Headline Spin — Recession Forecasting is Back!

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

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

 

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

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

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

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

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

 

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

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

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

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

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

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

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

Is there another side to this?

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

 

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

Investor Protection

There are two ways investors can protect themselves:

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

Actionable Investment Advice

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

The Quest for Investing Excellence and the Lesson of Dow 20K

The new movement to passive investments is a sharp break from the historical quest for excellence. Many articles claim that no one can do better than the market average. If that is true, you should just throw out your investment library and skip the popular lists of “best investment books.”

This post will suggest a short list of books that would have needed quite different titles. They also would not have become best-sellers! In the conclusion, I will provide some ideas about why this is important for your investment decisions. Here are the hypothetical titles followed by a cover shot of the real book. Suggestions for more examples are quite welcome!

 

In Search of Mediocrity

Market Sheep

The Average IQ Investor

The Little Book that Equals the Market

Common Stocks and Average Profits

Buffett: The Making of a Lucky Investor

Stay Even with Wall Street

Implications

In this series on investment expertise I have (so far) covered the following:

  • There are indeed experts. Sometimes it is obvious, and sometimes they are difficult to find. Consider the case of Phil Mickelson.
  • Forecasting is not always folly. I provide specific examples of expertise, and a checklist for finding the best modeling experts.
  • Dow 20K. The round-number milestone has finally been achieved – at least for today! There are many who are stepping up to claim some credit for their prediction on this front. Some were way too early, and others made the call as we got much closer. Each prognosticator had a method.

My own Dow 20K forecast came when the Dow was at 10,000 and many prominent pundits were calling for Dow 5000! My opinion was controversial at the time. Check out the history of the forecast to remind yourself of how bad things were (unemployment over 10%, and I was ridiculed for suggesting it might fall to 8%).

While it is nice to get some recognition (like this spot from CNBC when we got close to the milestone last month), I see it more as a validation of my methodology. I seek out the best experts. I am constantly looking for excellence. I know that I do not have all of the answers, but my background taught me how to search and to learn. Following superior methods helped to keep my readers and clients on the right side of the market through a long rally hated by most of the punditry and many traders.

There are many paths to trading and investment success. Mine was not the only way, but it was a good way. Having strong evidence and indicators is crucial for confidence.

What Now?

Most of the key factors I see as important are still in place. I summarize them each week. The list of worries has changed a lot but it is still there. The time will come to pull back – but it is not here yet.

 

Weighing the Week Ahead: When Will the Trading Range Be Broken?

We have normal week for economic data, including the first estimate for Q3 GDP. There are also important earnings reports. Election stories have become even more intense. Meanwhile, the market has been pretty quiet. I expect financial media to be asking:

When will the trading range be broken?

Personal Notes

I will be traveling next week and probably will not write WTWA.

I have completed my new 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 email address with anyone.

Last Week

Last week’s news was pretty good, despite the modest reaction in stocks.

Theme Recap

In my last WTWA, I predicted more attention to the “stealth market rotation.” This idea got a little attention on Monday from the Pundit-in-Chief, but that was all. The rotation was less pronounced and the competing stories were good ones.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. Stocks had a slightly positive week, but the real story is the continuation of a very narrow trading range.

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

The 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

  • Building permits rose and beat expectations. But housing starts declined (see below). New Deal Democrat analyzes this contrast and the effect on his leading indicators.
  • Philly Fed also beat expectations.
  • Existing home sales rose 3.2%. Calculated Risk is the go-to source on housing, and Bill continues his analysis of the effects of the small inventory. This concept is essential to understanding housing trends.

  • Industrial production registered a (small) increase of 0.1%. Steven Hansen notes that the year-over-year figure is still in contraction.
  • Hotel occupancy still on pace to be the second best year in history. (Calculated Risk)
  • Earnings season shows continuing strength. FactSet reports that 78% of S&P 500 companies are beating earnings estimates and 65% beating on sales. Take a look at the entire analysis. Here are two interesting takeaways.

The Bad

  • Rail traffic continues to decline, even when coal and grain are excluded from the data. Steven Hansen does a thorough analysis of the trends.
  • Jobless claims edged 13K higher, moving away from recent lows.
  • Housing starts declined and missed estimates. The annual rate was 1.047 million. Calculated Risk discusses and notes that his prediction at the start of the year, growth of 4-8% still looks about right.

 

The Ugly

Increased hacking. Yesterday’s widespread outage attacked a domain name service, according to MarketWatch. Engadget says, Blame the Internet of Things and provides the map below. The hacking began with home devices which often have weak security protocols. With that entry, the distributed denial of service attack took down a list of major sites, including “Twitter, Spotify, Reddit, The New York Times, Pinterest, and PayPal.”

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 Ryan Detrick of LPL Research. I am showing the power of his work via the two key charts, but reading the entire post will help you to spot these things on your own.

 

The Week Ahead

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

The Calendar

We have a normal week for economic data, along with many important earnings reports. I watch everything on the calendar, so you do not need to! Check out WTWA to focus on what is really important – and ignore the noise.

The “A” List

  • New home sales (T). Continuing strength needed.
  • Consumer confidence (T). The Conference Board version spiked last month. Few expect the gains to hold?
  • GDP for Q3 (F). Even though this is backward looking, it will get plenty of media attention in front of the election.
  • 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

  • Pending home sales (Th). Not as important as new homes for immediate economic effect, but a good market indicator.
  • Durable goods (Th). Volatile September data, but important for the overall assessment of the economy.
  • Existing home sales (Th). Without the impact of new homes, but still a good read on the overall housing market.
  • 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 of course…the candidates.

Next Week’s Theme

Despite the many events that normally increase volatility, the stock market has traded in a narrow range. There is an increasing sense that “something’s got to give.” The exact cause and timing remain unclear, but the obvious choice is Election Day.

I expect an active discussion about a looming market question:

When will the trading range be broken?

Here is a chart of the market over the last year:

If you look at mid-July through today, you can see that the trading range has been quite narrow.

Now let’s turn to the sequence of topics I have written about in the last two months. These remind us of what we were thinking and worrying about each week.

  • Possible rate increase after Jackson Hole 8/28
  • Chance of an Autumn Correction 9/3
  • Should we fear the Fed? 9/11
  • Is the bond correction at hand? 9/18
  • Election effects on the market 9/25
  • Time to get past the gloom? 10/2
  • Earnings recession over? 10/9
  • Market rotation at hand? 10/16

Despite this list of challenges, stocks have held up pretty well.

Many are expecting the trading range to be broken soon. But in which direction?

Election predictions range from a surprise, Brexit-style victory for Mr. Trump to a Democratic sweep. The markets seem to favor a Clinton victory, but a continuation of divided government, mostly because of reduced uncertainty.

At the beginning of the year I wrote that the investment effects of this election were smaller than most would expect. The President has much less power to change policy than most people think – especially in the face of a Senate filibuster. Either candidate would need to forge alliances with the other party to make major changes. OppenheimerFunds has some interesting comments about surprises from past elections, and advice for investors this time.

Data indicate that many are not following this advice. A BlackRock survey (via Financial Advisor IQ) found that 53% of investors have raised their allocation to cash because of the “persistent volatility.” The Presidential election gets credit as a major cause.

The perceived volatility is completely wrong – certainly for the last few months, and also for several years. If you missed my post on testing your Confirmation Bias Quotient, you might want to take a look. Something is causing many investors to perceive volatility that is not really there.

Bloomberg reports that investor cash levels have not been seen since 9/11.

Join in the comments with your ideas on when the trading range will be broken, and in which direction. 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.

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).

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.

“Davidson” (via Todd Sullivan): An excellent, understandable description of the interest rate cycle and its close association with recessions. The description of the factors we can expect to see before a recession will come — someday. Here is a key quote and chart:

Recessions, for the most part, in my opinion, are predictable. The rate spread between T-Bills and the 10yr Treasury is 1.20% today or 120bps (basis points). Based on history, lending continues, a relatively high level of pessimism continues and so does economic expansion. The rate spread is only one of several economic measures we have available that indicates economic expansion is likely to continue for several years.

 

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 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 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 also the best advice from sources we follow.

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar holds several aggressive sectors. The more cautious Holmes also remains fully invested. They now have a regular Thursday night discussion, which they call the “Stock Exchange.” This is the place to get some ideas from the best technical analysis – and you can ask questions!

Top Trading Advice

 

Brett Steenbarger provides a checklist to help you determine if you are “operating in peak performance.” As he often does, Dr. Brett has raised a point that few people think about. This is one that could make a big difference – and not just for traders.

The Trading Goddess considers pot stocks for an election trade.

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 “Davidson” (via Todd Sullivan) and the analysis of current market fears. It is a post packed with good ideas, one of which is in the quant corner as well.

The past 12mos has seen many a ‘high profile’ investor forecast that a recession is imminent. This is the consensus view. Some claim it is driven by economic weakness from one area or another. There are still claims that employment is weak when it is at record highs. Others claim that retail sales and personal income (wage growth) are nearly unchanged for more than a decade. Not so! They are much better. Then, there are those who claim that recoveries only last a certain number of years before they expire. Not so! Finally, there are some who claim no recovery has occurred and that the SP500 is only higher because interest rates are so low, i.e. high stock prices are only supported by the Federal Reserve keeping interest rates at historical lows. Definitely, not so! The range of commentary covers a broad spectrum, but remains pessimistic just the same.

Please take a few minutes to read this valuable post.

Income Ideas

 

Many investors are looking for income stocks. Rightly worried about the valuation and downside risk of utilities, they seek alternatives. Some have joined us in buying sound, conservative stocks and writing near-term calls against the position. This can generate an excellent yield and is safer than owning the stocks alone. It is a lot safer than a basket of utilities.

REITs present another alternative. The trick is to find those that have some ability to hold up in the face of interest rate hikes. Brad Thomas has been writing on this topic, presenting several good ideas. This week it is Apple Hospitality (APLE). I have been adding some REITs to the yield portion of our client portfolios. Like Brad, we include analysis from Chuck Carnevale’s F.A.S.T. graphs as part of our research.

David Fish has an interesting article on dividend increases anticipated before the end of the year. There is also a link to his updated list of dividend champions.

Stock Ideas

Lee Jackson writes about three “red-hot chip stocks.” These interesting ideas are based upon a research report from highly-regarded chip analyst Will Stein (SunTrust Robinson Humphrey).

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 Nike (NKE). Check out the post 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.

Dillard’s, Inc. (DDS): Has The Pendulum Swung Too Far? Asks Mitchell Mauer. I especially like to recommend articles that are backed by good analysis. Here you can see both pros and cons. It follows a method that is quite useful in selecting stocks.

Is the selling in Gilead Sciences overdone? Stone Fox Capital notes the falling analyst recommendations despite strong earnings. Should the stock really be trading at a multiple of 6. The net payout (stock buybacks plus dividends) is now almost 18%.

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 “lucky versus good” analysis from Jonathan Clements. He writes:

The problem: We typically judge our financial choices by a single, crude yardstick—whether they make or lose us money. But that measure of success or failure can result in faulty feedback that validates bad behavior. Consider three examples……

Check out the whole post for the examples and an excellent lesson.

Millennial Investors

Barron’s introduces a new site aimed at “a new generation of investors.” There is a combination of advice and some stock ideas. I enjoyed the article about why Apple Pay is more secure than a credit card. They also introduce “The Next 50 Index” with stocks geared toward Millennials.

And from another source – this provides some inspiration about our changing habits.

Final Thoughts

There are several points to keep in mind:

  • The market has been resilient in the face of challenges. Look again at the chart. The worrying seasonal predictions have all been wrong – as January goes, sell in May, September as the worst month. We now approach the period of greatest seasonal strength.
  • The earnings recession seems to be at an end. Forward earnings are trending higher.
  • There is no sign of an economic recession – just more of the same slow growth.
  • Consumer confidence is still strong.
  • Energy prices are back in a range where the threat to producers has been reduced and the consumer prices remain modest.

What is needed to spark a change? The biggest item is increased investment by business. Surveys continue to show caution among these leaders, even when their own business is doing well. When there are specific events to worry about, it is easy (and seems wise) to defer decisions.

Acclaimed system developer, author, and hedge fund manager Ralph Vince summarized the situation with a bold call in a post at Daily Speculations:

Regardless of who wins this election, this market is going to rip to the upside — and I can be quite certain of that without even looking at the numbers, just the very tentative nature of nearly everyone around it. I’ve smelled this dish cooking before, and so have a lot of folks on this site.

How is that for a contrarian position?

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 is the Risk/Reward for Stocks?

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

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

What is the risk/reward tradeoff for stocks?

Last Week

The news was very good, and the market responded.

Theme Recap

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

The Story in One Chart

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

SPX-five-day

The News

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

The most important economic and market news was quite good.

The Good

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

     

052616-Initial-Claims-SA

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

Michigan-consumer-sentiment-index

 

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

NHSApr2016

The Bad

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

     

The Ugly

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

MW-EN838_gao226_20160526041302_NS

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

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. Think of The Lone Ranger. This week’s award goes to Narayana Kocherlakota, former President of the Minneapolis Fed. Many of those who have moved on from a roles as official participants in Fed meetings are speaking out. This valuable information gives us an inside look. Sometimes the message is that we are making too many unjustified inferences. Kocherlakota writes:

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

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

The Week Ahead

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

The Calendar

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

The “A” List

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

The “B” List

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

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

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

Next Week’s Theme

 

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

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

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

What is the risk/reward tradeoff for stocks?

 

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

Indicator Snapshot 052816

The Featured Sources:

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

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

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

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

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

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

Noteworthy this week:

How to Use WTWA

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

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

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue our neutral market forecast. Felix is fully invested, and with more aggressive sectors. Most sectors remain in the penalty box. The (usually) more cautious Holmes is once again fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now.

Top Trading Advice

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

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

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

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

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

 

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read, it would be the overall market outlook from David Templeton at HORAN Capital Advisors. He covers many of the themes I regard as most important, but readers will enjoy getting the message from different sources.

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

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

correlation rates market

Stock Ideas

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

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

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

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading, but my favorite this week is from Ben Carlson for his discussion of Social Security Benefits. Here are but two points from a great post. You should read it all.

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

Screen-Shot-2016-05-09-at-9.35.14-AM

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

Screen-Shot-2016-05-20-at-4.19.39-PM

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

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

Value Stocks

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

Energy Stocks

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

5731ace1-a511-4e58-90cf-70fe183dad33

Watch out for….

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

 

w1056

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

 

Final Thoughts

 

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

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

1200x-1

 

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

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

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

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

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

And stocks could be 50% higher.

Weighing the Week Ahead: 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!

Weighing the Week Ahead: Can a Rebounding Economy Support Stock Prices?

This week’s economic calendar is loaded with all of the most important data. In addition, Super Tuesday might provide a defining event to the political campaign. Oil remains volatile, and Fed Speakers are on the loose. Despite the political stories, I expect the punditry to be asking:

Can the strengthening U.S. economy support the rebound in stocks?

Prior Theme Recap

In my last WTWA (two weeks ago) I predicted a focus on the biggest market worries. That guess was not very successful, since the market immediately began a nice, two-week rally. The list of topics was still good preparation, since stories quickly turned to “what could derail the rally?” As Doug Short notes, Friday’s market did not respond even when “an avalanche of economic data surprised to the upside”. Once again, a modest decline in oil prices accompanied a modest decline in stocks. 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.

This Week’s Theme

Earnings season continues, and the political stories will be dominant, at least through Tuesday’s elections and Wednesday morning’s news. In a non-political season, this week would be all about the economy. We have more of the important reports squeezed into a single week (helped by Leap Year?) than we have seen in many months.

Recent economic news suggests improvement, at least in the U.S. At some point, a better economy will lead to better earnings and more support for stock prices. By the end of the week I expect politics to be a sideshow with focus on the economic data. Market observers and pundits will be asking:

Can economic improvement provide a foundation for equity markets?

Background

  1. Doug Short’s observations about Friday’s trading highlight the ambivalent response to “good news.”
  2. Q1 GDP is tracking higher, as much as 2.5% according to the Atlanta Fed’s GDP now reports. (James Picerno looks at this source and others).
  3. Are first quarters a “one off” over the last few years? Brian Gilmartin writes:

    Has anyone else noticed how volatile the first quarter has been the last 3 years ?

    In 2014, it was Russia driving tanks into Ukraine, the Venezuelan devaluation and profit-taking after the 32% increase in the SP in 2013.

    In 2015, it was falling crude oil, falling commodities, West Coast Port slowdown, strong dollar and even weather in February ’15.

    In 2016, the volatility is the result of Financial stock volatility, European bank worries, negative interest rates, etc.

    Not one of the last three Q1’s seems to be driven at all by the US economy and worries therein. Jobless claims remain strong.

    So what gives? What is it with the first quarter every year?

    I don’t know, but it is always something.

Viewpoints

I expect the following to be the principal positions, with the usual vigorous support for each, ranging from bearish to bullish.

  • The reported data are flawed – a fluke, faked, subject to poor seasonal adjustments, etc. The economy is much weaker than the government claims.
  • Good news for the economy just means that the Fed will tighten sooner. Only central banks have kept the market afloat.
  • It is all about oil. Oil prices are the best economic barometer.
  • Positive economic news will reduce recession fears, helping many stock sectors.
  • Stronger economic news will lead to higher earnings estimates.

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 news was very good last week, despite the market reaction.

  • Initial jobless claims remained low at 272K.
  • Q4 GDP was revised higher. This is backward looking, of course, but the revision to 1% growth suggests that the base for 2016 was a bit better.
  • Existing home sales remained strong and beat expectations – 5.47M versus 5.3M. (Calculated Risk)
  • Durable goods reversed nicely from the recent slump – up 4.9% overall and 1.8% on the core (ex-transportation).
  • Low oil prices are starting to show benefits.
    • Gas prices continue to fall. $1/gallon coming this summer? (Oilprice.com)
    • Reduced food costs around the world. Quartz has the story and plenty of charts showing the relationship. Christopher Groskopf calls it a “huge hidden upside.”

      While the global economy’s biggest players are reeling, there is a less visible group of people who stand to benefit tremendously: those without enough to eat.

      The security of the world’s poor is inseparable from the price they pay for food, especially the grains that constitute most of their diet. Oil prices are a significant factor in determining the price of other commodities, including food. Tractors and other farm machinery require fuel, as does the manufacture of fertilizer. Once crops are harvested, oil prices dictate the transportation costs to get them to market, whether that’s down a highway or over an ocean.

    oil and grain prices

 

  • Michigan sentiment improved over January and slightly beat estimates. (But see Consumer Confidence below).
  • Personal income and spending both surprised with 0.5% growth. This is good news for housing and the consumer sectors. Maybe the improved employment picture and lower gasoline costs are finally having an effect.

The Bad

Some of the news was negative.

  • Leadership worries. Early primary results have favored “outsider” candidates. In my 2016 preview I said that it was far too soon to draw conclusions about the Presidential election. Things are shaping up faster than I expected. Most observers note that markets prefer establishment candidates and stable leadership. We can and should each express our own viewpoints and vote our consciences, but our personal choices may not be “market friendly.” TheUpshot has an interesting interactive GOP simulator. You can plug in your own assumptions and use it to follow the news this week. They lead off with a favorable Trump scenario:

2-27-2016 7-16-22 PM

Dshort confidence 

  • New home sales disappointed. The annualized level of 494K missed expectations by 25K and was down 50K from December.
  • Signs of the “wealth effect” hit earnings. Restoration Hardware blames its earnings miss on the stock market. (Fortune).

 

The Ugly

University bond ratings. Three Illinois state universities were downgraded to junk or just above by Moody’s. Illinois is especially bad, but state revenues nationwide have been slow to rebound from recession levels.

Some Fun

For those watching the Academy Awards this weekend (missing the important basketball game between Michigan where I did my grad work and Wisconsin, where I taught and from which Mrs. OldProf graduated) here is some fun.

Which nominated films showed the most profit, either overall or on a percentage. (The winner should be easy).

What about The Big Short? Here are some reactions from Brookings, which hosted an event including interviews – the director, some of those involved in real life, and also other financial professionals.

The Silver Bullet

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

 

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.

Recent Expert Commentary on Recession Odds and Market Trends

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

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

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

dshort big four

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

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

China is clamping down on negative data – omitting some from reports and fining journalists for negative reports. (NYT).

 

The Week Ahead

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

The “A List” includes the following:

  • Employment situation report (F). Still most important for markets.
  • ISM index (T). Important read on the direction of manufacturing.
  • Auto sales (T). Some suspect “peak auto” despite recent strength.
  • ADP payroll growth (W). A solid alternative to official numbers.
  • ISM services (Th). Less impact than manufacturing, despite covering more of economy.
  • 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:

  • Pending home sales (M). Housing market remains crucial to the economic rebound.
  • Fed beige book (W). Anecdotal information in front of the FOMC at the March meeting.
  • Construction spending (T). Volatile but important January data.
  • Factory orders (Th). January data. A rebound is expected?
  • Chicago PMI (M). Last month’s strength to be repeated?
  • Trade balance (F). Significant component for Q1 GDP.
  • Crude oil inventories (W). Attracting a lot more attention these days.

The election stories may well dominate the discussion until Wednesday. Earnings reports continue. Some FedSpeak is on the schedule, most importantly Vice-Chair Fischer on Monday.

 

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, but with more aggressive choices than last week. The more cautious Holmes is only about 1/4 invested. 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.

Oppenheimer’s John Stoltzfus has an idea about trading the bottom of the range. (BI).

screen shot 2016-02-18 at 1.59.58 pm

How to “pull the trigger” on a trading idea. One idea: Start small. (Finance Trends)

Finding edge in your trading ideas – new information or a fresh look at existing data. (Brett Steenbarger)

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 Philip Van Doorn’s MarketWatch piece on how to enhance returns with covered calls. This is a great job of demystifying the subject. He writes:

 

I promise to explain a “covered call” option strategy as painlessly as possible.

If you’re an investor seeking income, buying quality securities that pay high dividends or interest is a prudent strategy. But covered call options can boost income while providing downside protection. And that’s important nowadays, as some analysts are predicting a bear market for stocks, and traders expect low interest rates for quite a while.

There are many ways of implementing this strategy, with a significant effect on risk and returns. I have been using it for years, emphasizing the sale of near-term calls with the fastest time decay. Interested readers might enjoy my free report comparing this approach to other income programs like bonds, REITs, and dividend investing. (info at newarc dot com).

With information in hand, you can try it yourself. Start small!

 

Stock and Fund Ideas

Warren Buffett’s annual Shareholder Letter (HT Josh Brown). Hot news that will lead the talk on Monday morning.

Barron’s likes Walmart, but thinks utilities have gotten too expensive. I agree.

Finding good ideas requires thinking beyond yesterday’s news. Here are some suggestions on how to do it. And a few more.

Emerging market stocks are very cheap (GaveKal).

gavekal emerging markets

 

Energy Price

U.S. production is declining. Oil & Energy Insider has plenty of good data, and this chart:

59d3c871-694c-40da-a180-23c8603c3a24

George Trager of Investbrain.Net (via ValueWalk) explains the supply and demand behind oil prices in four charts. I especially liked this one:

oil supply and demand

Watch out for….

Tax scams. Hackers posing as the IRS try to steal your money. The IRS does not ask for money over the phone nor does it take credit card payments. The IRS has also admitted that even more taxpayer information has been compromised. Sheesh!

Hedge fund favorites. Low ownership has been good! What do those guys know, anyway? (ValueWalk).

1-13-770x372

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. There are several great posts, but I especially liked MIT economist Erik Brynjolfsson’s explanation of why it is better to own than to rent your home. It is very good. (BI)

With tax season upon us, some people will have refunds to spend. Here is some excellent advice on putting the cash to good use. Hint: Take a little for spending but pay off loans or save with most. (SunTrust)

336808

Final Thoughts

There is plenty of negative sentiment right now, despite the recent stock rebound. I do not expect any single news release – or even a series of them – to have a dramatic impact on stocks. Until a stronger economy influences earnings, most people will remain skeptical. We might well be three months away from seeing that evidence, even if the Q1 data continue to improve.

The recessionistas will be proven wrong on the current call, and that will gradually help to improve earnings estimates. Many analysts are building recessions into their forecasts, second-guessing their own top economists.

It is difficult to be patient, but it is often rewarding. Take what the market is giving you – a trading range with some sector and stock-specific opportunities.

Personal Note

Thanks to Brian at Investor in the Family for the invitation be interviewed on his podcast. We covered some interesting market topics.

Weighing the Week Ahead: What are the Biggest Market Worries?

The economic calendar is again light in a holiday-shortened week. There are a variety of important news items, but no dominant theme. I expect the punditry to seize the opportunity by asking:

What are the biggest market worries?

Prior Theme Recap

In my last WTWA I predicted that everyone would be talking about the high and rising worry about a recession. That was one of the most frequent media topics for the week, with some sources even choosing “looming” as part of the description. Fed Chair Yellen grabbed the spotlight for her testimony, but even that centered on economic concerns and what the Fed might do. Friday’s rebound was notable in size, but left plenty of skeptics. As Doug Short notes, the rally came in concert with yet another mystery rally in oil prices. Skeptics saw short-covering action, with issues to be revisited this week. 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.

This Week’s Theme

Earnings season continues, but the economic calendar is light in a holiday-shortened week. In most of the world there will be news on trading on Monday, which will set the tone for U.S. markets. With continuing worldwide volatility, I am not expecting a single issue to dominate next week. Instead I expect the pundits to be asking:

What is the biggest worry for investors?

2016 began with declining stocks and plenty of concerns. New candidates surface each week. Listed below are the most-noted worries. Those getting a lot of fresh attention are listed last. I have omitted the evergreen valuation and disaster scenarios.

  • Stocks show technical weakness
    • Almost breached important technical levels
    • Lack of breadth
    • Friday saved only by short-covering
  • The stock market is clearly signaling recession
  • Earnings growth weak and outlook weaker
  • Strong dollar hurting sales, exports, and earnings of multi-national companies
  • New variants on the “R word”
    • Earnings recession
    • Growth recession
    • Manufacturing recession
    • New recession definitions (e.g., slow growth)
    • Self-fulfilling prophecy recession
  • Falling commodity prices
  • China weakness and capital flight
  • There is an emerging leadership crisis
    • Barron’s cover featuring outsider candidates, Trump and Sanders
    • Early takes on Justice Scalia’s death
  • Negative interest rates
  • Declining dollar
  • End of Fed QE policy

I did the list without even going to ZH for ideas, so there are probably more. Feel free to add anything important in the comments!

Scott Grannis reviews many of the issues in one of his helpful chart packs, accompanied by commentary. He reaches a mildly optimistic conclusion, despite the high level of fear revealed in this interesting indicator:

Walls of worry

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 news was pretty good last week, despite the market reaction.

  • Initial jobless claims have turned lower. Bespoke has both analysis of the data and great charts, including this one:

021116-Initial-Claims-SA

  • Both job openings and the quit rate were strong. The WSJ reports the voluntary quit rate as the highest in nine years. This shows continuing expansion and confidence in job markets.
  • Bullish sentiment (a contrarian indicator) is back to bull-market lows. (Bespoke).

AAII-Bullish-021116

  • Retail sales were strong. Bloomberg calls it a broad-based advance, highlighting online sales and figures with (low-priced) gasoline excluded.

The Bad

As always, some of the news was negative.

  • Leadership worries. Early primary results have favored “outsider” candidates. In my 2016 preview I said that it was far too soon to draw conclusions about the Presidential election. Even though that was only a month ago, there have already been twists, turns, and surprises. That said, commentators note that markets prefer establishment candidates and stable leadership. Personally, we can and should each express our own viewpoints and vote our consciences. Our personal choices may not always be “market friendly.”
  • Michigan sentiment index declined to 90.7. This preliminary read was lower than last month’s final number of 92.0, and also missed expectations by the same amount.
  • Business sales and inventories are in contraction. Steven Hansen takes on a complex subject, showing many interesting takes on how to view the data. (Unadjusted – blue line, inflation adjusted – red line, 3 month rolling average—yellow line).

7980347ztemp

  • Earnings for Q4 remain disappointing. While the earnings “beat rate” is OK, only 49% of companies are beating on sales. Guidance is 68-17 negative. The blended revenue growth would be slightly positive without energy stocks. (FactSet).
  • Low inflation is bad (?) It is if you are the Fed, trying to raise inflation expectations. Data show an actual decline, although still above the Fed’s target. (WSJ).

BN-MO883_MICHIN_G_20160212112634

The Ugly

Cheating. This is more pervasive and important than you probably realize. We see the occasional story of a dishonest broker or insider trading. There are scandals in sports. Even my own world of top-level tournament bridge was recently rocked by revelations about several of the top professional partnerships.

In all of these cases, there are significant financial incentives. Steven Mazie reports on a scientific study that shows that winning begets cheating. Several different experiments show that winners in one game, randomly determined without their knowledge, will cheat on a subsequent game when having the power to do so unnoticed. And this happens with no financial incentive or even public acknowledgment.

But the upshot is troubling for people who care about the future of humankind. “It is difficult to overstate the importance of competition in advancing economic growth, technological progress, wealth creation, social mobility, and greater equality,” the authors write. “At the same time, however, it is vital to recognize the role of competition in eliciting censurable conduct. A greater tendency toward unethicality on the part of winners … is likely to impede social mobility and equality, exacerbating disparities in society rather than alleviating them.” There may be no way to completely remove this flaw from human nature, but “[f]inding ways to predict and overcome these tendencies” would seem to be a mission well worth pursuing.

The Silver Bullet

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

 

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.

Recent Expert Commentary on Recession Odds and Market Trends

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

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

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

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.

Econbrowser’s Prof. Menzie Chinn updates a yield-curve based recession model. He notes that the model predicts recessions accurately about 78% of the time and non-recessions at an 85% pace. The current recession probability for the next year is about 9%.

Similarly, see Jim Picerno, who does a similar analysis and concludes as follows:

Meantime, let’s keep reminding ourselves of a salient fact: every US recession has been accompanied by a plunging stock market but not every stock-market plunge has been accompanied by an NBER-defined recession.

 

The Week Ahead

We have another quiet 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:

  • Housing starts and building permits (W). Potential for more gains?
  • FOMC minutes (W). Even when you think there is nothing more to learn……
  • Industrial production (W). A sign of improvement in this sector would be very encouraging.
  • 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:

  • PPI (W). No sign of inflation. It would take a few “hot months” to get serious attention.
  • CPI (F). See PPI.
  • Philly Fed (Th). Gaining more attention as the first read on the prior month.
  • Crude oil inventories (W). Attracting a lot more attention these days.

There is some FedSpeak on tap, but less than usual. Presidential campaigning will be intense before next weekend’s primaries. The Chinese holiday is over, and some expect news on Monday, when U.S. and Canadian markets are not trading.

Earnings reports are still in full swing.

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, but with more conservative choices than last week. The more cautious Holmes is still about 1/3 invested. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix and Oscar’s weekly ratings updates via email to etf at newarc dot com. They appear almost every day at Scutify (follow here). 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.

When might human traders do better than computers? Rob Carver has a thoughtful comparison. As a manager employing computerized decisions in some programs, the topics reflect my own experience. The question of when a human should “override” a model decision is especially interesting. I frequently consider this when reviewing the decisions of Felix and Holmes.

Brett Steenbarger continues to suggest important and novel ideas about trading. This week he writes about having the macro wind at your back, and how to handle that happy news.

More importantly he gives some tips on how to spot the moves of big institutions.

It’s a common mistake to become tunnel visioned during times of market stress and only follow the position(s) you are trading.  That blinds us to the waxing and waning of macro themes and the influence of large market participants.  You may not trade the markets thematically yourself, but it helps to have those themes at your back–and certainly not in your face.

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 this short post from Tadas Viskanta. He speaks clearly and effectively to investor concerns about how they are doing and second-guessing decisions. He notes the weak start to the year by some famous investors, and also advises tuning out the so-called “authority figures” on financial TV. His key advice? Cut yourself some slack!

 

See also the Investment News report on some of the top fund managers, down 20-25% in spite of their long-term success records.

 

Stock and Fund Ideas

Three Warren Buffett picks are on sale. (Matthew Frankel at TMF).

Ben Carlson cites data showing the historical rebound of global stocks following a bear market. He also supplies a list of what has been working and what has not – at least so far.

Tough times for solar stocks. (ETF.com).

 

Energy Prices

Last week. (MarketWatch)

Long term. BP’s annual energy outlook is a great data source.

1455039323847

Watch out for….

Guaranteed income certificates. David Merkel has a nice post on investment charlatans with a good specific example.

Non-traded REITs and BDC’s. FINRA accuses broker of bilking Native Americans for over $11 million.

Special care is required when investing in these vehicles. You had better know what you are doing, and understand the risks.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. There are several great posts, but I especially liked this advice from Carl Richards (NYT) about the need to accept uncertainty. Check out the stories about medical examples. You might also review my recent piece on the costly craving for explanations.

Final Thoughts

Investors do not understand worries, uncertainty, and scary headlines. If there were no “headwinds” then the market would be more richly valued. Most people have heard the expression, “wall of worry” but few understand it.

Almost six years ago, when the DJIA was at 10K and many were expecting it to go to 5000, I made my controversial Dow 20K call. There were many market worries, which are now mostly history. Instead, we have moved on to a new list of challenges. (Check out the story here).

The market gradually rises as fears are surmounted and earnings rise. There will be a time to become more cautious, or even bearish. That time will be indicated by data, not by fear-inducing headlines and speculation.

For many weeks I have noted that traders and others with a very short time frame should reduce risk. Investors should be seeking opportunity.

My noted neighbor to the North is Brian Wesbury. (Wheaton and Naperville once contested the location of the County Seat. Wheaton took the records and Naperville folks met at the Pre-Emption House to plan a raid. Somewhere during the night, the plans became muddled. Rumor has it that strong drink was involved).

Brian also wrote this week about whether recession was “looming” and how to interpret the market action. His conclusion (similar to mine last week):

This is a correction, not a turning point for the stock market.  Our models, with stocks driven by interest rates and corporate profits, not sentiment, suggest the market is still significantly undervalued.

It’s not often you get recession level prices when there is no recession.

Put money to work, don’t run away.

Weighing the Week Ahead: Is a Recession Looming?

The economic calendar is light and it is the start of the week-long Chinese New Year. This means some media time and space that must be filled. Needing an attention-getter, I expect the punditry to be asking:

Is a recession looming?

Prior Theme Recap

In my last WTWA I predicted that everyone would be talking about whether the stock market correction was over. That was one of the most frequent media topics for the week, especially at the lows on Wednesday and again on Friday. As expected, answers varied and we still don’t know for sure. The early-week strength, mid-week rebound, and Friday selling 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.

This Week’s Theme

Earnings season continues, but the economic calendar is light. Because of the Chinese New Year, we will not have stock or economic news from there. With plenty of recent economic data and scary forecasts to digest, pundits are pondering the worst. When that happens they ask everyone (regardless of qualifications) the same question:

Is a recession looming?

With economic data, especially in manufacturing, weaker than it was for most of 2015, many wonder what this portends. Listed below are popular bearish arguments from a variety of sources:

  • The recession has already started.
  • The stock market is clearly signaling recession.
  • Falling commodity prices have signaled a recession.
  • Declining oil prices have started a death spiral.
  • China economic weakness will drag down the rest of the world.
  • Emerging market weakness will drag down the rest of the world.
  • Energy company bankruptcies will drag down banks.
  • The Fed is out of bullets.

The bullish arguments are more concentrated in the economic community:

  • The economy shows only modest growth, but not a recession.
  • A U.S. recession has never resulted from global weakness.
  • Historically reliable indicators do not show a recession.
  • Key economic indicators followed in dating recessions have not peaked.

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 news tilted to the negative side last week, but there were a few bright spots.

  • Federal receipts (and spending) are 3% higher. This is usually a positive economic sign. (CBO via GEI).
  • The Fed may be walking back the tough talk from last month. (Tim Duy).
  • Private payrolls grew by 205K according to the ADP report. James Picerno notes that while the level is solid, the pace is declining.

adp.03feb2016

The Bad

Most of the economic data tilted negative.

  • Earnings reports have disappointed. Even growth ex-energy is only 2.1% and sales growth barely positive. Earnings expert Brian Gilmartin provides data, analysis as well as a look at forward earnings. Bespoke notes that the overall stock reaction on earnings day has been slightly positive. Take a look at their lists of the biggest winners and losers.
  • ISM manufacturing was about as expected at 48.2, but it is the fourth consecutive month below 50.
  • ISM services remained in expansion at 53.5, but that was slightly lower than expectations.
  • Initial jobless claims edged higher, but Calculated Risk notes the level is still not bad.

WeeklyClaimsFeb042016

  • Ford F150 sales were down 5% on a year-over-year basis. It is still the best-selling U.S. vehicle, and is also popular with construction companies and small businesses, which is why I watch it as an economic indicator.

F150-Sales-YTD-2016-013116

  • Employment gains disappointed, at least on the overall non-farm payroll gain. The story was actually mixed, since the unemployment rate and earnings were both higher. Everyone should remember that the “headline number” has an error band of over 100K, even after revisions. I like the WSJ summary of the report, featuring twelve charts.

The Ugly

Martin Shkreli. His smirking non-testimony before a House committee was bad enough to make the Representatives seem attractive by comparison. My concern? A rational debate on drug pricing is needed. Between this guy and the candidates, we can expect months before this will happen. Meanwhile, what about the drugs that deserve investment — right now.

 

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 Paul Hickey of Bespoke Investment (via Pradip Sigdyal of CNBC). Over the last few years we have frequently heard about high margin debt on the NYSE. The argument was that the degree of leverage signaled danger. The accompanying charts seemed to show coincident peaks, but people saw what they wanted to see.

 

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

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

 

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 main 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.

Recent Expert Commentary on Recession Odds and Market Trends

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

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

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

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

Dwaine has a new article providing a first-rate analysis of various recession indicators. It is well worth a careful read and a study of the charts. Here is his conclusion, and a chart showing his version of the “Big Four” indicators.

To summarize, despite many pockets of disconcerting co-incident indicator weakness, many brought on by the energy and commodities complex, the risk of near-term recession appears low. Although many short-leading indicators are showing recession there are not enough of them yet to warrant a confident recession call. What remains highly elusive is finding long-leading data that points to recession.

Recession odds are rising, as is commentary surrounding recession. Most of this commentary centers around “cherry picking” this or that indicator or sector to bolster an argument but rarely covers broad-based assessments.

2016-02-03_1900

Peterson Institute and Market Valuation

I regard the equity risk premium from the Indicator Snapshot table as an important measure of market perceptions about the economy and earnings. A problem with many discussions of stock valuation is that they completely ignore expected inflation and interest rates. Olivier Blanchard and Joseph E. Gagnon, both top economists with many years of relevant experience, now at the Peterson Institute for International Economics, clearly explain this point.

…(T)he deviations of the P/E from its historical average are in fact quite modest. But suppose that we see them as significant, that we believe they indicate the expected return on stocks is unusually low relative to history. Is it low with respect to the expected return on other assets? A central aspect of the crisis has been the decrease in the interest rate on bonds, short and long. According to the yield curve, interest rates are expected to remain quite low for the foreseeable future. The expected return on stocks may be lower than it used to be, but so is the expected return on bonds.

The way to make progress is to compute expected returns on stocks and bonds, and look at the equity premium, pre- and post-crisis. With this in mind, table 1 compares expected real returns on stocks, constructed in three different ways, with expected real returns on bonds, constructed in two different ways. To smooth out temporary fluctuations, the measures are based on averages of four quarterly values in each year. We compare expected returns as of 2015 with those of 2005, a time when there was little concern about overvaluation in stock prices. Our results would be similar if we had compared with any year in the mid-2000s.

You can debate how much of an adjustment to make for interest rates, but not whether some consideration is needed.

blanchardgagnon20150201-figure1-1

 

The Week Ahead

We have a relatively quiet 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). Any sign of life in this important indicator?
  • Michigan sentiment (F). Important concurrent read on employment and spending – a bit off of the peak.
  • Initial Claims (Th). The best concurrent news on employment trends, with emphasis on job losses.

The “B List” includes the following:

  • Wholesale inventories (T). Volatile December data has GDP impact.
  • Business inventories (F). See wholesale inventories.
  • Crude oil inventories (W). Attracting a lot more attention these days.

Fed Chair Yellen testifies about the economy – Wednesday the House Financial Services Committee and Thursday the Senate Banking Committee. The statement will be the same, but the questions will be different. Market observers will be searching for hints about a changed attitude since the last Fed meeting.

Tuesday’s New Hampshire primary will have a big impact on the prospects for candidates, but probably not much market impact. Things will get more interesting when the primaries move on to different regions and larger states.

Earnings reports will also remain important.

 

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 increased from about 80% invested to 100%, but 2/3 is in foreign ETFs. The more cautious Holmes is about 1/3 invested. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix and Oscar’s weekly ratings updates via email to etf at newarc dot com. They appear almost every day at Scutify (follow here). I am trying to figure out a method to share some additional updates from Holmes, our new portfolio watchdog.

holmes

Hedge funds are hiring poker pros. (When I started in the business it was bridge players). The analysis of risk and reward combined with speedy decision making is common to both. Garrett Baldwin has an interesting and informative article as part of a series.

Brett Steenbarger continues to deliver help to traders that they could not get anywhere else. His seven tips for getting to the next level are quite helpful. I especially like #1.

1)  My profitability has improved since I’ve focused on consistency rather than profitability.  I’ve honed in on what are good trades for me and where my profits have come from.  I just want to be consistent in trading those good trades.  If I can do that, the profitability will come.  And if I want greater profitability, I should size up the good trades, not take other, more marginal trades.

 

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 main 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 a short but important post. Bespoke shows what can happen to high multiple stocks, using data from this earnings season.

 

decilespe

 

This naturally raises the question of how you can avoid such disasters. I recommend using Chuck Carnevale’s F.A.S.T. Graph tool. Here is an example of what you could learn:

lnkd fastgraph

Helping you to avoid this 45% haircut:

LNKD

 

Stock and Fund Ideas

AAPL is frequently recommended as a cheap stock. Charles Sizemore goes beyond the typical arguments in concluding that “It’s ridiculous!”

MLP’s may still have plenty of downside. (Kevin Kaiser via Barron’s)

Resource prices may have bottomed says Jeremy Grantham (!) in the analysis of the positives from low oil prices.

 

Interpreting Research Results

The Psy-Fi Blog explains the weakness in most current stock research.

Here’s what ought to be a really boring idea – we need scientists in general and psychologists and economists in particular to stop hypothesising after results are known (HARKing, geddit?). Instead they need to state what they’re looking for before they conduct their experiments because otherwise they cherrypick the results they find to confirm hypotheses they never previously had.

By coincidence, I wrote a similar post on the same day. My emphasis is on how costly it is to insist on some post-hoc explanation of surprising phenomena.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. There are several great posts, but I especially liked this advice unconventional advice from Allison Schrager – you might not always want to max out your 401K contribution. The article provides a good analysis of key factors in retirement planning, and the tradeoff with keeping some emergency cash.

Final Thoughts

My weekly prediction (guess?) for WTWA typically raises a theme question with a variety of possible answers. Even if it is the topic of the week, it is often not resolved. I offer my own conclusions, but sometimes do not have a strong opinion.

This week is different. My extensive research into the best methods for recession forecasting provides the basis for some confidence. The methods I highlight have worked the well, and done so for a long time.

The market is pricing in recession odds of nearly 50%. There are so many negative headlines, often misleading.

The “Oilmageddon” term coined by some Citi analysts captured the headlines. You had to read to the very end of the articles to see that this is something they suggested might happen. (CNBC interview). Their actual prediction was that it would probably be avoided by some appropriate policy adjustments. Scott Grannis notes that such problems are usually self-correcting and suggests that the best policy would be to get out of the way. Those predicting the inevitable increase of the dollar would do well to consider this chart:

Screen Shot 2016-02-02 at 12.37.09 PM

In sharp contrast, the best sources see recession odds of 10% or lower. This is the greatest opportunity left in this business cycle, since you can buy many value stocks with single-digit multiples. Great analysis from John Alberg and Michael Seckler (via Advisor Perspectives—read by advisors, but also interesting for individual investors).

 

Everyone wants to know when to expect the value rebound. I do not expect a single, mind-changing event. This is a change that will happen gradually, as evidence is reflected in higher earnings.

Finding the Real Expert

Successful investors are modest.  Overconfidence is dangerous.

When I started writing this blog more than ten years ago, I did not think I was an expert on everything.  My investment success had more to do with my ability to recognize the expertise of others.  I have given examples of what I learned from cab drivers as well as from sophisticated model developers.  Nearly everyone has interesting information.  You can often learn just by asking, “How’s business?”

This is in sharp contrast to the behavior of most investors.  It is just human to be impressed by people who make confident predictions of extreme events.  Doing some fact-checking is difficult.  Most people spend more time choosing a refrigerator than picking a stock.

But let us turn to a really serious decision — setting your fantasy football lineup!

[I know from my teaching experience that going to a problem in a different context is a great way to put our biases aside.  Even if you are not a sports fan or fantasy enthusiast, you will understand the point].

The fantasy sports business is popular and profitable.  Players, even those risking only a few dollars, spend many hours researching choices for their weekly lineup.  There is a cottage industry of experts — people who crunch numbers, do podcasts, and sell related services.  Suppose that we wanted to choose the best source from among the following:

  • An articulate newbie who had a new system that identified top players from the past weeks or years.
  • A great-sounding source with football knowledge but no track record.
  • Someone making less spectacular claims, but with a real-time record of reasonable success.

You can probably guess who gets the business.  Let’s turn to investment information.

Eighteen months ago I reported my enthusiasm about a great investment book:

Investors can be better consumers of this information with a little help from two insiders, Josh Brown and Jeff Macke. During my vacation I finished reading their entertaining and informative book — Clash of the Financial Pundits: How the Media Influences Your Investment Decisions for Better or Worse. I plan to do a complete review, but it is especially timely right now.

As you watch or read the news next week, you should realize the pressure on pundits to be bold, dramatic, and confident – even when their forecasts are a bit shaky. The financial incentives range from selling products to building a big reputation. Their analysis of these forces is supported with some compelling evidence from both history and interviews. Reading this book is inoculation against hype, and it is also a lot of fun.

It is now time to put this great advice to use!

Think back to the bogus fantasy advice.

  • We are seeing a rash of “instant experts” on recessions.  Most of them are cherry picking a single variable.  Those with stronger methods do data mining to fit several variables. There are at least a half dozen sources currently preaching doom and gloom.
    • Many of the sources are from “credit desks” writing to their current clients.  They are selling bonds.
    • Some sources are singing an old tune, enjoying their fifteen minutes of fame.
  • None of the confident voices have any record at recession forecasting.  CNBC posts their “street cred” but never shows a track record on this key subject.
  • The most successful recession forecasts get very little visibility. I did a massive search five years ago, inviting nominations. One key source, Bob Dieli, has had the best real-time forecasts for decades.  Other top analysts have analyzed past data with great care to avoid data mining.  I have a helpful resource on recessions here, and update the key information weekly.

The Choice of Experts

A CNBC anchor was conducting a recession discussion among a number of other anchors and one trader.  She noted that most of those forecasting a recession were traders, while economists had a different conclusion.  No one said much, but it was certainly accurate.  There is a divergence between those following commodities and those following economic data.

It is a shame that the best experts on recession forecasting are not getting more publicity — right now, when it really matters for investors.  There is probably no question that is more relevant.

Conclusion

Stock prices for economically-sensitive sectors are, in many cases, already at recession levels.  Oil prices are viewed by many as a sound forecast for the global economy, despite increasing energy demand.  The hot money understands this oil price correlation — both HFT algorithms and human traders.  The average investor infers from the market action that the recession theory is correct.

In the short term, this is the trade.  In the long term, investors should prefer real data and a genuine track record to the bombast of newbies.

And finally, I’m going with Aaron for my fantasy team this weekend!