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

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

What does the health care decision mean for stocks?

Last Week

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

Theme Recap

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

The Story in One Chart

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

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

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

The News

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

This week’s news was slightly negative.

The Good

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

 

The Bad

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

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

The Ugly

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

 

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s award goes to Charlie Bilello, whom we also featured on Stock Exchange. This is double recognition that is unlikely to be repeated!

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

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

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

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

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

What does? A business cycle peak (AKA a recession). That is the reason for our careful monitoring of that topic.

The Week Ahead

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

The Calendar

We have a rather light week for economic data.

The “A” List

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

The “B” List

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

     

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

Next Week’s Theme

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

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

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

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

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

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

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

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

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

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

 

The Featured Sources:

 

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

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

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

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

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

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

How to Use WTWA (especially important for new readers)

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix, Holmes, and Friends

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

Top Trading Advice

 

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

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

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

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would Chris Kacher’s popular and insightful chart, spread widely by Sue Chang. The various soft times in market history are considered. My own conclusion is that you had better have a good reason to fight the trend.

Stock Ideas

 

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

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

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

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

Yield Plays

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

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

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

Personal Finance

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

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

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

 

Watch out for…

 

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

Final Thoughts

 

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

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

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

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

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

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

 

A Conclusion for Investors

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

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

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

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

Stock Exchange: Model Picks Teach Us to Manage Risk

Individual investors are intensely focused on the concept of risk. And why shouldn’t they be? Finding an appropriate level of downside risk is paramount. However, too few give equal weight to the potential upside risk in their decisions. Permabears and doom-and-gloomers often watch from the sidelines as the market rallies beyond the fear of the day.

We’ve been able to enjoy such a rally in the wake of the election. As the uncertainty surrounding future government policy dissipates, investors have a broad range of new opportunities.This week, our models’ picks give us an opportunity to explore both upside and downside risk.

To help us cut through the fog, we are joined by Blue Harbinger (AKA Mark Hines).

What level of risk is right for you?

The Stock Exchange provides an expert-level debate on technical and fundamental analysis. (Important background is available here). Comments, dissent, and specific stock questions are welcome!

This Week—Is Athena late to the party?

It’s an extremely common mistake for investors to chase a stock on a rally, then panic and sell at the first downturn. This buy-high, sell low strategy is an obvious loser. Athena is our answer to everyone who wants to find a trend, enjoy the ride, and hop out near the peak. Let’s see what she has on tap this week.

Athena

Athena: Drill, baby, drill! Continental Resources, Inc. (CLR) was on a roll in November – though I couldn’t say why. All I see is solid upward trend and a spike in price to cap it off.

clr_technical_chart-athena

Blue Harbinger: Continental has some competitive advantages and challenges relative to other energy exploration companies, but its price still remains highly correlated with the price of oil. For example, Continental has competitive WTI break even prices of around only $30-$35 per WTI barrel, and it was an early mover in the Bakken Shale (Williston Basin). However, it will take a long time to develop its huge acreage.

A: I hadn’t factored in time for future development, but to me that sounds like potential for future growth.

BH: Two other things I know you didn’t factor in – the incoming administration (of which you have no knowledge), and attempts by OPEC to reduce crude supply.

Regarding the incoming Administration, it seems the regulatory balance may shift slightly towards pro-business, pro-profits and pro-growth, instead of pro-environment. That may work in Continental’s favor, but the bigger factor remains oil supply/demand, something the Administration has very little control of.

Regarding the attempt of OPEC to reduce supply, would-be buyers may have already missed that boat. Oil shot up on Wednesday (11/30) as OPEC agreed to its first oil production limits in eight years. Oil, as measured by US Oil Fund (USO) was up 8.65% on Wednesday, and Continental was up 22.88%. Caution is prudent with regards to initiating any new positions, because Continental will likely be very volatile in the near-term.

A: Well that’s all very interesting, but I’m only looking to CLR for the next couple weeks. Am I wrong to see upside here?

BH: We certainly won’t see any concrete policy shifts in your time frame, but that may not matter. Sometimes the appearance of a shift to market-friendliness can move a stock just as much.

Felix

I’m not looking for anything nearly as risky as Athena. Looking out a year or two down the road, I expect broad-based gains from the biotech sector (IBB).

ibb_technical_chart-felix

We’re reaching the bottom of a year-long slip, and the market seems to be correcting its perception of what IBB has to offer.

BH: From a contrarian standpoint, biotechnology and pharmaceutical stocks are attractive. And ETF IBB is a decent way to play the space because it provides diversified exposure at a decent price (the expense ratio is 0.47%).

F: Who’s the contrarian here? It looks like the market is coming to terms with a drastic change in this sector. Could the recent election be having an impact here too?

BH: It makes sense to consider IBB with regards to the goals of the incoming Administration and Congress. Hillary Clinton caused several big drops in IBB over the last year simply by taking issue with the way drugs are priced. Now that her Presidency seems off the table (at least for the next four years), and the threat of the House and Senate being flipped has been removed, the prospects for biotechnology and drug-makers looks better. IBB did pop (up nearly 10%) the day after the election, but it has given back nearly half of those gains.

If you are a long-term contrarian investor, it may make sense to consider some of the individual stocks within the ETF because you don’t have to pay the 0.47% annual expense ratio. For example, the two largest holdings (Celgene and Biogen) have only underperformed the broader market (as measured by the S&P 500) slightly over the last year. However, the third largest holding, Gilead, has dramatically underperformed. We don’t own Gilead, but we wrote about its attractiveness at the end of May (Gilead: A Trump Stock Worth Considering), and it’s valuation has only become more attractive since then.

Oscar

Fantasy football is going to be the death of me. I liked OBJ a few weeks back, but I didn’t like the Giants next few matchups. I left him on the bench. Naturally, he started playing his best games of the season. This on-again-off again approach isn’t working for me.

BH: Did you want to talk about stocks here or what?

O: Right – you gotta stick with what you know. I’m back on airlines & airline manufacturers. I liked ’em near the end of October and I like ’em again now. Check out BA. This one looks like a winner through the end of December, at the least.

 

ba_technical_chart-oscar

BH: Industrials in general (as measured by the Industrials ETF, XLI) have performed well since the election, and Boeing has performed well too. Industrials (like Boeing) tend to be cyclical, and the market seems to like the incoming administration’s pro-growth message.

From a valuation standpoint, Boeing is not unreasonable considering its price-to-earnings ratio (both twelve-trailing-months and forward) is within its historical range.

bh-oscar-1

O: Glad to see we agree (for once). Any reason to hold onto this one for a while longer?

BH: Boeing continues to spit off a lot of free cash flow that it has been using to reward shareholders with big share repurchases and healthy dividend payments. The dividend yield sits 2.9%, which is above average compared to the S&P 500, and may be attractive to many income-focused investors, especially considering interest rates are low and rising (i.e. bonds don’t offer a lot of yield and their prices will decline as interest rates go up).

Holmes

I spy brighter days for Under Armour (UA). The recent selloff here was overdone, and some recovery is expected. Since I’m familiar with profit-taking techniques like trailing stops, some recovery is all I need.

ua_technical_chart-holmes

BH: It appears the selloff was the result of management tempering long-term growth expectations. Under Armour has been growing like wild fire since 1996, but it’s a big company now, and it’s much harder for Under Armour to keep growing at the same high rate.

H: There may be some long-term concerns, but I’m not terribly concerned with that. How does this position look in the fundamentals?

BH: From a valuation standpoint, Under Armour is cheaper than it was, but it’s still very expensive, and the market still has very high expectations for future growth. For example, check out Under Armour compared to its rival, Nike.

bh-h-1

Blue Harbinger: The market can be very fickle when it comes to brands and fashion. Under Armour enjoys a lot of brand recognition and favorability now, but that can change quickly. Plus, it already doesn’t enjoy the same profit margins as Nike.

bh-h-2

H: Be that as it may, I’ll again say I’m really only interested in the stock’s modest recovery. Talk to me again in February, and we’ll see how this one worked out.

Background on the Stock Exchange

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

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

Questions

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

Conclusion

Our models’ picks for this week were uncharacteristically risky – but that’s not all they had in common. By and large, the gang picked big potential movers for their short-term potential. Fundamental analysis and broader market context raise questions, where technical pings see a big upside.

This is why it is important to consider your level of risk tolerance as a function of your objectives. For many long-term investors, these positions would have little to offer. For those with a trading mindset, there may be a tidy profit to make before the holidays.

Weighing the Week Ahead: Time for a Portfolio “Transition?”

There is some important data on the schedule for this week, along with earnings and the expected doses of FedSpeak. None of that will attract much attention. Instead expect “all Trump, all the time”. The slant in financial media will be the implications for investors. As we get news of the leadership transition, I expect the punditry to be asking:

Do investment portfolios need a transition?

Last Week

Last week’s economic news was all good, but less important than the election.

Theme Recap

In my last WTWA, I predicted a focus on the election and the chances for greater economic and financial clarity. The election expectation was obvious, and there was indeed a focus on the implications for investors. That said, I embraced the consensus expectations which proved to be dramatically incorrect. I did correctly note that the crystal ball would remain cloudy, but that proved to be quite an understatement.

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 post-election rally as well as the Friday fizzling.

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. Here is one additional example.

The big story of the trading week does not show up in the stock market data. As the Trump victory became apparent, overnight trading in stock futures showed a massive decline. This chart shows the selling and the morning rebound.

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

  • Election uncertainty ended. This was a known, market-friendly event, although the amount of the reaction was a surprise.
  • Framing lumber demand drives higher prices. Those who prefer market data to other source should take note of the data from Calculated Risk.
  • Earnings reports continue strength on all measures. Earnings growth, results versus expectations, sales versus expectations, and outlook are all solid (FactSet). It is not getting much attention, but the “earnings recession” is over. Brian Gilmartin provided the first alert on this dramatic shift, and now points to a possible expansion in multiples. Ed Yardeni shows the impact via changed expectations.

  • Michigan sentiment showed strength with a reading of 91.6, solidly beating the prior month and expectations. The survey was before the election.
  • JOLTS remained positive. This may be the most misunderstood indicator. Pundits use it to analyze job growth, because that is what they want to know about. Many other measures do that job better. JOLTS is about the structure of the labor market. How tight things are and whether employees freely leave jobs for others. If you do not understand the Beveridge Curve, you do not understand JOLTS.

  • Initial jobless claims declined to 254K, marking 88 consecutive weeks below 300K. This is the best record since 1970. Calculated Risk has the story and a helpful chart.

The Bad

  • OPEC output jumped. This calls into question the planned production cuts. Whether you agree with me that stock prices should not be linked to oil prices, that continues to be the reality. Thus – this news is market unfriendly. (MarketWatch)

 

The Ugly

Financial abuse of the elderly. Reshma Kapadia of Barron’s has a great feature article on this topic, describing the various scams and consequences. Here are a few of the top ones:

The Silver Bullet

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

Could you pass the U.S. Citizenship Test? You might enjoy the quiz from BuzzFeed. Example: Who was not one of the writers of the Federalist papers? John Jay, James Madison, Alexander Hamilton, or Thomas Jefferson? Mrs. OldProf tells me that this one is too easy if you scored a ticket to Hamilton and paid attention.

The Week Ahead

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

The Calendar

We have an important week for economic data, with a special focus on housing.

The “A” List

  • Housing starts and building permits (Th). Different directions in recent reports.
  • Retail sales (T). Continuing strength expected.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Philly Fed (Th). Continuing small gains expected in an early read on November.
  • Industrial production (W). Small growth expected despite recent weakness.
  • PPI (W). Still not a major market factor, but moving higher.
  • CPI (Th). Not the Fed’s “official” inflation indicator, but it is moving beyond the target.
  • Business inventories (T). September data, but relevant for final Q3 GDP.
  • Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

There are still some earnings reports, including housing stocks. Once again we also have almost daily Fedspeak. We’ll get to watch some dancing around the political questions.

Next Week’s Theme

 

In a different year, this would be a week for special attention to housing. The economic data feature some important forward-looking indicators and earnings reports include important housing-related stocks. Instead, the surprised investment community is scrambling to identify the implications of a Trump presidency and a GOP Congress. Regular media will have daily reports of transition plans, cabinet appointments, and shifting policy stances. Financial media will focus on what it means for investors. Expect this question to be a common theme:

Does your portfolio need a complete remake?

Here are the important issues:

  • Has the best asset allocation shifted? More stocks, less bonds?
  • Is the overall market more dangerous? Time for more cash?
  • What are the likely economic consequences, in both the short and long terms? The WSJ has a nice general summary, loaded with charts, about the economy Mr. Trump will inherit.
  • Which stock sectors are likely to benefit, and by how much?
  • Are there specific stock favorites?

Traders rushed to act, frequently on hastily and ill-formed ideas. The overnight futures trading is a spectacular example, but most of the other conclusions are also quite speculative. Consider how wrong many of the big names in investments have been. Citi, Goldman and Bridgewater Associates all expected declines of 3 – 10% on a Trump victory. Even after the market was rallying, many of the pros were expecting the story to end at any moment. As Time notes, the three errors included the event itself, the impact, and the aftermath.

I advised caution in a message to my readers “the morning after.” (Clients got more detail). Check out the post for my list of four key points.

As one person noted in the comments, using patience left you behind on some day-trading possibilities. True enough, if you guessed well. Would stocks down 6% continue to decline or stocks up 6% keep ascending.

I’ll have a few ideas of my own about what comes next 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.

The Featured Sources:

 

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

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

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

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

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

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

 

How to Use WTWA (important for new readers)

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

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

My objective is to help all readers, so I provide 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?)

Thanks also to readers for the interest and early comments for my latest paper, The Top Twelve Investor Pitfalls – and How to Avoid Them. Readers of WTWA can get a copy by sending an email to info at newarc dot com. We will not share your address with anyone.

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 holds several aggressive sectors. The more cautious Holmes also remains fully invested. Now joined by Athena, the group has a regular Thursday night discussion which they call the “Stock Exchange.” This week’s question was the effectiveness of technical analysis in the aftermath of a disruptive event. You can see that discussion as well as the most recent ideas for consideration – and you can ask questions!

Top Trading Advice

 

Brett Steenbarger warns against overtrading simply because things are boring. Not so much this week, but that might make it the best time to consider a great lesson.

He also presents an update on his market trading models, an interesting comparison to our approaches.

Bill Luby shows that the volatility crush was among the top 25 in history. If you have been trading VIX as a long, plenty of agility was necessary to limit your losses. If it was a hedge, you needed significant positions in the right sectors to make a profit. Check out VIX and More for the full story.

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be the cool-headed and accurate analysis from Liz Ann Sonders: Don’t Fear a Recession or Market Overvaluation. This coverage of Schwab’s IMPACT 2016, the largest conference in the investor business. Robert Huebscher continually brings the best analysis to advisors through special posts. I always read them along with many other advisors, but they are not a secret. You too can see what the advisor community is following. Here is a key quote on valuation:

“Valuation metrics can support any view of the market,” she said. The metrics that are dependent on an inflation or interest-rate component show that the market is cheap, she said. But metrics such as the forward P/E ratio show a median valuation. Sonders said that valuations tend to be highest when inflation is 2-3%, just above its current range. “But inflation going higher is a risk for P/E ratios,” she explained.

A slavish devotion to valuation indicators that ignore low interest rates has been an expensive mistake for investors. Here is a chart of the ETF modeled on Prof Shiller’s famous CAPE ratio. Despite the professor’s repeated statements that he is personally invested and recommends a significant stock allocation, his work is most frequently cited as indicating potential for a market crash. That is not his personal interpretation. The Barclay’s ETF uses CAPE to find the most attractive sectors, and it remains fully invested.

Suppose that each of the CAPE devotees who went to cash because of alarming valuations had allocated just 25% of the portfolio to the CAPE fund. (Not that this has been the very best choice, but it illustrates the Shiller contrast very well.)

 

Stock Ideas

 

Companies that may participate in “rebuilding the aging infrastructure.” Here are eleven stocks (24/7 Wall St) that could benefit from the $2.75 trillion that The American Society of Civil Engineers sees as necessary. Some of the ideas might surprise you.

Barron’s has a summary of other stock ideas, for those interested in immediate pursuit of the Trump theme.

 

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 Tractor Supply (TSCO). 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.

Marc Gerstein plays the “semi-contrarian” with his EBAY idea.

Chuck Carnevale has a very important post combining an analysis of the risk from increased market volatility, with the analysis of specific stocks. Investors should be reading Chuck’s work carefully every week.

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 advice on how to handle market volatility from Christine Benz (Morningstar). She easily clears the first hurdle – the temptation to give blanket advice. Each investor is different. She offers time frame as one important consideration. If investors want to copy what I do with clients, this article provides a good basic outline.

As you gauge whether to make any changes in light of the volatility, the really important concept to keep on your radar is risk capacity–what sort of losses can you endure without having to rework a goal?

If you still have a reasonably long time until retirement–say, 10 years or more—you have a fairly high risk capacity. That means that regardless of how you feel about near-term losses, you’re likely to recover from them during your time horizon. In fact, stocks have generated positive returns in more than 90% of rolling 10-year periods. For that reason, such investors ought to have aggressively positioned portfolios with at least 50% in stocks; given today’s low bond and cash yields, a more conservatively positioned portfolio will barely preserve purchasing power, let alone grow.

Seeking Alpha Editor Gil Weinreich was one of the few to highlight the possibility of a Trump victory, and do so with confidence. He reasoned from the Brexit precedent and a sense of the popular uprising. In a helpful and constructive fashion, he disagreed with my highlighted sources in last week’s WTWA. While his work is popular among investment advisors writing on Seeking Alpha, the topics are frequently important for active individual investors.

Out of the several helpful posts last week, my favorite was the individual investor advice (and appreciated the mention) to follow your plan rather than the election. This is especially persuasive from someone who called the election result. The money line from Gil?

But as we all know, investing is best accomplished unemotionally.

Other ideas?

For the most conservative investors, who normally stick to Treasuries, it may be time to switch to TIPS. Barron’s explains that inflation fears have now given the edge to the inflation-protected securities.

Emergency fund idea bad advice? Sally Krawcheck explains why paying off credit cards is more important. Do the math!

Blue Harbinger provides an update on Business Development Companies (BDCs). The article ranks many of the opportunities, and provides criteria for evaluation. This is a good start for anyone considering investments in this space.

Watch out for…

Dividend stocks? Many observers opined that this week’s decline in the bond substitutes was only the start. (I agree). The dividend investment gurus have a different take. While they are looking for buying opportunities, here are the early returns.

Final Thoughts

 

Last week I embraced the conclusions from the polling community, which was dramatically incorrect. They are preparing post-mortems. They will try to figure out the sources of error and improve their methods, because that is what professionals do. Of the sources I cited last week, Nate Silver was the best. Even his methods gave Mr. Trump only about a 30% chance. That is not high enough to predict the outcome, but it should get one’s attention. I will be doing my own review of what went wrong with the pollsters, and whether we gave them too much credit.

I was more accurate concerning what investors should be doing about the election. I have expected a market rally after the election, if only because a big element of uncertainty would be removed. I also have warned that plenty of uncertainty will remain!

If you allowed your political preferences to influence your investing, you probably have had poor results. If you have been sticking to the fundamentals – a solid portfolio of cheap stocks – you are doing well.

What’s Next?

As I write this we have already seen a change in the Trump transition leadership and acceptance of some elements of ObamaCare. Each policy needs fresh scrutiny, using the following elements:

  • The possible difference between candidate Trump and President Trump
    • Which proposals were serious
    • The effect of actual responsibility
    • The influence of the team
  • The limitations of power (See this great take on what Truman said about Eisenhower)
  • The potential for compromises

I will look at these questions on a policy-by-policy basis, discovering the changes in value in the related stocks. Many journalists and pundits are on this job, of course, but the instant conclusions are unreliable. Even the best journalists and financial analysts have little experience in analyzing the workings of the policymaking process.

For most investors, a portfolio review is in order, and a remake might be. As the leadership transitions, so should your asset allocation and stock selection. It is a job that should be done carefully, and done right. You have a lot at stake.

Post Election: Pause, Reflect, and Act Carefully

Take a deep breath. Or maybe two.

The biggest trap for investors during an aggressive political campaign? Allowing the political narrative to become the foundation for your portfolio decisions. I have frequently advocated that investors should be “politically agnostic,” willing to make sound investments regardless of who is in power. This is always easier said than done, particularly in an environment of extreme claims.

Acting emotionally and without sufficient thought is usually a costly mistake. Those who sold all stocks when President Obama was elected missed a huge rally. Those who sold futures contracts on the breaking news last night also have big losses this morning. Here are some key points:

  1. Do not go “all in” if you supported Mr. Trump or “all out” if you backed Sec. Clinton. We have a resilient economy and a political system with many ways of resisting extreme actions.
  2. Things will change less than most people expect. Many proposals that sounded attractive on the campaign stump will prove impractical. The responsibility of governing also has an important effect on every new President. There will not, for example, be a recession just because of the election.
  3. The trading reaction is swift and large, but often overdone. I see price weakness in nearly every company that Mr. Trump criticized during the campaign. Does this make sense? Every aspect of the Trump agenda is reflected in this morning’s trading: Hospitals and technology down. Companies with strong links to Mexico down. Drug stocks higher. Interest rates higher. Banks higher. Construction stocks higher. The general ideas sound reasonable, but there is a great distance between concept and achievement.
  4. There will be new opportunities. Careful analysis will provide a better idea of where policy change is likely. Stock picking and sector picking will be more important than in recent years.

I wanted to provide some of the important considerations right away, but there is plenty of work to be done. If you focus on objective analysis, you too can find profitable investments no matter who is in power.

Weighing the Week Ahead: Time for Some Clarity?

We have a light week for data, but plenty of other big news. Earnings season continues. There will be plenty of FedSpeak, and most importantly the results of the U.S. elections. I everyone to be asking:

Will the election results provide clarity for financial markets?

Personal Note

 

I enjoyed my Wisconsin weekend away with Mrs. OldProf, who is completely sick of election stories. Especially after seeing a few ads in a battleground state! She will probably will not read this week’s edition, focusing instead on her Packer-laden fantasy football entry and tomorrow’s game.

I know that some readers will not like my conclusions this week. Please read them as investment advice, not voting advice.

Thanks also to readers for the interest and early comments for my latest paper, The Top Twelve Investor Pitfalls – and How to Avoid Them. Readers of WTWA can get a copy by sending an email to info at newarc dot com. We will not share your address with anyone.

Last Week

Last week’s economic news was all good, despite the modest negative reaction in stocks. The election story is the culprit.

Theme Recap

In my last WTWA (two weeks ago), I predicted a focus on the trading range, and whether it would soon be broken. Breaking election news attracted most of the attention with earnings playing a secondary role. Since then, we have experienced a 40-year flood, so to speak. The nine consecutive days of market declines are the most for 36 years. And still counting. Whether the range has been broken remains open to question, but I was wrong about the key theme.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. Some sources said the market was in the “grip of the worst decline since the financial crisis.” Doug notes that the nine days of decline amounted only to 3.09%. By comparison, the nine-day streak from 36 years ago represented 9.37%. Even single-day declines can be more than this, including the -3.59% on June 24th of this year. Doug’s analysis helps to put the recent trading in perspective.

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!

The Good

  • Personal income and spending were up 0.3% and 0.5% respectively. These results were better than the prior month, and in line with expectations.
  • ISM manufacturing index registered 51.9 beating the prior month and most expectations. This is roughly consistent with recent GDP readings.
  • GDP for Q3 increased 2.9%, the highest rate in two years. James Hamilton notes that this is still slightly below the long-term trend, but good enough to reduce the recession odds of his model to 12.3%.

Some skeptics have claimed that the good report is “full of beans” in the words of Dr. Ed Yardeni. While the one-time effect of soybean imports was important, he cites several other factors that suggest future strength.

  • Earnings strength continues. Despite the importance of this story, it has not gotten much attention. The earnings recession is over, as I concluded from our first-rate sources a few weeks ago. FactSet has some key points in their update:
    • 71% of S&P 500 companies have reported earnings above the mean estimate and 54% of S&P 500 companies have reported sales above the mean estimate.
    • For Q3 2016, the blended earnings growth rate for the S&P 500 is 2.7%. If the index reports growth in earnings for the quarter, it will mark the first time the index has seen year-over-year growth in earnings since Q1 2015 (0.5%).
  • Corporate narrative agrees. Avondale Asset Management tracks hundreds of earnings calls. Their helpful summary includes quotations from the calls, organized into topics. Here is the encouraging list of topic headings for the U.S. macro section. There is supporting evidence for each of the points below.

 

The environment has stayed slow and steady

The economy is fully healed even if it’s not setting new records

Conditions are still pretty difficult for industrial companies, but turning up

Still, there’s a pervasive sense of uncertainty

CEOs are waiting to see what happens in the election

Companies are setting strategic plans that assume weakness

The consumer has been slowing

But energy and currency are moving from a headwind to a tailwind

Inventories are much leaner than they have been

And pricing pressures are building

 

  • Employment
    • Non-farm payrolls increased by 161,000 and the prior month was revised upward by 35,000.
    • ADP private employment growth was 147K, 23,000 less than expected, but the prior month was revised up by 48,000.
    • Unemployment decreased slightly to 4.9%.
    • Hourly earnings increased 2.8% on a year-over-year basis –
    • One slight negative was initial jobless claims edging higher by 7000, but still historically low at 265K.

 

The Bad

  • ISM non manufacturing registered at 54.8, down from 57.1 in September and missing expectations. Calculated Risk has the story, highlighting a comment in the report about the effect of uncertainty from the Presidential election.

The Ugly

The last days of a very personal and negative election campaign. Scott Grannis called for a “mulligan.” (For non-golfers, a complete do-over). I would probably just slice another drive into the rough! If you want to change outcomes, you must be willing to reform the process and go to work on your swing. In such a long election season, campaign managers finally resort to techniques that are proven to influence the undecided and the faithful. You and I might be turned off, but we are not the target market.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s winner is Bill McBride of Calculated Risk. Debunking recession calls is not popular. It is not the way to get page views. Please read Bill’s entire post to see the full story about the endless parade of recession calls. Here are some of the key points:

Note: I’ve made one recession call since starting this blog.  One of my predictions for 2007 was a recession would start as a result of the housing bust (made it by one month – the recession started in December 2007).  That prediction was out of the consensus for 2007 and, at the time, ECRI was saying a “recession is no longer a serious concern”.  Ouch.

For the last 6+ years [now 7+ years], there have been an endless parade of incorrect recession calls. The most reported was probably the multiple recession calls from ECRI in 2011 and 2012.

In May of [2015], ECRI finally acknowledged their incorrect call, and here is their admission : The Greater Moderation

In line with the old adage, “never say never,” [ECRI’s] September 2011 U.S. recession forecast did turn out to be a false alarm.

I disagreed with that call in 2011; I wasn’t even on recession watch!

And here is another call [last December] via CNBC: US economy recession odds ’65 percent’: Investor

Raoul Pal, the publisher of The Global Macro Investor, reiterated his bearishness … “The economic situation is deteriorating fast.” … [The ISM report] “is showing that the U.S. economy is almost at stall speed now,” Pal said. “It gives us a 65 percent chance of a recession in the U.S..

The manufacturing sector has been weak, and contracted in the US in November due to a combination of weakness in the oil sector, the strong dollar and some global weakness.  But this doesn’t mean the US will enter a recession.

The last time the index contracted was in 2012 (no recession), and has shown contraction a number of times outside of a recession.

Bill cites this chart:

Bob Dieli also made both of those calls in real time, as he has been doing for a few decades. His work goes mostly to private clients. It helps all of us to monitor objective sources like this. They benefit only from being right.

The Week Ahead

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

The Calendar

We have a light week for economic data, but some important earnings reports for retail stocks. I watch everything on the calendar, so you do not need to! Check out WTWA to focus on what is important – and ignore the noise.

The “A” List

  • JOLTs report (M). Few understand, but the main use is labor market structure.
  • Michigan Sentiment (F). Has been weaker than the Conference Board version. An important indicator.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Wholesale inventories (W). Volatile and challenging to interpret. Rebound expected.
  • Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

More important than the economic data will be continuing earnings news. We also have almost daily Fedspeak and plenty of international events and speeches. And most important of all – the election.

Next Week’s Theme

 

With increasing uncertainty about the election outcome and resulting policies, markets pushed the trading range lower over the last two weeks. Eddy Elfenbein describes this as an extended period of small lower moves. Each of the daily declines has been less than 0.7%. During the same period, the economy has been showing signs of acceleration. Eddy provides a helpful chart:

Earnings have also been solid in the face of the longest market losing streak in 36 years.

I expect discussion of the election and the implications of the results to be the key market question:

Will we finally get some clarity?

The possible election results are not binary. There is a wide range of possible outcomes, listed below from bearish to bullish. Please note that I am not opining about who I want to win or how you should vote. I am reporting how the market will probably react under differing circumstances, with some references for you to start your own research.

  • No clear result. We might think it’s over when it’s over, but that might not be the case. (Robert Schroeder, MarketWatch)
    • Some states might require recounts, either automatic by state law or after a challenge.
    • A third-party candidate might win the electoral votes of one state in a close split between the major parties. That is the explicit objective of candidate Evan McMullin.
    • Trump and /or supporters might challenge the outcome, possibly with some legal basis. Most people will remember the Bush/Gore controversy and the infamous “hanging chads.”
    • The Supreme Court decided that dispute, splitting along partisan lines. Right now, that would be a 4-4 vote, placing emphasis on how states and lower courts decided.
  • A Trump victory. Estimates are that the market would decline by 5-7%, mostly because of increased uncertainty. Many market participants believe that Trump economic and regulatory policies would be market-friendly. (CNBC)
  • A Democratic sweep with a majority in both houses of Congress. The perception, possibly not accurate, is that this would allow a much more aggressive legislative agenda. This is probably not accurate because of the filibuster potential in the Senate. Cloture currently requires 60 (out of 100) votes. This serves to block nearly everything that does not have solid overall support. Making it more complicated is the idea of the “nuclear option” where the cloture requirement would be reduced. (Barbara Kollmeyer, MarketWatch)
  • Divided control — a Clinton Presidential victory with Republicans maintaining control of one or both houses of Congress. Markets have generally liked a deadlocked government. (Allianz)

Which of these will happen? Join in the comments with your thoughts about the election implications. As always, I’ll have a few ideas of my own in the conclusion.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

 

The Featured Sources:

 

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

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

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

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

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

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

 

How to Use WTWA (important for new readers)

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

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

My objective is to help all readers, so I provide 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?)

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 holds several aggressive sectors. The more cautious Holmes also remains fully invested. They now have a regular Thursday night discussion, which they call the “Stock Exchange.” This week the gang came up with some contrarian, pre-election ideas. You can see the best technical analysis – and you can ask questions!

Top Trading Advice

 

Brett Steenbarger cites that noted trading guru, Bruce Lee, to illustrate our need to be flexible in trading.

In another post he emphasizes the need to ask the right questions. As he often does, this is a good technique for other life missions, not just trading. He uses an excellent specific example of VIX trading.

Options expert Bill Luby sheds some light on VIX trading, a widely misunderstood topic. He explains the difference between “median reversion” and using five-year moving averages. I doubt that most have event considered this significance.

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 Ben Carlson’s post, Don’t Be Afraid of All-Time Highs in the Stock Market. This is a concern that you see often, because many people equate a high level of the index with “expensive.” It is also true that declines begin from a peak. Forgotten in this is that most peaks lead to new peaks! Here is a key table:

And a key quotation:

Here’s also another way to think about this — since nearly 7% of all days since 1950 have been an all-time high that means that more than 93% of the time the stock market is in a drawdown state from a previous peak. So 9 times out of 10 you are going to be beating yourself up for not selling at the previous high. This is what makes the markets so interesting and excruciating all at the same time. Most of the time you’re in a state of regret.

Stock Ideas

 

Many people are mystified by the PEG ratio. Chuck Carnevale does a deep dive on the derivation and provides examples to show when and how it should be applied. If you invest in growth stocks, this is a must-read article with many ideas.

Brian Gilmartin draws upon the changes in earnings estimates to highlight attractive sectors for Q416. This is extremely helpful work, and worth a close read. Hint: Technology and Financials.

Is health care a sector to avoid or to embrace? Eddy Elfenbein comments on the decline in the group since July, 2015.

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 Biomarin (NKE). Check out the post, Stock Exchange: Contrarian Pre-Election Trade Ideas in Chips, Biotech, Trucking, and Energy, for my own reaction, and more information about the Holmes method.

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

How about housing? Barry Ritholtz has a great post highlighting the big best on housing by one of those who called the decline and has now switched sides, fund manager Donald Mullen. The entire post is worth reading, but here is the key argument:

Given how wary some people are of homeownership, why should we be thinking about demand strengthening? Here are a few possibilities:

  • Millennials seem to be moving out of their parents’ basements, and forming households;
  • Mortgage rates are starting to rise, and the potential for further rate increases could lead potential buyers to getting off the fence;
  • Low equity constrains inventory; that drives up rental demand as well as prices;
  • The economy continues to recover and even expand;
  • Unemployment has been about 5 percent for about a year, and wage increases are finally beginning.

All of these add up to an increase in the number of households, including renters — many of whom go on to become buyers.

This is also what we see from the Calculated Risk reporting on home prices, consistently higher but with room to run.

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 story about how even math teachers cannot understand 403-b annuities. Tara Siegel Bernard explains in the NYT. I have a lot of experience with people who come to me, seeking to escape something that sounded great at the time. The products are fine for some people, but because of high commissions are sold to many more. Anyone considering an annuity needs some advice ahead of time.

Another good piece is the Barron’s Next article on excessive concentration in stock of your own company. I have seen millionaires lose everything that way.

Seeking Alpha Editor Gil Weinreich’s market is the community of financial advisors, but it also attracts spirited comments from investors. I especially enjoyed this post featuring retired RIA Jim Sloan. The topic is one I rarely cover in WTWA – spending. I focus on clients’ investment plans; these must match their spending needs. Sometimes it is better to find a few economies than to take excessive risk.

Morgan Housel pulls together some themes that are among my favorites. It is a good explanation of why even the smartest individual investors go wrong. Hint: You are good enough to explain why it is not working and toward complex solutions.

Watch out for…

Facebook? Marc Gerstein provides an interesting and balanced analysis, driven by his quantitative methods.

Final Thoughts

 

The election outcomes that the market sees as most distressing are extremely unlikely. The best sources I follow suggest a Clinton victory, a toss-up in the Senate, and the GOP retaining the House. These are not partisan pollsters, but those who benefit only from accurate interpretation of data. Here are the key sources and a starting link. The message changes with new information, as we would expect. Barring any fresh news, the outcome has a high probability.

Larry J. Sabato of the University of Virginia Center for Politics.

Nate Silver, a numbers guru with respect from the Political Science community.

Sam Wang and the Princeton Election Consortium. Their method of median-based probability estimation is interesting and plausible.

The resulting gridlock will be perceived as positive. That will be true only if our leaders learn to compromise. There are decisions ahead that require action.

The first market reaction will be positive, if only because the worst cases were avoided and the uncertainty ended. Hedge fund managers who have lagged the market and are hoping to catch up via big short positions will need to cover. Based upon trader commentary and performance reports, this is a large group.

The second reaction will be sector and stock specific, and it will take time. Most of the financial punditry does not realize the limitations on Presidential power. I expect changes in drug pricing policies, for example, but not a sweep against an entire sector. The targets will be the most egregious excesses.

I understand that many people will disagree with these conclusions, despite my care in identifying sources. They will have theories about bad polls, hidden voters, and the like. I recommend reading this post. It is fine to keep cheering for your candidates until the last vote is tallied, but you do not have to lose money as well.

Weighing the Week Ahead: Time for the Bond Correction?

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

Last Week

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

Theme Recap

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

The Story in One Chart

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

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

 

The News

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

The Good

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

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

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

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

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

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

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

The Bad

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

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

 

The Ugly

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

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

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

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s award goes to Chris Ciovacco (See It Market) for his great explanation of the VIX. Featuring a prior piece by Jeff Macke, he emphasizes that the VIX is not really about fear, but expected volatility.

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

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

 

The Week Ahead

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

The Calendar

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

The “A” List

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

The “B” List

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

 

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

Next Week’s Theme

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

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

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

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

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

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

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

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

JP Morganseems to be on the same page.

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

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

The Featured Sources:

 

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

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

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

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

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

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

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

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

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

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

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

 

 

How to Use WTWA

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

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

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

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

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

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

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

Top Trading Advice

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

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

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

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

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

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

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

Insight for Investors

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

Best of the Week

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

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

Stock Ideas

 

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

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

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

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

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

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

OK, here is another….

You can get some great ideas from this approach.

Personal Finance

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

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

Market Outlook

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

This week I was struck by two excellent posts.

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

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

Watch out for…

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

Final Thoughts

 

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

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

The long end reflects (at least) five factors:

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

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

Investment Implications

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

Holdings to reduce or avoid include:

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

Holdings to emphasize include:

  • Technology
  • Banks
  • Homebuilders

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

Weighing the Week Ahead: Earnings Recession Ending Next Quarter?

This week’s calendar includes a little data, a lot of politics, slow summer trading, and the last of the earnings reports. I expect financial media to focus on an earnings season post-mortem by asking: Has the Earnings Recession Reached a Turning Point?

Last Week

The important economic news was excellent, and the market reaction was positive.

Theme Recap

In my last WTWA (two weeks ago), I predicted a focus on what the U.S. elections might mean for stocks. With major conventions in both parties and saturation coverage of anything said, that was a pretty easy forecast. My own final thoughts included the idea that there were not yet any clear implications. Since the major averages are about where they were in my prior post, the market seems to agree.

The business of figuring out what a President will do is pretty tricky. Morgan Housel uses historical data to rank past presidents on various criteria – stock market, profit growth, GDP, and inflation. Even knowing your history, the results will surprise you. The “best” presidents on these measure often started at a time when things were pretty bad.

The politics digested, the market turned to the biggest data of the last two weeks, the monthly employment report. The news relieved some continuing concern about the economy.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. While the range is pretty narrow, you can clearly see the early weakness and Friday’s rally to a new all-time high. Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

 

The News

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

The Good

  • Initial jobless claims remain low. There was a slight miss of expectations this week, but Calculated Risk provides the overall perspective.

  • Chemical activity hits a new high. Scott Grannis continues to follow solid indicators that most others miss. This one has a good record and “points to stronger growth than is widely perceived to be the case.”

  • Vehicle sales beat expectations, but some complained that higher incentives were required.
  • Employment increased solidly and more significantly than expected with a net gain of 255K payroll jobs and even more strength in the individual survey. While some are, as usual, seeking nits to pick, these data were an encouraging signal about economic strength. Expect the dialog to shift back to Fed policy. Bloomberg has good coverage.

The Bad

  • Rail traffic declined again. Steven Hansen covers the story including non-seasonally adjusted data in several time frames.
  • ISM services Index dropped slightly to 55.5, a little below estimates.
  • GDP growth was only 1.2% in Q2, significantly lower than expectations. Prof. James Hamilton has an objective analysis of what is going on. Hint: Inventories are crucial, and difficult to gauge. See also Bloomberg on the inventory story.
  • ISM Index dipped slightly but remained in expansion territory. Calculated Risk has the analysis and this chart:

The Ugly

Printed firearms on airplanes? The TSA caught this example, but there is a technology war going on. If you read the TSA Blog, you will see how many loaded weapons discovered at checkpoints.

 

 

The Silver Bullet

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

 

The Week Ahead

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

The Calendar

We have a moderate week for economic data, as earnings season winds down. While I watch everything, I highlight only the most important items in WTWA. It is important to focus.

The “A” List

  • Michigan sentiment (F). Good read on jobs and spending.
  • Retail sales (F). Consumer spending remains as a key factor for economic growth.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Wholesale inventories (T). Volatile June data, but an important part of gauging GDP.
  • Business inventories (F). More June data with implications for GDP adjustments.
  • JOLTS report (W). Important to understand labor market structure – not job growth.
  • PPI (F). This will become important after a few hot months – but not yet.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

The big story will still be corporate earnings. We have a little FedSpeak. Expect questions to focus on whether a policy change is more likely after the employment report. Don’t expect much new information before Yellen’s Jackson Hole speech. More politics, of course, but without a clear implication for markets.

Next Week’s Theme

Markets seem to have digested the Brexit story, and surprisingly shrugged off the terrorist violence. The economic data have quieted recession worries, and even turned positive. In the slow summer trading I expect more attention to analyzing earnings. Everyone will be asking:

Has the Earnings Recession Reached a Turning Point?

  • The bearish side will emphasize multiple points;
    • The streak of losses continues
    • Profit margins remain high, and (theoretically) vulnerable
    • Earnings results reflect stock buybacks and other financial engineering
    • And other points about how earnings are calculated.

In many ways, this debate will hinge upon forward expectations for the economy, business investment, and future profits.

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

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

The Featured Sources:

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

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

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

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

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

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

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

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

How to Use WTWA

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

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

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We have moved to a bullish market forecast. Felix is fully invested, including some more aggressive sectors. The more cautious Holmes is still about 80% invested. The recent strength has moved Holmes into the bullish camp, and we expect an increase in the number of candidates.

Top Trading Advice

Are you worried about “missing” a trade? Do you switch your system a lot? Do you make “boredom trades?” If your answer to any of these is “yes” you should read this post from Adam H. Grimes.

Is your trading affected by high-frequency models? Do you need to change your methods? Josh Brown has some answers and what you should be thinking about.

Brett Steenbarger distinguishes between successful discretionary traders and successful quantitative traders. Which are you?

Successful discretionary traders I’ve known and worked with have been distinguished by their level of market understanding.  Successful quantitative traders I’ve encountered have excelled at analysis and prediction.  Sometimes the successful discretionary trader makes use of predictive models as inputs to decisions; the successful quantitative trader will ground models in sound market understanding.  At the end of the day, however, quants trade their predictions and discretionary participants trade their understanding.  One trades universal patterns; another trades insights specific to what is observed here and now in a particular market.

 

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility! Mixing insurance and investments is a terrific way to kill two birds with one stone.

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Tony Isola’s discussion of widely believed lies. He includes a great list. I like so many entries that it is tough to pick a favorite. I’ll go with “Mixing insurance and investments is a terrific way to kill two birds with one stone”. What is yours?

Stock Ideas

The Zika virus is prominent in the news. While we all sympathize with the victims, we can also invest in companies working on a cure. Angus Nicholson of IG has some interesting suggestions for biotechs set to win big.

Chuck Carnevale turns his focus to dividend growth stocks in healthcare. This is an attractive sector, and he provides nine timely ideas in Part 1 of 3. This entry was excellent and we look forward to the future installments.

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

 

Market Overview and Outlook

Josh Brown explains (Rules-based tactical vs wizardry and witchcraft) why you should not attempt to imitate big-firm pronouncements by following their calls.

Eddy Elfenbein also weighs in on market timing, reporting the dramatic difference in a Fidelity study.

Avondale’s weekly Company Notes Digest is especially useful during earnings season. You do not have time to listen to all of the conference calls and you certainly cannot count on the media coverage. This is a good way to find important themes. (terrorism more important than Brexit). Also why Aetna is leaving the health insurance exchanges. And much more.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are several great choices worth reading, but my favorite is Jason Zweig’s important warning about the risks of too much stock in your 401-K account. He writes:

Since June, four dozen companies whose stock fell by at least half in 2015 have filed disclosure forms to the Securities and Exchange Commission on their 401(k) and other savings plans. By my estimate, workers at these companies lost $1 billion in 2015 by over-investing in the stock of their own employer.

This is very important. I frequently see such risks in the accounts of potential clients. It is one of the first things we fix.

Value Stocks

Since value stocks have lagged, many strong voices have suggested that the market message is that the economic cycle is over. I covered this subject last week. If you missed it, please take a look. I provide discussion of several stocks recently dissed in the media.

Watch out for….

For those at or nearing retirement, here are eleven common Medicare mistakes.

Final Thoughts

Over the past several weeks we have gotten quite a bit of new evidence to guide our investing. I see four major themes:

  1. Most investors seem to be looking beyond concerns about uncertainty and matters without quantifiable market impacts – Brexit, the election, terrorism.
  2. The economic data looks better than it did in the second quarter.
  3. Earnings expectations seem to have made a trough.
  4. Some sectors are much more promising than others both because of potential earnings growth and current valuation.

The biggest concerns relate to improving earnings, the need for more business confidence, and a resulting increase in corporate investment.

We are entering a period where we can expect a showdown on the economy and earnings – probably in Q3, despite the upcoming election. Fasten your seatbelts!

Weighing the Week Ahead: What Might Derail the Stock Market Rally?

This week’s calendar includes a light schedule for data with an emphasis on housing. Earnings season is in full swing with important reports every day. The early reception has been surprisingly good, creating plenty of mystified pundits. The financial media will be asking: What Can Derail the Rally in Stocks?

Last Week

The economic news was excellent, and the market reaction was strong. The continuing market rebound has caught many off base. This week’s review is mostly positive on economic data.

Theme Recap

In my last WTWA, I predicted that the post-Brexit rally now depended on earnings, especially management discussions of outlook. I noted that there were a record number of appearances by Fed participants as well as the release of the Beige Book, but felt that would be much less important. This proved to be a very accurate guess. In particular, the reception to some key earnings reports was quite strong. CNBC had a couple of short pieces on the FedSpeak, basically proving the expected lack of fresh news.

I hope readers have stayed with the rally during the post-Brexit move. It is important to know what to watch.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. You can clearly see the two big rally days and the quiet Friday. Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

SPX-five-day

 

The News

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

The Good

  • Rail traffic is shows continuing improvement. Steven Hansen helpfully covers the weekly data and various comparisons. Part of the improvement relates to comparisons to weaker 2015 data, so it is not all good news.
  • High frequency indicators have turned better – nearly all of them. New Deal Democrat’s weekly update is very helpful for those wanting a comprehensive survey.
  • The Labor Market Conditions Index (recently weak) has improved. “Fred” has the data.

Labor Market Conditions

  • Wholesale sales improved so I am scoring it as a positive. Steven Hansen goes beyond the seasonally adjusted data, noting that sales are still at “levels associated with recessions’ and there is “degradation in the 3 month averages.”
  • Industrial production rose 0.6%, beating expectations of a 0.2% gain. This is a nice rebound in an important sector.
  • Initial unemployment claims handily beat expectations at 254K. The extremely low level of new jobless claims continues.
  • Retail sales soundly beat expectations with a gain of 0.6% versus 0.2% expected. Ex-auto the results were even better. This was reassuring to those worried about the consumer. (Calculated Risk).

RetailJune2016

The Bad

  • JOLT’s showed a decline in job openings but the important voluntary quit rate was the same. Many observes mistakenly try to use this report to coax out stories about net job growth. That is not the point of this research. It is both slower and less accurate than the regular payroll report. It is much more important for labor market tightness and structure.
  • Congress is leaving on recess. Normally I list this under “good news” but this time there are quite a few issues that were not addressed. After the political conventions the return will be brief. Our legislators naturally need to get back to the campaign trail! Maybe it is time to consider a more efficient way of changing leadership. The Hill has the story about work left undone.
  • Michigan sentiment declined and missed expectations. The experts at Michigan noted concern about Brexit among the high-income respondents. (Steven Goldstein at MarketWatch). This will be interesting to watch. As usual, Doug Short has the best chart summarizing the series.

Michigan-consumer-sentiment-index

 

The Ugly

This week our hearts go out to the French. I am really hoping for a week without ugliness.

 

The Silver Bullet

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

The Week Ahead

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

The Calendar

We have a rather light week for economic data, with an emphasis on housing news. While I watch everything, I highlight only the most important items in WTWA. It is important to focus.

The “A” List

  • Housing starts and building permits (T). An important sector, but a modest decline is expected in starts. I am more interested in permits.
  • Leading indicators (Th). A rebound expected in a series widely followed as a recession signal.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Existing home sales (Th). Less important for the economy than new construction, but a good read on the overall market.
  • Philly Fed (Th). Attracting more information as the earliest data with a label from the prior month.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

The big story will still be corporate earnings, as reporting season moves into full swing. The Republican Convention will grab plenty of news. FedSpeak will die down after last week’s thirteen appearances.

And of course, we can expect more updates on international crises.

Next Week’s Theme

Markets seem to have digested the Brexit story, and surprisingly shrugged off the terrorist violence. The economic data have quieted recession worries. The post-holiday FedSpeak was not threatening. Early earnings reports were OK, but not great.

So why is the stock market reaction so positive? The punditry is already hard at work on this question. I expect the discussion to continue. The market reaction is clearly at odds with what many call “the fundamentals.” If markets keep going higher, the questions will increase. If stocks pull back, we can expect a parade of pundits explaining why.

Either way, everyone will be asking:

What can derail the rally in stocks?

Feel free to join the discussion in the comments, but I see several worry themes:

  • Terrorism. The world is a nasty place and seems to be getting worse.
  • Economic concerns.
    • Deflation – signaled by falling commodity prices, especially cheap oil. Or alternatively–
    • Inflation – signaled by rising commodity prices, especially higher oil prices.
  • Politics.
    • Trump would be a disaster for the U.S. and world economies.
    • Clinton would be a disaster for the U.S. and world economies.
    • Uncertainty. Not knowing who will be elected is a disaster for the U.S. and world economies.
  • Central banks. They painted themselves into a curve, merely delaying the inevitable economic disaster. (I actually heard one of the Fast Money guys use one of mixed metaphors about the Fed. Maybe it was an accident, but he certainly didn’t cite the OldProf!)
  • Market valuation. Markets are too expensive. All of them. Investors cannot expect any reasonable return over the next twelve years (except gold, of course).
  • Technical indicators.
    • Stocks were declining – lacking leadership.
    • Stocks are now overbought and frothy.
    • Stocks are stuck in a trading range.
    • There was a Hindenburg omen – when was that?
  • Weak and mistaken leadership worldwide.
  • Delayed Brexit effects.
  • Global hot spots – South China Sea, Korea

 

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

indicator snapshot 071516

The Featured Sources:

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

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

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

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

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

Big-Four-Indicators-Since-2009-Trough

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

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

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

BCI-Fig-1-7-14-2016

How to Use WTWA

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

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

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue our neutral market forecast. Felix is once again fully invested, including some more aggressive sectors. That continues to work well during the rally. The more cautious Holmes is still fully invested, in a diverse group of 16 stocks from a universe of nearly 1000, selected mostly by liquidity. Sometimes we have had only 14 or 15 stocks. That is revealing. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now. It is not a resounding endorsement of the overall market, but a vote for opportunistic trading. I am curious about what it will take for Holmes to turn “mildly bullish.”

Top Trading Advice

Who is participating in the current market? How and at what levels? Know the background before trading! (Brett Steenbarger).

When you have met your “goal” for a session or a time period, do you stop trading? There is a great discussion at daily speculations. I have a strong opinion on this one, but I am interested in your comments.

Do you use Twitter in your trading? Finding other opinions? Breaking news? Here are some ideas.

Why a systematic daily approach is important to your trading. Holmes was barking appreciatively at the ideas from Pradeep Bonde, especially the unemotional focus on setups and execution. (Easy for him to say!)

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 Aaron Task’s 3 Reasons the Stock Market Is Rising Even As the World Feels Like It’s Falling Apart. Here is a key quotation:

The World Isn’t Ending: While there’s plenty to worry about—including global terrorism, uncertainty over what Brexit really means, anxiety over how U.S. election plays out, and much more—the global economy is expanding, albeit slowly, and the U.S. looks pretty good relative to other developed economies. (Insert “best looking horse in the glue factory” joke here.) And despite legitimate concerns about anti-globalization forces being on the rise here and abroad, the volume of global trade is expected to rise 2.6% this year after climbing 2.8% in 2015.

An old Wall Street saying also helps explain why stocks have fared well despite all the negative headlines: The market climbs a wall of worry.

You should be more worried about the stock market when “everyone” is bullish and the conventional wisdom says buying stocks (or real estate or any other asset) is a “no brainer.” That is certainly not the case today: UBS says wealthy investors are holding on to record levels of cash and 84% believe the election will have a significant impact on their financial health, Reuters reports.

The entire article acknowledges some current concerns, but brings the story back to data.

Stock Ideas

Chuck Carnevale remains cautious, even including top dividend candidates. Anyone seriously interested in finding great stocks should be following his series closely. It provides suggestions, but also the underlying reasoning and data.

Barron’s has a cover story on Royal Dutch Shell. The analysis covers dividends, cost-cutting, and oil prices. Even if you do not agree with the conclusion, this is an interesting approach.

Barron’s also cites Madison Square Garden as almost 60% undervalued on a sum-of-the parts analysis of trophy properties. Once again, this combines an interesting pick with a useful method of analysis.

2016_07_18_cmyk_NL_

Market Overview and Outlook

Traders see a conspiracy to keep the market higher. (Art Cashin). I believe that Art is accurately conveying a widespread sentiment.

The Fear and Greed Trader has a nice overall market summary, providing a refreshing balance to the normal daily news. It is a comprehensive summary and well worth reading in its entirety, but here is a key quotation:

The new highs are being dismissed for one reason or another. Maybe those that are saying that are on to something. I prefer that investors, do some research, draw a conclusion, and exhort all to run far away from the rhetoric that has been wrong now for months and years.

I don’t know where the S&P can trade to now with any certainty as momentum is hard to quantify. What I do know is that the entire market dynamic has now changed given this breakout.

Eddy Elfenbein is musing about Dow 20,000, which he thinks might happen this year.

I agree that this is a good time to buy or own stocks, even for those who have missed out so far. Please check out my own recent update on the market potential and how to find the best stocks and sectors.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are several great choices worth reading, but my favorite is the simple and accurate message from Carl Richards:

When I first start working with clients, there’s a period of time I refer to as the financial pornography detox. It’s when you’ll get calls from clients wanting to know what they should do based on what some talking head said or some headline they read. Your job as a real financial advisor is to help them detox from this nonsense and understand they don’t need to do pay any attention to this so-called investment news.

Check the full post for the helpful illustration and the full podcast.

Brexit News

There is continuing interest about implications beyond the immediate effects. I follow these developments in three different ways.

  • Fundamental economics. Focus Economics has an excellent update on expectations for the UK as well as implications for other countries. (See also).

focuseconomics_uk_afterbrexit_infographic

 

  • Earnings data. We know the outlook is important. What sort of factors are coming up in the conference calls? FactSet offers this distribution:

FactSet earnings calls

  • Extra “color” from the earnings calls. Avondale does a great job with this. I found the JP Morgan comments on loan demand and spending to be especially interesting.

Value Stocks

Value strategies have lagged for the last few years. This year the trend seems to be shifting. (The Capital Spectator).

R1000.val_.gro_.2016-07-13

Watch out for….

Any story mentioning the “aging bull.” This popular theme has been taken up by some of the best sources – probably because it resonates with the instincts of the average reader. It is now competing with “self-taught in Austrian economics” as the most dangerous phrase in the investment lexicon. I will omit citing the multiple references last week, but do not be convinced. There is no relationship between the length of a bull market and the expected number of years remaining.

Even bond king Gundlach warns about the current risk in bonds, with the setup in the ten-year Treasury the “worst in his career.”

 

Final Thoughts

The simple reason for the market rally? Many stocks were priced as if we were already in a recession. As the economic data refuted this notion, prices partially normalized. There is plenty of remaining room, especially in economically sensitive sectors.

Of course there is plenty to worry about. Everyone should be aware of national and world problems, and try to act constructively. Compassion toward those suffering is in the nature of most people, regardless of their values or religious background.

When you think about investments, the problem is sharply different. It is expected and even desirable that the world is filled with problems. The challenge is to understand which problems are actually meaningful for your investments.

One way to keep your eye on the ball (since it is baseball season) is to evaluate the impact of any events on corporate earnings. Look at overall earnings, sectors, and stocks. Be specific. Do not use any lightweight arguments like “the first domino” or “if you see one cockroach.” Brian Gilmartin’s work is a great source for regular updates on earnings trends, combined with his insights. His latest post notes the reversal in both earnings and revenue, a turning point that he accurately predicted.

If your disciplined investigation cannot determine a link to profits, the news may still be very bad — but not for your investments. Embrace times when everyone else seems to have emotional worries.

Afterword – Worries Circa 2010

From one of my key posts in 2010. Please look at the reasons why so many were depressed about the market six years ago. You probably do not even remember some of them, but they were prominent at the time.

Here is a list of worries that I have noted, in no particular order:

  • ETF liquidation doomsday scenario
  • Flash crash — and overall worries about market manipulation
  • Bush-era tax cut expiration
  • Collapse of the euro and/or European Union
  • The Hindenburg Omen
  • Increase in US budget deficits
  • Ominous head-and-shoulders pattern in market averages
  • Dow 5000
  • Dow 2000
  • Dow 1000
  • The collapse of the US consumer
  • The double-dip recession
  • Sell in May
  • Sell in October
  • Sell, Mortimer, Sell (OK, I sneaked that one in for those who know).
  • The BP spill
  • Fear of Obama
  • Obamacare
  • Weakness in the dollar
  • Strength in the dollar
  • Weakness in China’s economy
  • Strength in China, leading to higher rates
  • Korea
  • Iran
  • Initial claims spiking to over 500K
  • Initial claims falling, but results skewed by seasonality
  • Shadow housing inventory
  • Foreclosure robo signing
  • Overstated and exaggerated corporate earnings
  • Fed blunders — QE II
  • High frequency trading
  • Worldwide collapse and deflation
  • Worldwide hyperinflation

 

The single most important thing for the investor to understand — right now — is the value of worries.  If you are looking for good investment returns, you need a time when others are worried.

The concept of the “wall of worry” is difficult for the average investor.  They seem to think it is bad when there are many worries.  In fact, the lack of worry is a sign of a market top.  Let me simplify.

Here is the image of the market top:  “What?  Me Worry?”

6a00d83451ddb269e20148c6fca9d9970c-450wi

 

Weighing the Week Ahead: Why the Surprising Strength in Employment?

The economic calendar had most of the big news last week. Earnings season is winding down. It is a time to digest and analyze what we have learned. Many will be asking:

Why is employment growth still strong while other indicators show weakness?

Prior Theme Recap

In my last WTWA (two weeks ago), I predicted that the media buzz would focus on the challenge to the old highs in the stock market. This was indeed a popular topic as the market moved higher. After last Tuesday’s primaries, it was trumped by political news. (I have trumping on my mind (heh heh) only because many of my friends are currently competing in the Team Trials to determine the U.S. representative to the 2016 World Bridge Games).

The attempt at a new stock record missed again and the early strength last week also faded. Doug Short captures the story with his excellent weekly chart. (With the ever-increasing effects from foreign markets, you should also add Doug’s World Markets Weekend Update to your reading list).

SPX-five-day

The entire post adds more analysis on the major themes as well as a multi-year context. Since it has been two weeks since the last WTWA, I will include a second of Doug’s charts to catch up. You can see another failed rally, a triple top, a head-and-shoulders, and an upside down head-and-shoulders.

SPX-2

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

 

This Week’s Theme

The economic calendar has mostly secondary reports this week. Friday’s employment data rekindled an ongoing debate about employment growth versus the other indicators showing economic weakness. We will have help (?) from plenty of FedSpeak, probably offering widely different conclusions. I expect attention to center on the following question:

Why is employment fairly strong while so many other indicators seem weak?

The Sideshow

My suggested theme is a bit too wonky for media sources seeking viewers and readers. I understand that many will be tempted instead to wax political, trying to infer what the election means for your investments. I wrote about the political theme two months ago, and the implications have not really changed. Just skip to the conclusion of that post. This week Barry Ritholtz does one of the better pieces on political implications for investors, reaching a conclusion similar to mine. He notes the biggest new idea, also debated by the Squawk on the Street gang: A Trump presidency might well involve refinancing debt and doing a lot of construction.

Here are some public policy differences between the leading candidates. It is a starting point for thinking about specific stocks.

Background

Pundit scrambling continues. After Monday’s modest market strength, a TV anchor glibly stated that the gains were not surprising given the start of the month and the expected news from BuffettFest. He had not suggested this on Friday, in time for your trading and the tune quickly changed on Tuesday. So typical.

Those charged with explaining each and every piece of economic news have had to deal with a mixed picture.

Question

How much time per day does the average Facebook user spend on the site? Answer at the end of today’s post.

Viewpoints

The basic themes, moving from bearish to bullish on stocks are as follows:

  • Global recession is upon us. There is something wrong with employment data. GDP is better.
  • Most recent U.S. indicators have missed expectations.
  • Leading indicators show a slower rate of expansion. Employment will soon catch up.
  • Earnings have been engineered. Just look at sales for the truth.
  • Job growth is the most reliable economic indicator, better than GDP. (NYT)
  • Wages show a consistent 2.5% year-over-year increase. Spending will follow.
  • Q1 will mark (yet another) soft spot to the start of the year. Expect a resumption of modest growth.
  • Growth is about to increase, stimulated by increased Federal deficits, policy changes in China, and low interest rates.

 

It is easy to find disciples for each viewpoint.

As always, I have my own opinion in the conclusion. Make your own choice, and feel free to make your case in the comments.

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 an “ugly” and on rare occasion something really good. My working definition of “good” has two components:

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

The Good

There was some good news.

  • Bullishness registers a major drop. Mark Hulbert explains why the market timer behavior is probably bullish for stocks.

w704 

  • ISM services increased and beat expectations. The reading of 55.7 also reflected some positive comments from respondents.
  • The lending environment has improved. Torsten Sløk of Deutsche Bank (via Barry Ritholtz) writes that banks are more willing to lend and consumers more willing to borrow. Using the Fed’s Senior Loan Officer Survey, he cites stronger consumer balance sheets and solid improvement growth as reasons for improvement from a sluggish start to the year.

lend 

  • Earnings reports were mixed. FactSet reports that the earnings beat rate is positive. The sales beat rate remains below the five-year average. A common story is a company beating on the bottom line, but missing on sales, also slightly worse than the five-year average. Outlooks are better than average. Utilities are weak. Auto companies are strong. Brian Gilmartin is a bit more optimistic (but cautious) as he cites the ex-energy numbers.
  • Employment growth remains positive. The monthly employment report is sufficiently complicated to permit spinning in any direction. I heard authoritative sources comment on the net jobs increase needed to avoid more unemployment, with a range from 85,000 to 130,000. My employment preview post explained why too much is made over small changes in a single month. The basic trend of reasonable growth continues, but without the major increase we normally see in an expansion. This economic recovery has been slower and stretched out. The question is how much further employment can improve. While everyone has an opinion, the WSJ always had a good chart pack on this subject. Here is one.

 

WSJ employment

 

A source with no horse in the race (Holmes instructed me not to use “dog in the hunt”) has an interesting take on seasonal adjustments. He believes that the adjustment background is too short and the weather recognition too limited. This is a good subject for a full post, but readers may want to consider it.

jobnumbers5616

 

The Bad

Some of the news was negative.

  • Productivity increased and beat expectations. But it remains unacceptably low. Scott Grannis calls it the “missing ingredient.”
  • ISM manufacturing dropped to 50.8 and slightly missed expectations.
  • Auto sales missed expectations by about 0.5%, but improved over the prior month.

The Ugly

Cheating on data announcements. A study by the ECB suggests the presence of “informed trading.” (This sounds like one of my euphemisms!) The results cover a wide range or reports including both public and private. This is an important topic for traders, especially those carrying positions overnight. Here is a key quote:

Abstract

We examine stock index and Treasury futures markets around releases of U.S. macroeconomic announcements. Seven out of 21 market-moving announcements

show evidence of substantial informed trading before the official release time. Prices begin to move in the “correct” direction about 30 minutes before the release time.

The pre-announcement price drift accounts on average for about half of the total price adjustment. These results imply that some traders have private information about macroeconomic fundamentals. The evidence suggests that the pre-announcement drift likely comes from a combination of information leakage and superior forecasting based on proprietary data collection and reprocessing of public information.

 

If you believe that the results are achieved from “superior forecasting” you are not a long-time reader of WTWA!

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts.  Think of The Lone Ranger. This week’s award goes to Jeff Reeves who questions a Reuters column suggesting that Tesla was overvalued since its market cap represented a huge multiple of cars sold.

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

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

Reeves suggests (after the mandatory “with all due respect”) that you are an idiot if you take that approach. He provides a number of excellent examples from other companies illustrating that this is a completely irrelevant approach to valuation. Please read the article to see how Netflix, Facebook, Apple, Coke, the New York Times, and biotech might compare.

There are so many catchy headlines and so little refutation!

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. I recently made some changes in our regular table, separating three different ways of considering risk. For valuation I report the equity risk premium. This is the difference between what we expect stocks to earn in the next twelve months and the return from the ten-year Treasury note. I have found this approach to be an effective method for measuring market perception of stock risk. This is now easier to monitor because of the excellent work of Brian Gilmartin, whose analysis of the Thomson-Reuters data is our principal source for forward earnings.

Our economic risk indicators have not changed.

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

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

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

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

For more information on each source, check here.

Indicator Snapshot 050716

Recent Expert Commentary on Recession Odds and Market Trends

Doug Short: Provides an array of important economic updates including the best charts around. One of these is monitoring the ECRI’s business cycle analysis, as his associate Jill Mislinski does in this week’s update. She cites a recent presentation by ECRI co-founder Lakshman Acuthan suggests a period of “stagflation lite.” The review of the ECRI is comprehensive and provides an interesting comparison with Recession Alert, one of our featured sources. Chart lovers will love this regularly updated article.

Doug’s Big Four update is the single best visual review of the indicators used in official recession dating. You can see each element and the aggregate, along with a table of the data. Doug’s updates cover both the individual elements and a chart-packed summary helping to see what it all means. Here is the look after Friday’s employment report.

Big-Four-Indicators-Since-2009-Trough

 

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.” His view of where we are in the business cycle differs sharply from that of the ECRI. His approach has been more accurate over a long period and especially in the last decade. I am overdue for an update comparing the recession methods. (So many great topics to consider, so little time).

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

Georg Vrba: provides an array of interesting systems. Check out his site for the full story. We especially like his Business Cycle Indicator, updated weekly and now featured in our table. Georg also has an unemployment rate recession indicator. This has long confirmed that there is no recession signal. What would it take to change the prognosis? In this interesting post he suggests that an increase of 0.3% in unemployment would warn of a recession.

This week Georg added a new indicator, (DAGS) a variant of Bob Dieli’s Enhanced Aggregate Spread. His excellent article includes a discussion of what might cause a recession as well as an approach that historically would have improved the lead time for a recession signal. In a companion post he describes the Dieli method including similar charts for comparison. Concerning the prospects for a recession, Georg writes as follows:

Assuming that the current trajectory of the DAGS does not change, then it will reach zero in the fourth quarter of 2016, signaling the possibility of a recession start 40 weeks later, in the third quarter of 2017. However the DAGS could rise again, as it did after January 2012 when it was at a similar level to where it is now.

Under current economic conditions the DAGS would indicate a cycle peak much earlier than the EAS, and when such a signal occurs there would be ample time to consult a set of coincident indicators to make a recession call.

DAGS+-fig-1

 

 

The Week Ahead

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

The “A List” includes the following:

  • Retail sales (F). Expectations are for a solid rebound.
  • Michigan sentiment (F). Some distrust survey data, but there is no better way to discover current spending and employment trends.
  • JOLTS Report (T). The report on job openings is still relatively new and widely misunderstood. Important indicator of structural changes in the job market.
  • Initial claims (Th). The best concurrent indicator for employment trends.

 

The “B List” includes the following:

  • Wholesale inventories (T). Volatile March data, relevant for Q1 GDP.
  • Business inventories (F). March data, but relevant for Q1 GDP.
  • PPI (F). Inflation by any measure remains of secondary importance until we get a few hot months. Then the story will change significantly.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

     

FedSpeak is back! Those thirsting to hear more from Fed Regional Presidents will have an opportunity almost every day next week.

Political news will continue, but a big market impact is unlikely – at least for now.

There are still some important earnings reports as the Q1 reporting season winds down.

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

We continue our neutral market forecast. Felix is still 100% invested, but there are fewer attractive sectors. The more cautious Holmes remains close to fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. Holmes holds a maximum of 16 positions at one time. For more information about Felix, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix and Oscar’s weekly ratings updates via email to etf at newarc dot com. They appear almost every day at Scutify (follow here). I am trying to figure out a method to share some additional updates from Holmes, our new portfolio watchdog. (You learn more about Holmes by writing to info at newarc dot com.

Dr. Brett continues to find ideas that no one else has discussed. This week he explains about the “path” to a good trade. Here is a stimulating excerpt:

Let’s do a thought experiment:  I might expect a stock index to move from 2000 to 2100, a 5% move.  Let’s say the index remained nearly unchanged in value for six months before shooting higher to 2100 in the seventh month.  How many traders would have stuck with this trade?

Let’s consider a different scenario:  The index moves from 2000 to 2100 in one month, but only after having dropped to 1940 in the first week.  How many traders would have stuck with this trade?

Mike Bellafiore warns not to jump the gun, anticipating before your setups are really in place.

(The cautious Holmes is barking approval at this idea).

Insight for Investors

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

We also have a page summarizing many of the current investor fears. If you read something scary, this is a good place to do some fact checking. Pick a topic and give it a try. Feel free to suggest new topics if your own “fear” is not on the list.

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

Other Advice

Here is our collection of great investor advice for this week. If I had to pick a single most important source for investors to read, it would be Morgan Housel’s post, Alternative Definitions of Risk. He explains that even significant market volatility (like 2011) does not signal real risk. He cites several types of risk that are often neglected. Here is a good example:

The risk of inadequate return

Cash is now the most desirable asset among savers age 18 to 29,  even if the money isn’t needed for 10 years, according to a survey by Bankrate.

Young investors do this to cut down on the risk of investing in stocks. But odds are they will come to see this as one of the riskiest investments they ever make. Cash for the long-term won’t fund future goals, while the market volatility they’re avoiding today posed little risk to those future goals.

 

Stock Ideas

Goldman Sachs recommends a dividend basket.

When should you sell a stock? George Athanassakos a Professor of Finance and the Ben Graham Chair in Value Investing suggests eight reasons. I like and use them all!

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. There are several great choices worth reading. We all like apps and we also like saving money, so you will enjoy my favorite from the group, 5 Apps That Will Actually Save You Money.

Outlook

Oppenheimer Funds sees the China prospects as encouraging. This is an interesting contrarian viewpoint.

Value Stocks

Has the tide turned? Morgan Stanley notes that in 2016 value has beaten growth. So far, so good for my prediction that 2016 will be the year of the value stock. (For those interested, get a free report from main at newarc dot com).

MS-5-2-USD-value

Watch out for….

Non-traded REITs. Before deciding that this is the right investment for you, be sure to read the fine print. Here some excerpts of listed risk factors from an actual offering. As a buyer, you sign off indicating that you have read all of this stuff!

the proceeds from a sale or redemption of shares may be less than the original amount invested;

there are substantial conflicts among the interests of the REIT’s advisor, sponsor, dealer manager and respective affiliates;

may incur substantial debt, which could adversely impact the value of an investment;

obligated to pay substantial fees to its advisor;

may pay distributions from any source, and there are no limits on distributions that may be paid from sources other than cash flow from operations;

…and a general observation that payments may come from assets rather than operations. So much for your expected 7% annual return.

Final Thoughts

When I do not have a solid answer to the weekly theme question, I am not afraid to say so. If only more observers would do the same! Readers sometimes complain that I do not give a specific answer to my own question. That misses the point. The weekly question is my prediction for the market theme – what you will see in the media. I cannot control that, and it would be dishonest to claim an answer that I do not really have.

This week is different. I have confidence in the recession indicators I cite – chosen after extensive study and analysis. I also have studied labor economics and the various tracking measures. Most of those commenting on the employment versus GDP question are talking their book. The bond folks disparage employment and the stock reps cite employment data. My mission is quite different. I need to guide clients into whatever is best for their personal circumstances and the current environment.

While I have looked at many indicators, here are two that are typical of the main theme.

  1. The global economic fears are overstated. Gavyn Davies (FT) has a thoughtful article, Fading Risks of Global Recession. He cautiously notes as follows:

    The latest nowcast shows a rebound in global activity growth to 3.4 per cent, which is just below trend. Growth in the advanced economies has rebounded from a low point of 1 per cent in February to 1.4 per cent now (ie still about 0.3 per cent below trend). Growth in the emerging economies has jumped from 3 per cent in February to 5.5 per cent now, which is at trend for the first time in three years. However, the rebound in the emerging economies is driven by improvements in China and Brazil, both of which are subject to large risks of renewed setbacks in coming months.

ftblog1073

  1. Employment, measured in many different ways, shows no sign of rollover. One advantage of subscribing to Bob Dieli’s service is a monthly deep dive into the employment data, published the day of the report. Whether you are interested in labor force participation, part time workers, wages, job quality or overall trends, one of the forty pages of charts will provide an answer. I am trying to persuade Bob to offer a lower-priced version for average investors. His big theme this week was that the economy was not rolling over. The expansion phase continues. The chart below is but one example:

Dieli April 2016 Employment

Getting the most out of your investments is not just a matter of buy-and-hold. It also does not require guessing the “normal” market volatility in an effort to be a genius. It certainly does not mean going all-in or all-out.

Long-term investors profit from a focus on data, not emotion.

Answer to the Facebook question: 50 minutes per day. My reaction is Wow! What is yours?

Weighing the Week Ahead: What Does the Election Mean for Financial Markets?

Last week’s economic calendar was the biggest of the year and this week’s is the lightest.  In the absence of important economic news and earnings, where will financial media turn to fill that space and time?  The Presidential election campaign is providing a lot of zest as well as a little substance. I expect financial pundits to be asking:

What Does the Election Mean for Financial Markets?

 

Prior Theme Recap

 

In my last WTWA I predicted that attention would focus on whether the improving economy could support stock prices.  Despite political events, that was a main theme of the week, with many observers noting that the data did not seem to support the widespread worries about a recession.  Things were “less bad” than thought, and maybe even getting better.  Friday’s employment data sealed the deal.  There was not much additional gain in the overall market, but value stocks and economically sensitive names did very well.  You can see the story in Doug Short’s weekly chart.  (With the ever-increasing effects from foreign markets, you should also add Doug’s World Markets Weekend Update to your reading list).

SPX-five-day

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

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

Personal Note

I will be traveling next weekend and might not be able to post.

This Week’s Theme

With a very light economic calendar and earnings season winding down, how will the punditry fill the air time and blank pages?  One solution is to look for raucous entertainment that has a little market content as well.  These stories were already grabbing attention last week after the (ahem) spirited GOP debate and Super Tuesday results.

As always, I want to emphasize that I write about investments, not politics.  Sometimes the two intersect.  I try to show how investors should use knowledge about candidates and policies for profit, even if their personal opinions differ from the likely winners.  (See today’s Final Thought).

WTWA starts with identifying the upcoming theme.  I do not get to choose what the media should cover!  This week, I expect a focus on the Presidential election, with people asking:

What does the election mean for financial markets?

Barron’s reached a similar conclusion with a cover story asking whether Trump or Clinton was better for investors.  Some might be surprised at their conclusion.  This table summarizes their opinion about the key policy differences:

IMG_0019

Viewpoints

Election coverage by financial sources includes the following:

  • The “horse race” stories are all about who is leading and projections of results.
  • The campaign stories feature interesting moments and quips.
  • The advocacy stories tell you how you should vote — sometimes with contending viewpoints, but often not.
  • The macro stories try to reach a conclusion about the overall economic and market effects that are the likely result from the election of each candidate.
  • The policy stories bring in experts from sell-side firms to explain ideas of the market impact for the election of each candidate.

 

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

Last Week’s Data

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

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

The Good

On balance the important news was pretty good last week.

  • Construction spending was up 1.5% versus expectations of 0.5%.
  • Factory orders turned positive with a gain of 1.6% in January.

HotelFeb280216

 

  • ISM services best expectations at 53.4 and remained in expansion.  Steven Hansen at GEI analyzes with some emphasis on the mixed nature of the report.
  • Employment showed solid gains both in the ADP private payrolls (up 214K) and the “official” BLS report (up 242K).  Both beat expectations. (See The Capital Spectator for charts and coverage of the ADP story).  The unemployment rate remained below 5% and labor participation increased.  (Please note the absence of commentary on seasonal adjustments from the sources featuring that interpretation last month.  This month the change was a subtraction of about 600K jobs.  We need to observe when dogs quit barking!)  FiveThirtyEight has a new economics column from Ben Casselman.  He features the improvement in labor force participation.

One negative was the drop in hourly wages.  Business Insider has the whole story in thirteen charts from Deutsche Bank.  Many critics of employment gains point to the U-6 rate as a better read on conditions.  It has been improving rapidly, suggesting less slack in the labor market.

the-u-6-unemployment-rate--a-broader-measure-that-includes-workers-who-are-working-part-time-but-want-full-time-work--is-falling-.jpg

The Bad

There was also negative news, but mostly consistent with continuing sluggish growth.

  • Federal budget reform had a setback.  This did not get much attention, which is very unfortunate.  Former Congressional Budget Office Director, Georgetown Prof., and think-tank veteran Donald Marron explains both what happened, and why we should care:

On Monday, the Government Accountability Office (GAO) defended the current method for budgeting for federal lending programs, known as “credit reform.” By endorsing the status quo, GAO puts itself at odds with the Congressional Budget Office (CBO), which has championed a “fair value” alternative. The details are wonky but the stakes are big. Over a decade, federal lending support for mortgages, student loans, and the Export-Import Bank could appear $300 billion more costly under fair-value budgeting than under credit reform.

  • Pending home sales declined by 2.5%.  (Calculated Risk)
  • The trade balance was -45.7 billion, a bit worse than expectations.  Lower exports represent a drag on GDP.
  • Auto sales had a SAAR of 17.43 million, slightly below the 17.6 expectations.  The pace was about the same as last month and still up 7% from last year.  (Calculated Risk)
  • Nonfarm productivity continued the slide at -2.2%.  I am scoring this as negative (even though it beat expectations) because a change here is especially important.
  • Initial jobless claims increased to 278K.  While this increase missed expectations, it is still in a comfortable range.  Bespoke analyzes and includes this great chart:

030316-Initial-Claims-SA

  • ISM manufacturing remained in contraction territory at 49.5.  The Chicago PMI was only 47.6.  Given the long-term decline in manufacturing, it is important to remember that these readings are consistent with a 2% increase in GDP.  The official ISM report provides some color by showing examples of responses from different sectors:

WHAT RESPONDENTS ARE SAYING …

“Low oil prices and reduced activity continue affecting our business.” (Petroleum & Coal Products)

“U.S. business demand is solid; international demand is soft.” (Chemical Products)

“Mobility spend is up.” (Computer & Electronic Products)

“Business has to get better. And it appears it is. Healthy backlog for 2016.” (Fabricated Metal Products)

“Very strong demand for product. Material availability very good and commodity pricing continues to be depressed.” (Machinery)

“Airlines are still ordering planes and spare parts for plane galleys.” (Transportation Equipment)

“Market is beginning to trend up with spring season on its way.” (Wood Products)

“Not seeing impact from global economic volatility or oil prices. Business is strong and growth projections remain the same.” (Miscellaneous Manufacturing)

“Orders are coming in stronger than expected.” (Furniture & Related Products)

“Still a bit sluggish.” (Food, Beverage & Tobacco Products)

 

The Ugly

The small town hospital crisis.  Many rural hospitals have closed and hundreds more are near bankruptcy.  This affects the access to care as well as where people will choose to live.  (Small towns watch aging hospitals shutter)

 

Noteworthy

CityLab takes up a recent popular topic — inequality.  They provide an interesting interactive national chart showing the most distressed areas.  I cannot do justice to it in this post, but here are the most distressed cities:

fdc1f45fa

The Silver Bullet

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

This week’s award goes to Robert Novy-Marx (HT Alpha Architect) for his article,  Predicting anomaly performance with politics, the weather, global warming, sunspots, and the stars.  The analysis shows explanations for a number of interesting subjects.  Taking the stock market as an example of interest to us, he finds a correlation with the weather in Manhattan.  We could infer some causation from the mood of traders, he suggests.  But the same effect is present when looking at the weather in Hilo, Hawaii and Bozeman, Montana.  He then further slices the data looking at seasonals.  January is biggest.  Sound familiar?  It certainly should.  You see similar post-hoc “explanations” every day.  (If you missed it, please see my “Craving for Explanations” post, which is important for understanding the energy/stock relationship).

 

Quant Corner

 

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

Our economic risk indicators have not changed.

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

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

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

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

For more information on each source, check here.

Indicator Snapshot 030516

Recent Expert Commentary on Recession Odds and Market Trends

 

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

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

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

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis.  While we feature the recession analysis, Dwaine also has a number of interesting systems.  These include approaches helpful in both economic and market timing.  He has been very accurate in helping people to stay on the right side of the market.  The key is the change in the unemployment rate.  (This is a factor in several methods).

Dwaine has introduced a new indicator, using only the timeliest data and a distinct improvement over the ECRI approach.  Read the entire post for details and a number of interesting charts.  He has also updated his long-leading index, which is starting to show some weakness.

Philosophical Economics joins those in search of the “perfect recession indicator” and concluding that there is no current threat.

Scott Grannis on the equity risk premium, which we recently began to feature:

So far, earnings are down only a little more than 2% in the past 12 months, and most of that is coming from the oil patch. Put another way, the current PE ratio of the S&P 500 is 17.4, whereas the PE ratio of the 10-yr Treasury is 58! To pay so much for the presumed safety of Treasuries is to have truly dismal expectations for economic growth and corporate profits.

Equity risk premium

The Week Ahead

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

The “A List” includes the following:

  • Initial Claims (Th). A lot of attention to the recent volatility in the best concurrent news on employment trends.

The “B List” includes the following:

  • Crude oil inventories (W). Attracting a lot more attention these days.
  • Wholesale inventories (W).

There is also plenty of FedSpeak on the schedule.

 

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

We continue both the neutral market forecast, and the bearish lean.  Felix is still 100% invested in fairly aggressive sectors. The more cautious Holmes is completely out of the market, after taking profits on the remaining positions.  For more information about Felix, I have posted a further description — Meet Felix and Oscar.  You can sign up for Felix and Oscar’s weekly ratings updates via email to etf at newarc dot com.  They appear almost every day at Scutify (follow here).  I am trying to figure out a method to share some additional updates from Holmes, our new portfolio watchdog.  (You learn more about Holmes by writing to info at newarc dot com.

  • Dr. Brett has another post with an insight you would not find anywhere else.  He notes that there are cycles in life as well as in markets.  His advice?  “The trading psychology literature speaks a great deal of discipline and confidence and emotional control.  Rarely do we focus on acceptance as a cardinal virtue”.
  • Mark Hulbert sees more upside for stocks because of negative sentiment.  Check out his comparisons and the chart of the Wall of Worry.

Insight for Investors

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

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

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

Other Advice

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

If I had to pick a single most important source for investors to read, it would be Morgan Housel’s article on the “Anti-Reading List”.  He warns that despite the need to read constantly, but warns about the need for filters.  He cites three types of reading to avoid, including political opinions disguised as investment analysis.  (He also quotes Sherlock Holmes, earning a “bark out” from our new company dog!)

 

Stock Ideas

Berkshire Hathaway.  Warren Buffett notes that he might buy back stock if it were to trade at 1.2 times book value.  It currently represents 1.3 times (a growing) book value.  Many see this as providing a floor under a stock that is already attractive.  (Brett Arends, MarketWatch)

Think tires, not autos.  Lower gas prices mean more miles driven.  Chris Bryant at Bloomberg explains.

Dividends are important, but must come from somewhere.  Chuck Carnevale shows the need for considering total return in dividend stocks.  As always, he has some great stock ideas.

Watch out for….

FANG stocks — now lagging the market.  Beware of chasing last year’s favorites. (Horan Capital Advisors)   (If you agree with me that 2016 might well be the “year of the value stock” then you should request a free report from info at newarc dot com).

Auto lenders.  The WSJ highlights the risks.

Bonds (and especially bond funds).  Scott Grannis has one of his typical chart packs covering current economic conditions.  The entire post is good reading, but this comment is especially interesting for investors:

With 10-yr Treasury yields currently a mere 1.73%—only 25 bps above their all-time lows of mid-2012—the bond market is priced to slow-growth, low-inflation perfection; it’s vulnerable to any sign that inflation is either not falling or rising, and/or any sign that economic growth is, say, 2% or better.

10-yr Treasury yields 25-

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years.  The average investor should make time (even if you are not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. There are several great posts this week, but I especially liked Tony Isola’s advice on how to choose an honest investment advisor in ten minutes.  It will only take two minutes to read the five statements that should be flashing a red light!

Final Thoughts

As always, my strong recommendation is that you should be politically agnostic when making investment decisions.  Vote your heart and your conscience, but invest logically and without emotion.

Avoid the confirmation bias trap — believing that a candidate you do not like will wreck the country.  We have had some pretty bad Presidents, and managed to muddle through.  It is fairly routine for opponents to predict disaster and then miss out on big rallies in stocks.  Barry Ritholtz writes:

Recall that some investors believed Obama to be a Muslim Kenyan Socialist who was going to destroy the Dow — just before the market tripled during his presidency. And before him, George W. Bush was going to blow out the deficits, kill employment, and cause other problems — instead, the market nearly doubled.

Watch developments strictly to determine which themes or economic sectors are most likely to gain or lose.  The election is just one factor among many.

Most importantly, it is too soon to know who will be elected — and maybe not even who will be nominated.  If you are a political junkie, go ahead and watch for entertainment.  As an investor, you should just tune out the noise!