 20K story. That was very accurate, with the closest call coming just as I arrived at Chicago’s NBC tower for a CNBC interview on my 2010 forecast. I think it represents a delay rather than a jinx. Some might attribute the selling to the Fed and Chair Yellen’s press conference, an “effect” that was reversed the next day. It must have been meJ I’ll stay at the office for the rest of the year!

The Story in One Chart

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

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

Personal

I will have several year-end posts planned for the next two weeks, but will probably skip WTWA next weekend. I am planning a Weighing the Year Ahead installment, probably in two weeks.

The News

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

This week’s news was quite good—almost all positive. I make objective calls, which means not stretching to achieve a false balance. If I missed something for the “bad” list, please feel free to suggest it in the comments.

The Good

  • Framing lumber prices are higher, year-over-year. Calculated Risk sees this as an important leading indicator for housing, so we should, too.
  • Initial jobless claims edged lower, to 254K.
  • Hotels are close to an occupancy record. (Calculated Risk).
  • The Fed provided the expected increase in rates with almost no market reaction. (That is the good part). Tim Duy provides some insight. See also “Davidson” via Todd Sullivan.
  • The Philly Fed showed a big gain to 21.5 (7.6 prior) and trouncing expectations. I am not very interested in the Empire State survey, but it mirrored the Philly result. Business and consumer confidence have both strengthened since the election. Confidence is essential for spending, investment, and economic strength.
  • Inflation is still tame, even as it creeps toward the Fed’s target.
  • Household balance sheets are much stronger. Scott Grannis regularly produces this chart. It is far more valuable than material from those focusing exclusively on debt, and ignoring assets.

  • Homebuilder confidence hits the highest level since 2005. (Calculated Risk).

 

The Bad

  • Industrial production declined by 0.4% from October to November.
  • The rail contraction continues. Steven Hansen continues his coverage with multiple takes and time frames. Check it out!
  • China/drone incident. The drone seizure coincided with Friday selling, a hint of market reaction to sensitive international issues. China will return the drone and claims that the story was “hyped up.”
  • High frequency indicators edge lower. NDD’s useful weekly compilation shows continuing strength in short leading indicators, neutral in the coincident group, and some weakness in the long term. He is downplaying the effects due to seasonality, but it bears watching.
  • Housing starts dropped by 18.7%. This was a very bad headline number. Various sources suggest that it emphasizes multi-family while single-family is strong. This is a shift that is quite acceptable, so we should follow it closely. Calculated Risk, our go-to source on all things housing, has a great analysis and this chart.

The Ugly

The Young. Colleges are profiting from helping credit card companies. The choices are frequently worse than the student could find otherwise.

The Old. Brett Arends opines that cost-of-living adjustments may soon end. Already the inflation rate for seniors, mostly because of medical costs, exceeds the standard CPI calculation.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week, but opportunities abound and nominations are welcome!
The Week Ahead

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

The Calendar

We have a normal week for data, loaded into the latter part of the week. Things will get very quiet after Friday’s opening.

The “A” List

  • Michigan sentiment (F). Confidence is important right now. Will the mid-month preliminary high hold up?
  • New home sales (F). Not much change expected in this important sector.
  • Leading indicators (Th). This widely followed measure is likely to be flat.
  • Personal income and spending (Th). This important read on the economy is expected to show solid growth.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Existing home sales (W). A small decline is expected. Less important than new construction, but still relevant.
  • PCE price index (Th). The Fed’s favorite inflation indicator – still very tame at a touch over 1%.
  • Q3 GDP third estimate (Th). Little change expected in what is now viewed as “old news.”
  • Durable goods orders (Th). This volatile series is expected to be much weaker than the October data.
  • Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

Despite the end of the FOMC quiet period, we have little FedSpeak. Chair Yellen makes an early-week appearance, and that is all I see.

Next Week’s Theme

 

Last week attention focused on Dow 20K. This was true even though it is a rather meaningless round number in a flawed index. It shows the power of symbolism to attract attention. When the rally fizzled out, the story swiftly turned. Everyone questions rapid, short-term moves, so it is a natural for the punditry.

I expect it to carry over into a quiet week, with plenty of focus on 2017. The popular question will be about what could stop the rally. What should we worry about? It is time to rebuild the wall or worry.

What could go wrong?

Pundits were already hard at work last week:

You should ignore the lists or 2017 winners.

Trump’s policies might not get enacted, disappointing markets. S&P businesses are in line for $87.1 billion.

Trump’s policies might be enacted, hurting the economy and markets. (Think trade matters).

Trump might make a bad decision in a crisis. An ill-timed tweet?

Valuations are still excessive. Stocks are too pricey to buy.

The Fed and a strong dollar might hurt earnings.

Stocks might get too expensive for dividend reinvestment. (You can’t make this up).

Bonds are sending a warning.

Or maybe we should look at the bright side?

A nice reversal from the negativity of last January, the worst start to a year ever. (Josh Brown).

The rally is real. Brian Wesbury’s valuation model showed stocks as 30% under-valued on election day.

20% upside for next year? Brian Gilmartin sticks to the facts. This is an earnings-based conclusion.

 

What should investors conclude from these sharply conflicting ideas? As usual, I’ll have a few ideas of my own in today’s “Final Thoughts”.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

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

The Featured Sources:

 

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

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

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

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

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

Doug Short: The World Markets Weekend Update (and much more). Jill Mislinski updates the ECRI coverage, noting that their public leading index is at the highest point since 2010. Surprisingly, the ECRI public statements remain bearish on the U.S. economy, the global economy, and stocks. It is as if they never recovered from the bad recession call in 2011. They have been out of step ever since.

James Picerno highlights an important, oft-ignored relationship. Many worry about higher interest rates. He notes the relationship between higher rates and stronger economic growth.

 

How to Use WTWA (especially important for new readers)

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

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

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar is fully invested in aggressive sectors. The more cautious Holmes also remains fully invested, but with continued profit-taking and position switching. The group meets weekly for a discussion they call the “Stock Exchange.” This week we had a great topic – whether the focus on Dow20K had an effect on technical analysis. The prior two segments were on limiting risk and maximizing returns. (We report exits from announced Holmes positions if you ask to be on that list. Write to holmes at newarc dot com).

Top Trading Advice

 

Brett Steenbarger continues to provide almost daily insights for traders. Sometimes the ideas draw upon his expertise in psychology. Sometimes they emphasize his skills in training traders. Sometimes there are specific trading themes. They all deserve reading. This week I especially liked the following:

Adam H. Grimes has an excellent piece on finding ideas. You must be experienced, but also avoid confirmation bias. Dr. Brett gives a HT and follows up.

Brendan Mullooly takes one of my favorite approaches – drawing a lesson from outside trading, especially from sports. This approach helps rid us of confirmation bias, providing a fresh look. Check out the full post for data on the impact from overtrading. And the sports analogy? Teams that keep switching quarterbacks!

[This chart was approved by Mrs. OldProf, a native of Green Bay and a knowledgeable football fan.]

 

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 advice from legendary investor Peter Lynch. Instead of finding something from the last week, I wanted to find the best choice for current conditions. Ben Carlson did the Peter Lynch report about two years ago, starting with this very relevant quotation:

Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.

And also….

Now no one seems to know when they are gonna happen. At least if they know about ’em, they’re not telling anybody about ’em. I don’t remember anybody predicting the market right more than once, and they predict a lot. So they’re gonna happen. If you’re in the market, you have to know there’s going to be declines. And they’re going to cap and every couple of years you’re going to get a 10 percent correction. That’s a euphemism for losing a lot of money rapidly. That’s what a “correction” is called. And a bear market is 20-25-30 percent decline.

They’re gonna happen. When they’re gonna start, no one knows. If you’re not ready for that, you shouldn’t be in the stock market. I mean the stomach is the key organ here. It’s not the brain. Do you have the stomach for these kinds of declines? And what’s your timing like? Is your horizon one year? Is your horizon ten years or 20 years?

What the market’s going to do in one or two years, you don’t know. Time is on your side in the stock market.

 

Stock Ideas

Lee Jackson has an interesting screen that produced 5 Dividend Stocks that You Can Still Buy With Market at Record Highs. “We screened the Merrill Lynch research data base for stocks that are rated Buy, pay a dividend and haven’t gone parabolic this year. We found five that make good sense for investors”.

Wind energy stocks have been left behind in the “Trump rally.” Buying opportunity or victim of policy changes?

But keep in mind that solar is now cheaper than wind energy. Tom Randall (Bloomberg Technology) has a helpful analysis of how much and why.

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

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

Some Merrill Lynch top picks for 2017 (via 24/7 Wall Street).

Ben Levisohn (Barron’s) sees 23% upside for FedEx.

Interested in REITs? Try health care.

Get ready for Eddy Elfenbein’s new buy list. This annual event is a great source of ideas for investors who like to think in a time frame of at least a year. You can also join in the whole list via Eddy’s new ETF (CWS). It is both convenient and inexpensive.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, you should join us in adding this to your daily reading. Every investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading. My personal favorite this week is the important article by Jonathan Clements on your personal risk-free rate. It is not the T-Bill or T-Note from financial analysis, but your own most costly loan. This may seem obvious, but many people fail to consider it in their financial calculations.

Seeking Alpha Editor Gil Weinreich’s Financial Advisors’ Daily Digest is a must-read for financial professionals. The topics are frequently important for active individual investors, so the series is worth following regularly. This week I especially liked the discussion of financial literacy. Even active investors are unable to answer basic questions. WTWA readers would get them all right, so it may seem very surprising.

Watch out for…

Bonds cratering while stocks rally. Eddy Elfenbein presents a telling chart.

Final Thoughts

 

My biggest reason for the 2010 Dow20K post was to alert investors to the idea of “upside risk.” There is always – always – a list of plausible worries. These dominate the news and the financial discussions. The other side is difficult. It is boring to say repeatedly that things are normal and promising. Talking about some new development seems smart – attracting viewers, page views, more gigs to make you famous, and even investors who seek confirmation.

The natural process leads to a focus on problems. These are easy to see, while solutions are not. Therefore, most investors do not understand the ill-named concept of the wall of worry.

The new list of worries, all well-known and reflected in current market prices, is a replacement for those listed on my current “investor fears” page, which replaced those from the 2010 era. It seems smart to study world events and use that knowledge to guide your investment decisions. But it is not!

You cannot make these calls as well as the market does. You are almost certain to over-react.

The investor mistakes I highlighted in 2010 are still with us:

  1. Excessive attention to headline events;
  2. Reliance on poor forecasts of the economy, especially recessions; (James Picerno has a great list of typical forecasts)
  3. Too much reliance on backward-looking earnings, reflective of unusual events and times.
  4. Ignoring the long-term economic forces putting idle assets to work. (Mark Hulbert on 24K)
  5. Emphasizing politics instead of investing. In 2008 many investors hated the prospects and principles of the Obama administration. They sat out the start, and never found an entry point.

It is more profitable to accept a measure of uncertainty, rely upon the best recession and earnings indicators, and remain agnostic about politics.

 

This is a good time to ask yourself about how have you done? If you are wondering whether you might do better with a financial advisor, check out my latest paper, The Top Twelve Investor Pitfalls – and How to Avoid Them. If you regularly navigate these problems, you can fly solo! That is true for 99% of my readers, whom I am trying to help. Some readers might well benefit from our help. Readers of WTWA can get a free copy by sending an email to info at newarc dot com. We will not share your address with anyone.

Weighing the Week Ahead: Dow 20K?

The post-election market run has been accompanied by improving economic data and increasing confidence. The result has the punditry asking a question that seemed crazy in January:

Will the Dow hit 20K?

Before reading this week’s installment, “Sherman, set the WABAC machine to” mid-year, 2010. The Dow was at 10K and many famous pundits were predicting a fall to 5000. In order to appreciate the psychology of the time, please read my post and especially the comments at Seeking Alpha. You will see some very colorful criticisms of my work! You will enjoy a few good laughs. I’ll comment more on this below, but it is a great place to start.

Last Week

Once again, last week’s calendar of economic news was nearly all good, supporting the market gains.

Theme Recap

In my last WTWA (two weeks ago), I predicted a period of stronger economic news and the possibility of a more positive market reaction. This is what has happened, but most commentators still are not emphasizing the main theme. It is not all about the Fed.

The Story in One Chart

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

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

 

The News

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

This week’s news was quite good—almost all positive. I make objective calls, which means not stretching to achieve a false balance. If I missed something for the “bad” list, please feel free to suggest it in the comments.

The Good

  • Rail traffic finally scores a slight positive. Steven Hansen provides the current data, as well as the more negative long-term perspective.
  • Senate passes stopgap funding. This is not getting a lot of attention, but it is a big shift from the past eight years, especially 2011, when the last correction came for this very reason. (The Hill).
  • OPEC reached a production limit agreement. Whether this will attract cooperation from non-OPEC countries is open to question. We might also ask whether a floor under energy prices is a positive. That said, the oil price/stock correlation has been a factor since the energy collapse. Months ago, I suggested that we were entering a sweet spot for oil pricing. The OPEC participants see a cap of about $60/barrel, which makes sense.
  • Jobless claims down ticked, and remain near all-time lows. See Calculated Risk for the story and charts.
  • Productivity rose over 3%.
  • Michigan sentiment spiked to 98 on the preliminary estimate. LPL shows why this is important.

  • Borrowers continue to move out of negative equity on their homes. 384K in Q3 (Calculated Risk).
  • ISM non-manufacturing strengthened to 57.2. Doug Short has the story and this chart:

 

The Bad

  • Gas prices rose over five cents. (GEI).

  • Interest rate components of long leading indicators are weakening. (New Deal Democrat). This is mostly a positive story, but the long-term interest effects are worth watching. NDD’s report of high frequency indicators is a regular read for me, and should be for other frequent traders.

 

The Ugly

Secret outside influence on U.S. elections. Foreign countries frequently have an interest in the most important elections. There is nothing new or unusual about that. Voters can weigh the opinions and arguments in the same way they use other information. Actions that are secret are another matter, especially when following the “dirty tricks” approach.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week, but opportunities abound and nominations are welcome!
The Week Ahead

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

The Calendar

We have a big week for data.

The “A” List

  • FOMC rate decision (W). An increase is widely expected. The statement and Yellen’s press conference may yield hints about next year.
  • Housing starts and building permits (F). Softening pace expected in this important sector.
  • Retail sales (W). November data following a very strong October.
  • Industrial production (W). Any improvement in this economic weak spot?
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • PPI (W). Interest in inflation measures is increasing, but prices are not.
  • CPI (Th). See PPI above. Eventually these will be important.
  • Philly Fed (Th). The first look at December data is expected to be positive.
  • Business inventories (W). Significant for Q4 GDP, but little change is expected.
  • Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

With the FOMC meeting at mid-week, FedSpeak is on mute. Expect plenty more news on possible Trump policies.

Next Week’s Theme

 

The strong data continues, as does the market rise. We still do not see a reflection in forward earnings, but the earnings recession has ended. The Fed is about to raise rates, and no one cares. It is not all about the Fed, and more are learning that. As the market hits new highs, including a big round number on the DOW, the focus this week will be on DOW 20K.

In my 2010 articles I tried to emphasize the right focus for investors. Too many were paralyzed by fear from the frequent disaster predictions. Their upside risk was huge. This section was crucial:

Asking the Right Questions

The bias is inherent in the situation. The problems are known. If you write for a major publication, you are rewarded for analyzing the negativity. If you go on TV, you are expected to parrot the analysis of problems. This makes you seem smart.

By contrast, the solutions are vague and unknown. If you even talk about them, all the “hot shots” are skeptical.

That should be your clue to pay attention. Repeating the known news does not make you money. Try asking these questions:

What if unemployment falls to 8%?

What if the annual budget deficit is reduced?

What if housing prices and sales show a clear bottom?

What if mortgage rates remain low?

What if politicians negotiate a compromise on tax increases?

What if Europe stabilizes?

What if China and other emerging countries resume a solid growth path?

What if earnings for US companies continue to surge, leaving the 10-year trailing earnings in the dust?

What if the US rationalizes immigration?

If you have not thought about these possibilities, you have a fixation on negativity. My Dow 20K concept is designed to set you free — to get you thinking about the long sweep of history and the potential for success. If even a few of these things happen, what would be the market reaction?

This list of worries seems so old….

Two years later the New York Times ran a story with the analysis from a big firm. The reasoning was like mine, but missing the first 30% of the move.

Josh Brown takes note of the Barron’s cover. Since magazine covers are often viewed as contrary indicators, he adroitly includes a few others that might have been viewed as signals of a top. Great insight, and great fun.

Scott Grannis shows the wall of worry climb (but I still like my own version better!)

Eddy Elfenbein highlights the sharp contrast between now and January as well as the impact of the banking sector.

Remember how the start of 2016 was one of the worst market starts in Wall Street history? Howard Silverblatt noted this stat: At the market’s February, low, the S&P 500 was down 10.5% YTD, yet the Financials were down 17.7%. Since then, the S&P 500 has rallied 21.5%, while the Financials are up 45.6%. It’s as if the entire market were the dog being wagged by the banking sector’s tail.

None of this really answers the DOW 20K question, but the information is great. As usual, I’ll have a few ideas of my own in today’s “Final Thoughts”.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

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

The Featured Sources:

 

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

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

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

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

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

Georg Vrba: The Business Cycle Indicator 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.

There is a Correlation Nosedive says Nick Colas (via Josh Brown). This signals an opportunity for those who can identify the best stocks and sectors. The phrase “stock-picker’s market” is oft-repeated. Now it makes some sense.

Dr. Brett analyzes the divergences and the implications.

Brian Gilmartin reports on the recent Chicago CFA luncheon where “Dan Clifton of Strategas Partners gave a great presentation on the coming fiscal stimulus and what it might look like and what it might mean for the US economy in 2017”. This means plenty of money for share buybacks and earnings increases. Brian (who has been very good on both earnings and the market) reaches this conclusion:

In year-end meetings with clients, I’m telling clients from both sides of the aisle that the SP 500 could be up 20% next year. Prior to the election and since last Spring ’16, the SP 500 was already looking at its best year of expected earnings growth in 5 years. The proposed President-elect and Congressional fiscal policy could be another level of earnings growth above what was already built into the numbers, before November 8th.

Personally, the $1 trillion repatriation estimate that Dan Clifton threw out seemed on the lighter side to me. Apple alone has $250 billion sitting on its own balance sheet, which is 1/4 of the expected total.

This is something we all should be monitoring.

 

How to Use WTWA (especially important for new readers)

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

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

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar is fully invested in aggressive sectors. The more cautious Holmes also remains fully invested, but with continued profit-taking and position switching. The group meets weekly for a discussion they call the “Stock Exchange.” This week we talked about maximizing gains. Last week the topic was minimizing risk. (We report exits from announced Holmes positions if you ask to be on that list. Write to holmes at newarc dot com).

Special thanks to our guest expert, Blue Harbinger, who provided first-rate fundamental analysis, providing counterpoint for our technical models.

Top Trading Advice

 

Brett Steenbarger continues to provide almost daily insights for traders. Sometimes the ideas draw upon his expertise in psychology. Sometimes they emphasize his skills in training traders. Sometimes there are specific trading themes. They all deserve reading. This week I especially liked the following, each reflecting one of the main themes:

 

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 post on The Art and Science of Investing. I am delighted that he is keeping his promise to keep writing, leading the effort at a new, multi-contributor blog. This entry, as is the case with much of the best investing work, does not emphasize immediately “actionable” advice, designed to attract plenty of page view. The concept is great, and the post is worth a careful read. Here is the thesis:

This drives people crazy, because the more important a field is, the more scientific and predictable we want it to be. People take scientists seriously because they can count of them. Art is taken less seriously because it comes and goes.

But most fields outside academia are both science and art.

Including investing.

An example?

There is scientific data showing the best way to invest is to buy the cheapest set of companies you can find. There’s equally persuasive data showing the best way to invest is to buy the fastest-growing set of companies, which tend to be expensive. Some investors obsess over brand and intangibles. Others say ignore those and only look at fundamentals. Neither is right or wrong. You just have to appreciate that each strategy lives in its own context, and that market trends come and go. It’s an art.

I love this concept! There are many ways to profit from trading and investing. Arguments about approach may either distract or enlighten.

 

Stock Ideas

 

Brad Thomas suggests two REITs for the new Commander-in-Chief. Besides the recommendations, Brad analyzes some potential losers.

Still wondering about winners from the election? Marc Gerstein’s stock screening methods generate a great list of stocks and sectors.

Looking for safe yield? Who isn’t!! Blue Harbinger provides a first-rate analysis of Saratoga Investment Corp. (SAR). There are plenty of traps in the Business Development Company (BDC) universe. Mark’s analysis shows how carefully you must consider the data in finding sound choices. He carefully considers the implications from higher rates.

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

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

But Tom Armistead warns that there is too much enthusiasm about Deere.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, you should join us in adding this to your daily reading. Every investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading. My personal favorite this week is the Bloomberg analysis of when it is right to wait before claiming Social Security benefits. While it is an individual choice and calculation, delay is good for many. (See also “Watch out for” below.)

Seeking Alpha Editor Gil Weinreich’s Financial Advisors’ Daily Digest is a must-read for financial professionals. The topics are frequently important for active individual investors. Gil is on a well-deserved vacation, but his last post is very helpful. He takes a nice look at the current risks and rewards from the market rotation away from bonds.

Watch out for…

Structured products. Larry Swedroe (ETF.com) provides a careful analysis of what the investor is really getting. Most have inflated notions about the returns and are not properly informed about risks. In many cases, a simple fixed-income security would be better. This is a complicated story, but it is worth reading carefully if you, like so many, are considering these investments.

 

Final Thoughts

 

Will we reach DOW 20K? And stay there? I expect us to touch that level soon. When the market gets close to such numbers there is a magnetic attraction. Sellers see it as inevitable, so they back away. It becomes a self-fulfilling prophecy. Whether the level holds will be a trickier question. It will, but perhaps not right away. No one really knows.

My purpose in the DOW 20K project, including buying the domain name, was to help individual investors to focus on the right problem: Missing the upside because of the paralysis of fear. Consider the following:

  • For many years, anyone forecasting more than an 8% gain in the market was tagged as super-bullish.
  • Since 2010 there have been incessant warnings of another market crash, a decline of 50% or more.
  • A market doubling in 6 ½ years represents 11% compounded growth.

It was not a prediction of rush to 20,000, but an emphasis on taking the right perspective. There are always market worries. The big negative predictions always get the attention. It is always difficult to stay the course.

Is DOW20K the end? Definitely not. The fundamentals are all better than in 2010, and the worries are different. I’ll write soon about the methods behind the original call and the current implications. For now, I’ll just say that the upside/downside risk is still attractive.

Investors need not just “buy and hold.” Recessions are the biggest risk, so I watch that closely. The right allocation among asset classes deserves a regular review.

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

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

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

Can the market embrace some good news?

Last Week

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

Theme Recap

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

The Story in One Chart

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

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

Personal Note

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

The News

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

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

The Good

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

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

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

The Bad

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

 

The Ugly Beautiful

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

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

 

 

The Silver Bullet

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


The Week Ahead

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

The Calendar

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

The “A” List

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

The “B” List

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

     

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

Next Week’s Theme

 

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

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

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

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

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

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

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

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

The Featured Sources:

 

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

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

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

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

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

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

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

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

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

This is very good advice to the recession worrywarts.

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

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

 

How to Use WTWA (especially important for new readers)

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

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

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

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

Top Trading Advice

 

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

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

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

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

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

Insight for Investors

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

Best of the Week

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

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

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

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

Stock Ideas

 

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

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

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

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

Personal Finance

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

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

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

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

Market Outlook

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

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

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

Value Investing

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

Watch out for…

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

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

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

And also this:

 

1955-2014:

            Interest rate range           average P/E

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

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

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

Final Thoughts

 

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

When does change start?

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

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

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

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

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

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

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.

Some Crucial Facts about Energy

It is magical!  Whatever the topic of current interest, there is no shortage of pundits.

The current energy experts were recently (it seems like only yesterday) the leading authorities on the Fed, Europe, Ukraine, Libya, deflation, hyperinflation, stagflation, and of course, Ebola.

The current crop of experts confidently talks about an oil glut, the motives of the Saudi’s, and the demise of the US energy industry.  The nearly universal perception is that there is no bottom in oil prices.

I wonder how many experts could actually pass a test.  Suppose that CNBC used this to qualify experts.  My guess is that they would have no content!  If you can even give ballpark estimates on these questions, you will beat the pundits on television.

Pop Quiz

Pop quizzes were universally hated by my students, but were infallible at finding those who did not know basic facts.

  1. What country was the world’s largest overall producer of energy?  The largest consumer?
  2. What region has the largest proven reserves?
  3. How does Chinese consumption per capita compare with Europe?  With the US?
  4. How many car drivers are there in China?  What is the growth rate?
  5. What is the change in demand for oil in 2014?
  6. What is the daily oil consumption?  How much is the supply/demand imbalance?

Answers

  1. China — on both fronts.  And just getting started.
  2. The Middle East — by far.

energy reserves

3.  China is 1/2 the consumption of Europe — generally frugal and with shorter travel distances.  1/4 of the consumption of the US.

world energy

4.  300 million.  A growth rate of about 900% over the last ten years.  There are plenty of new highways and car dealers.  The growth rate will surely slow, but there are still about a billion drivers to come.  How about India?

5.  An increase of about 0.7% and a bit more in 2015.  I suspect that most “experts” are projecting declines.

6.  Daily oil consumption is around 92.5 million barrels/day.  This is a useful number to keep in mind when someone says that a few million barrels is a “glut.”

Conclusion

One of our authoritative sources on oil prices is Prof James Hamilton at Econbrowser.  He has a great post on the “glut” with plenty of charts and excellent analysis.

Prof. Hamilton contrasts the current oil prices with the cost of production, showing that oil is not so cheap.  He has meaningful advice for producers:

Here’s my advice to anybody who’s contemplating selling $85 oil at $66 a barrel– don’t do it. If you can wait a few years, that $85 oil will be worth more than it costs to produce. But selling it at a loss in the current market is a fool’s game.

While he does not write with investors in mind, I frequently draw upon his excellent work.  His analysis of the supply/demand relationship, crucial in analyzing the 2008 period, does not square with current trading.

It is not unusual for short-term trading to diverge from long-term fundamentals.  Taking advantage of this tries the patience of everyone. [Full disclosure. Some of my programs have had relatively modest holdings in energy stocks, but anything at all was too much.  It is not the first time I have held an unpopular position, and it will not be the last.]

Additional Source material from the authoritative  BP Statistical Review, which should be required reading for pundits.

I have some specific ideas to exploit divergences.  More to come.

 

Keeping Investors Scared Witless

Investors, as usual, are bombarded with reasons to sell stocks.  This means that they are Scared Witless (TM OldProf).  Let’s take a deeper look.

Short-Term Advice

There has been (yet another) sighting of the Hindenburg Omen.  I pointed out the flaws of this approach in 2010.  Those seeking a higher authority might check out Barry Ritholtz:

Hindenburg Omen?  Put a Fork in It.

Why do People Fear the Hindenburg Omen?

Despite the facts, CNBC keeps pitching this story with multiple interviews of Tom McClellan.  I tweeted a reasonable question, asking them to provide some review of his infamous and misleading “1929 chart.”  Will we get an answer?  It is time for some accountability from the featured guests.

Long-term Advice

There is no limit to the efforts of those on a bearish mission.  Here is the chart getting wide circulation among those who want confirmation bias:

 

B214SoPIIAEQYce

Meanwhile, the actual 20-year returns for ANY time period from 1930 to date are an annualized rate of 7.43% or higher.  What is the difference?  The popular chart adjusts for inflation.  Good idea.  That is what investors should do.

Why not make this clear?  Owning stocks is one of the best methods for protecting against inflation, especially in times of strong economic growth.  Does the author have some better investment idea for the next ten years?  A bond, perhaps?

A really serious study should examine inflation and interest rates at the starting and ending point of the period.

Bond Pundit Advice

Bill Gross is out with a new commentary.  It uses his analysis of Fed policy (which has been consistently wrong) to suggest that investors should take money off of the table.

Wow!  I would be more impressed if I could remember a time when Gross recommended owning risk assets.  He did a great job of  beating other bond managers, but has stumbled in an era when bonds may have topped out.  Check out the comparison:

In 2010 Gross had the same advice about cutting back on risk assets.  This article reviews some of the top guru’s from that period, all advising caution and/or a bubble top circa 2009.  In late 2008 Bill Gross wrote that we were going to Dow 5000 unless we do everything right.  Since then he has continually complained about Fed policy, suggesting that we failed his test.  Meanwhile the market has reached new highs.

You cannot advise taking chips off the table unless you had some there to start with!

Current Market Worries

Frightened investors might gain perspective by going back to 2010, when a similar list of worries caused most to criticize my anti-Gross forecast:  The Dow would double rather than cut in half.  In other words, Dow 20K.

There is always a laundry list of worries.  Focusing on earnings and the odds of a recession provide a better foundation for the long-term investor.  This story is boring compared to the flashy crash predictions.  The repetition of these scare stories is shameless.  Should we not expect a little balance from major media sources?

Weighing the Week Ahead: Are Investors Too Complacent?

The upcoming calendar has plenty of data in a holiday-shortened week. There could be OPEC or Black Friday news. In spite of this avalanche of information, I expect commentators to look for an organizing principle. In a week when many will be giving thanks, there will be scrutiny of the new market highs.

Many will ask: Are investors too complacent?

A Personal Message

It has been a very good year for WTWA and our followers. I have had a lot of help, so I have personal thanks for many.

  • My original editor at Seeking Alpha who helped to develop this concept. She does not like to be named, but she knows who she is, and I think of her each week.
  • The continuing support and help from the Seeking Alpha editorial team.
  • Abnormal Returns – the gateway to the investment world and an early blogging colleague. Tadas has both guided me to great information and helped me to find many new friends.
  • Sources that pick up and circulate my work, especially including Doug Short, Advisor Perspectives, Global Economic Intersection, and Investing.com.
  • My friends on Twitter who provide pointers and help me reach new readers.
  • The many great sources that I rely upon each week.
  • And most of all – my readers. Without the comments, ideas, and encouragement, I could not tee it up each week.

I must not leave out Mrs. OldProf, who has given up many Saturdays and Friday nights while I was writing. I might take off next weekend or do an abbreviated column while enjoying the visit of her family.

Prior Theme Recap

In my last WTWA I predicted that media would focus on commodities, with special attention to the rebound potential. Instead, there was plenty of discussion of the Fed Minutes and the energy discussions were all pretty bearish. Even looking at the week’s history it might be hard to come up with a single theme.

By the end of the week, Melissa Lee and the Options Action traders were discussing some of the rebound action in commodities, with a focus on FCX (which I have been using as an example). But no excuses. Sometimes the theme is difficult to capture in advance.

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, mostly crammed into two days of releases. On Friday those who are working will be greeted with the results of the OPEC meeting and early releases about Black Friday sales. It is a very tough week for my “Guess the theme” challenge.

I am going to fudge the exercise just a bit this week by discussing “complacency.” This has been a frequent recent pundit theme and is certainly a candidate for a week where it could be confused with “giving thanks” for past gains and warnings to take profits. I will venture out onto that limb and suggest that the week will feature the question: Have investors become too complacent?

The basic argument for this viewpoint is twofold:

  1. The market is making new highs despite a long list of geopolitical concerns and “nosebleed valuations.” Is everyone blind? These sources colorfully describe investors as “sheeple” who have been sold a bill of goods. It will end badly.
  2. Low volatility is a sign of complacency. The low VIX and even the low St. Louis Financial Stress Index indicate danger. Beware!

The theme is worth a separate post, but let me highlight the most obvious responses:

  1. Those who choose to buy stocks are not ignorant of the list of worries or the crash warnings. They have the same information as the worriers, but they have reached a different conclusion. Check out Richard Bernstein’s list of fifty concerns that have kept people out of the market. It is a great list, perhaps helping people to understand the most difficult concept for investors – the Wall of Worry. It was a factor behind my Dow 20K forecast.
  2. Thinking about a group of people, or a market, as if it were an individual but be done with care. It may be a useful shorthand, but you cannot forget the underlying dynamic. Right now the market has been trading in a narrow range. That might represent an uneasy balance between those with sharply divergent viewpoints. The result might change rapidly with new evidence. Think of a tug-of-war, with two sides evenly matched. Do these men look complacent?

220px-Touwtrekken

I emphasize risk control and have special methods for avoiding complacency. You should, too. More about that 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

The news last week was mostly good, even better than stock prices suggested.

  • Inflation remains low. The stubborn unwillingness of many investors to accept this conclusion is a big source of error – mostly from misreading the Fed and buying gold. Remember when many complained about using core inflation because food and energy were important? Now that energy prices are lowering the overall inflation rate many complainers have moved on to a new argument. Rex Nutting has a nice article explaining that “stuff” that we buy is getting cheaper while services are not. Barron’s shows that core inflation is better described as the trend, including this chart:

ON-BH177_BeatEy_G_20141121203058

  • The Philly Fed index was incredibly strong – a reading of 40.8 versus 20.7 in the prior month. It was the best reading since 1993. One of the reasons that I ignore this report and other regional Fed diffusion measures is that the market usually does not take the result seriously. No one understands what a diffusion index is (change over the prior month, not a level). The interpretation is always flawed. In this case the market did not really react and everyone rushed to explain that it was probably an outlier. To realize the flaw in this reasoning, suppose that it had been 25 instead of 40? Would that have made it credible? Or what if it was only 8? Would Rick Santelli be explaining the economic weakness behind the “big miss?”
  • Building permits showed strength – the highest level since 2008. It is good, forward-looking news. (Calculated Risk) Steven Hansen at GEI focuses on the decline in the long-term trend.
  • Chinese rate cut. The market celebrated, but the verdict is probably mixed. This is a story worth monitoring. It is probably good for our commodity theme from last week, but perhaps not for the overall US economy.
  • Existing home sales were solid. The verdict is from Calculated Risk, our “go to source” on all things housing. The data involve inventories, seasonal adjustments, and plenty of noise from the sample. Read the full story to get a good explanation for the summary chart:

TruliaOct2014

  • Leading Economic Indicators beat expectations. The sharp increase is part of an overall picture of October strength for the US. New Deal Democrat’s summary of high frequency indicators covers the story well.
  • Q3 earnings beat estimates handily. Q4 is also looking good. There are various ways of calculating the change. Brian Gilmartin cites Thomson Reuters data as showing the Q3 growth rate as 11.2%. (He carefully examines some of the big outliers). FactSet reports that 77% of the S&P 500 companies have beaten earnings estimates (best since Q210). In a refreshing change from recent quarters, 59% beat revenue estimates. (But please note that more Dow 30 companies reported declines in European sales).

 

The Bad
There was not very much bad news. Readers are invited to nominate ideas in the comments, but remember that we are focusing on recent developments, not a list of continuing macro concerns.

  • Politics. The rhetoric escalated again. The Keystone pipeline bill failed by one vote in the Senate (with the parties agreeing that a 60% super-majority would be required). This legislation will pass next year, possibly with enough support to override a veto. The President advanced his immigration via Executive Order plan in spite of GOP warnings. I am not scoring this as “bad” because of the merits of the specific policies. As investors, the key aspect for us is a government shutdown or questions about the debt ceiling. We are not yet at that point, but it bears watching.
  • Q1 Job Gains. I have insisted that we should monitor the actual count of job changes from the state employment agencies and compare it with the estimates from various sources. The “official” BLS report is an estimate, based upon surveys and modeling. The true count is part of the Business Employment Dynamics series. It is ignored because it is “old news.” It should be used to measure the accuracy of those doing the estimates. This week’s release showed that Q1 net job gains were only 397K, about 200K less than the BLS series. Last year the BLS estimate as a bit too low. The early returns this year are different.
  • Markit Flash PMI for Europe was only 51.4. This is the lowest in 16 months, and is consistent with growth of only 0.1 to -.2%. (MarketWatch) Scott Grannis takes the contrary side. Bespoke has the story with both analysis and one of their great charts.

PMIs

 

  • Industrial production disappointed. There was a slight decrease instead of the expected increase in the October report.

Noteworthy

The most stolen car in my state is the Dodge Caravan? Check out your own state and the reason behind the unlikely results.

stolen_cars.0

The Ugly

Ebola stock scams. The SEC has suspended trading in four small companies making “unverified claims.” Also beware of calls concerning private companies. (Reuters).

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts.  Think of The Lone Ranger. No award this week. Nominations welcome!

 

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

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. This week there is (yet another) change in the ECRI story. See also his regular updates to the “Big Four” economic indicators important for official recession dating.

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. I am following his results and methods with great interest.

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.

This week Dwaine has updated one of his timing approaches in Fingerprints of a short-term market top. It is a nuanced report, but you can check it out without charge. You should read it in full. Here is a key conclusion:

The SP-500 is on a tear. Normally such rapid advances coming from rare, deep, oversold levels and rare great-trough buying signals signify new bull-mark sequences with multi-month gains. However some intermediate corrections are likely on the way up. For now, some short-term breadth momentum has faded, but there are no immediate signs of an intermediate market-top forming. But this situation could change rapidly.

Stay tuned!

We are fans of The Bonddad Blog. Last week we highlighted Hale Stewart’s concerns about the global economy. His colleague, New Deal Democrat, has also been a recent skeptic about economic prospects. This week saw something of a change in his viewpoint – sparked by building permits! This is an indicator that I also favor. NDD helped to identify this as something that the ECRI (probably unwisely) dropped from their WLI series. His conclusion:

This doesn’t mean the economy finally achieves lift-off in 2015.  But it pretty much takes contraction of the table for the US economy.

Paul Kasriel has a wonkish analysis of US and European monetary and fiscal policy. One reason that I read GEI is their embrace of a wide range of viewpoints. No matter what you think, you will find this piece stimulating. Here is the conclusion:

The point is that in both the U.S. and the eurozone, there has been fiscal austerity in recent years. Yet, U.S. aggregate domestic demand has been considerably stronger than that of the eurozone. The tale of the two economies is that in one, the U.S., the Fed pursued a QE policy, resulting in the better of times. In the other, the eurozone, the ECB eschewed a QE policy, resulting in the worst of times.

The Week Ahead

There is a lot of data packed into three days of a holiday-shortened week.

The “A List” includes the following:

  • Initial jobless claims (W). The best concurrent news on employment trends, with emphasis on job losses.
  • Consumer confidence (T). Conference Board version. Another high in store?
  • Michigan sentiment (W). Also making new, post-recession highs. CXO Advisory has a nice report showing that this indicator does not lead the stock market. It is a coincident or lagging indicator. I agree. There are few true leading indicators. Most of what we see just fills in the current economic picture.
  • Personal income and spending (W). An important economic series.
  • PCE prices (W). The Fed’s favorite inflation indicator.

The “B List” includes the following:

  • Durable goods (W). Possible rebound from weak September?
  • Chicago PMI (W). Assumes a greater interest as an indicator for the national ISM index when released before an extra-long weekend.
  • Pending home sales (W). Everything in housing is important, but this has less direct impact than new sales.
  • Case-Shiller home prices (T). September data and a lagging average of 20 cities.
  • FHFA home prices (T). September data and a limited sample of homes.

Most of the speech making will be on hold for the holiday. The big news might come from Thursday’s OPEC meeting. We will also have the expected “flash bulletins” about Black Friday shopping. This could lead to some action in Friday’s slow and abbreviated trading.

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 the profitable bullish posture for another week. There is excellent breadth among the strongest sectors. Ratings have gotten a bit lower, but are still quite solid in many sectors. Felix does not anticipate tops and bottoms, but responds pretty quickly when there is evidence of a change. The penalty box can be triggered by extremely high volatility and volume. It is similar to a trading stop, but not based only on price. There has been quite a bit of shifting at the top, so we have done some trading.

You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

Traders might also be interested in Goldman’s top ideas for 2015.

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. The recent “actionable investment advice” is summarized here.

Whenever there is a market decline, we are bombarded with “explanations” and predictions of disaster. To keep perspective I wrote a section recently covering these three points:

  1. What is not happening;
  2. Factors most often linked to major market moves; and
  3. The best strategy for the current market.

If you missed this section from a few weeks ago, I urge you to check out the Investor Section of the earlier WTWA.

Taking advantage of what the market is giving you is always a good strategy.

Other Advice

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

Stock Ideas.

  • David Tepper’s holdings (via Josh Brown). Josh also points to Dataroma, which lets you explore the filings of other big-name fund managers.
  • The top 50 stocks held by hedge funds (Business Insider).
  • More dividend stocks from the hard-working and prolific Chuck Carnevale.

 

Interpreting Information. Morgan Housel covers many Stupid Things Finance People Say. You will see plenty of familiar silliness and also have a good laugh from this article. Here are some of my own favorites from his list:

“He predicted the market crash in 2008.”

He also predicted a crash in 2006, 2004, 2003, 2001, 1998, 1997, 1995, 1992, 1989, 1984, 1971…

“More buyers than sellers.”

This is the equivalent of saying someone has more mothers than fathers. There’s one buyer and one seller for every trade. Every single one.

“Stocks suffer their biggest drop since September.”

You know September was only six weeks ago, right?

“We’re cautiously optimistic.”

You’re also an oxymoron.

Market Outlook

There are plenty of stories about bubbles and crashes and what the Fed has done wrong. Those who focus on corporate earnings and use P/E ratios more recent than the Taft Administration have a more positive outlook. This is especially true if your concept of an appropriate multiple is adjusted for interest rates and/or inflation. If this viewpoint is correct, there is plenty of market upside left, especially if the economic cycle continues for another two years.

Bryan Rich has a “rational case” for stocks rising 45% by the end of 2015. Here is part of the argument:

The P/E on next year’s S&P 500 earnings estimate is just 16.8, in line with the long-term average (16). But we are not just in a low-interest-rate environment, we are in the mother of all low-interest-rate environments (ZERO). With that, when the 10-year yield runs on the low side, historically, the P/E on the S&P 500 runs closer to 20, if not north of it. A P/E at 20 on next year’s earnings consensus estimate from Wall Street would put the S&P 500 at 2,600.

 

Final Thought

It is vital to avoid complacency, asking what would change your mind. My sense is that most of those using the “C word” never ask about what might convince them to reach a different conclusion.

In July I did an extensive analysis of the potential for a mid-course correction. This included a list of things to watch for as downside risk. In later posts I highlighted the potential for upside surprises.

The key word here is “surprise.” There is no investment edge from repeating what you read in the morning paper. Here was my list – still worth watching:

  1. Geo-political that is not on the current radar – a true black swan.
  2. An increase in the PCE index that was not accompanied by strong economic growth.
  3. Wage increases that were not accompanied by strong economic growth.
  4. Declining profit margins that were not accompanied by strong economic growth and increased revenues.
  5. An increase in the chances for a business cycle peak (the official definition of a recession). Remote at this point.
  6. An increase in financial stress to our trigger point. Remote at this point.

If you have a good list of concerns to monitor you may count yourself as vigilant, not complacent.

Bad Reasons for Avoiding Stocks

There is a broad group of individual investors who are
completely out of stocks or significantly under-invested.  Many were paralyzed by fear in the time after
2008.  They have still not returned to investments in stocks.

This is a natural and normal reaction to risk.  People fear losses more than they crave
gains.  This natural human trait causes
most investors to do exactly the wrong thing at the wrong time!

There are multiple sources of fear, but the current theme is
that it is too late for this year.  If you have not
been invested, you have missed the rally for three reasons:

  1. The market has already made most of its gains
    for the year, getting close to the targets of the most bullish of
    prognosticators;
  2. The move has been too far and too fast;
  3. The time of seasonal weakness is upon us.

Let us focus on the first of these reasons – the price
target.

Why We Need Moving Targets

Here is an idea that can liberate investors:

Ignore calendar year market
forecasts!

If you are looking for an investment edge, here it is.  Most people analyze portfolios based upon the
calendar.  World events march to a
different drummer!

This year is a great example.  The annual forecasts were done at a point when
everyone was worried about the fiscal cliff, a downgrade of US debt, an
imminent recession, and a hard landing for China.  When this did not happen, (an eleventh hour
result that I predicted), the market rallied about 6%.

Suppose that you missed that rally.  Should you pretend that the facts did not
change?  Should you remain anchored to
your December, 2012 forecast?

Or should you adjust your thinking to reflect new evidence?  Just suppose that the fiscal cliff issues had
been resolved in November, 2012.  We
would have started 2013 from a higher level.

My Method

I have a personal method that has worked well for more than
a decade:  I use a rolling twelve-month
forecast.  I do this for individual
stocks and also for the market.  I refuse
to be chained to the calendar.

When the underlying data change, so does my price target.  The calendar does not matter.  My thinking is flexible, taking what the market is offering.

Some Agreement from The Street

I am surprised and pleased to see that some top analysts are
recognizing the need for more frequent reviews of their price targets.  Instead of going with the knee-jerk reaction,
please give some careful attention to these analysts, who see S&P targets as high as 1760 for this year:

There are others in the club.

As background, Bespoke noted more than a month ago that the rally was approaching the Street targets – check the chart and commentary.

Goldman Sachs boosts from 1575 to 1625.

Morgan Stanley's bearish Adam Parker boosts to 1600.

These are all analysts who  recognize that circumstances have changed since the time of their original forecasts.  This is in sharp contrast to what happened at the end of last year, when analysts stubbornly held to foolish forecasts.

Investment Implications

This is one of the easiest ways for the average investor to get an advantage over the big-time sell-side forecasts.  Most data sources provide earnings for a calendar year.  Here at "A Dash" I try to do better by finding the best sources.

Isn't it obvious that a rolling one-year forecast is better than locking into the calendar?

If you had the data, you would do it.  I often provide such information.  I get it from Brian Gilmartin, and occasionally Ed Yardeni

I explain to all of my new investors that even good years will include a correction of 15% or so, regardless of the fundamentals.  I cannot time these and neither can anyone else.  It just comes with the territory.  Develop and stick to your forecast.

Looking at the long-term fundamentals is the key to long-term success.  There are many stocks trading at significant discounts based upon current earnings.  These can often be found via Chuck Carnevale's first rate web site.

Some current favorites from assorted sectors are AFL, CAT, and JPM.

I will try to elaborate further on this theme, but this installment is timely.

A Bull Market in Bad Predictions

Why does this happen whenever I try to take a few days off?  The market for dubious predictions has geared up in earnest!

While on vacation I was watching the market (but without my customary TIVO), events developed exactly as I predicted.  I warned about signal and noise, the challenge to traders, and the opportunity for long-term investors.

I have also been reading Nate Silver's book, The Signal and the Noise, which includes a lot of wisdom on these topics.  I plan a full review when I finish.

One of Silver's points concerns predictions without any confidence interval.  Many themes will be familiar to readers of "A Dash" since I highlight pundits who claim expertise outside of their "happy zone."  Let us highlight the three worst items from the past week.

  • The fiction –  the ECRI claims that we are now in a recession.  This is ECRI 4.0 after their 2011 forecast failed, their revised 2012 forecast failed, and their complaint about seasonal adjustments being wrong has not proven out.  They are now playing out the last straw, that they are the only ones who can forecast recessions in advance and that no one else knows until after it is over.  This will obviously require a deeper look.  Let me cite the most obvious incorrect statement in their claims: The business cycle has peaked and they are the only ones who know this.

The reality.  No one knows whether the current period will eventually be defined as a recession.  A recession requires a significant decline (which you do not know until you have seen it).  At that point the NBER goes back to the last peak.   The ECRI presentation last week "assumed facts not in evidence."  They are ignoring the reduction in business spending before the election and the fiscal cliff.  They are exploiting the Super storm Sandy effects.  We can expect them to pound the drum even more during the next month, since the weak patch will take a couple of months to sort out.

I have a personal sadness about this, since I like and admire the ECRI principals.  I am going to write another piece about how and why their methods failed.  I wish that they had just been willing to accept the changing evidence — and maybe open the kimono a little bit.

  • The fiction — the decline to zero growth.  GMO's Jeremy Grantham opines that the US economy is on a zero growth path until 2050.  He focuses on the two best drivers of growth — population and productivity.  In this CNBC segment Maria Baritromo breathlessly praises Grantham:

"…He gets paid to make predictions, steve. that's what he's doing. by the way, his former predictions have been right. let's give him that."

The reality.  No one knows what will happen in 2050.  Grantham has ignored a decline in immigration (something that has helped US GDP in the past) to support his perma-bear position.  Pretending to this kind of knowledge gets headlines, but should be a warning signal to investors.  The media commentary points out that he manages a gazillion dollars or so.  Maybe a few of those investors should look to managers who are more grounded in facts.

And by the way, maybe Maria should cite Granthams track record — 47% — before claiming that he has made so many great calls.  Anyone who takes this silly prediction seriously should look back forty years for a comparison.

  • The fiction.  The latest new and greatest recession indicator.  This is from Lance Roberts (who without apology highlighted the bogus 100% recession indicator).  He is now back with a new entry, endorsed by John Hussman.  Roberts takes some existing economic forecasting indicators that do not initially give the result he hopes for.  He then does some arithmetic and creates something that has a lame correlation to past recessions.  Hussman (who does similar things) embraces this approach.

The Reality.  The St. Louis Fed creates about 60,000 data series.  If you do some math transformations as Roberts did, you can turn this into a million or so possibilities.  If you then set a "trigger"  at an arbitrary level based upon a handful of past cases (the way Hussman does)  you can multiply this into the hundreds of millions range.

It is bad research, bad methodology, and a seriously misleading result.  It is impossible to prove, since the bad guys used all of the data.  There is nothing left to prove them wrong.

Conclusion

So much bogus commentary, and so little time.  Can't a guy take a few days off?

I will follow up on all of these themes.  Here are the main ideas:

Recession

The ECRI errors will require a more careful review — it is on my agenda.  Meanwhile you can get the basic concept of their mistake by reviewing my recession forecasting page.

Fiscal Cliff

This theme continues with silly trading in the absence of information.

Listen up!!  We have no new information since the election.

We will not know anything new for a few weeks.  Trade at your peril.

Opportunity

It almost seems too obvious.  So many have much at stake in scaring investors.  They have clearly won the battle, with aggressive money flowing into anything with a high yield and conservative money going to farmland and ammunition.  My conversations with investors show that many are scared witless (TM OldProf).

Since the big rewards go to the contrarian investor, there are some great opportunities.

I like CAT as the proxy stock for an economic rebound, although it is (incorrectly) China-centric.

I also like some health care insurers and defense stocks — UNH and LMT as examples — as winners in the fiscal cliff compromise.

AFL is a good play if there is no disaster in Europe.

These are complex questions, so I plan to write more on each issue.