Weighing the Week Ahead: Are You Scared Yet?

If you find the current market action frightening, you are not alone.  There is a bull market in disaster predictions, with a chorus of pundits predicting “another 2008.”  Sentiment indicators show increasing fear.  Improvement in corporate earnings is seen as more evidence that something is wrong.  After all, a market that cannot rally on good news is showing weakness.

The chart of the S&P 500 from the last year makes the case for a market that moved too far, too fast.  Some see a new bearish leg — not a correction but a major move to the old lows.

Sp500 1 year

There is another perspective.  Conditions are much different from the time of last March’s low and also from the October, 2008, post Lehman period.  A decline of ten percent or so after a big move is to be expected.  Let us look at the S&P 500 with a two-year time frame.

Sp500 2 years

The indicators in the two charts are the same, but the context is dramatically different.  The fear from 2008 is ever with us.  Patrick J. O’Hare, writing Briefing.com’s regular feature, The Big Picture, summarizes it this way:

After the credit crisis of 2008/2009, which clearly presented a
systemic risk
few portfolios were positioned to deal with, there will be
hyper-sensitivity to
staying out in front of the next systemic risk.

To this point, consider for a moment how often the word “bubble” is
tossed
out to explain any uninterrupted rise in asset prices.  Before the
technology stock crash of 2000, the word “bubble”
was rarely invoked in the marketplace, and when it was, it was typically
used in
association with an exposition on the South Sea Bubble of the early-18th
century.

What there is today in the stock market is a bubble in the use of the
word
bubble.

That is a clever and accurate summary.  He might have added that black swans are not found in herds.

Last Week’s Action

Let’s start with a look at the key data from last week.  As usual, I am not trying to be comprehensive, nor am I taking a viewpoint.  I will highlight what I found significant.

The Good

The earnings news is petering out for this season, but the general pattern of strength continues.  Positive guidance is beating negative guidance by the widest margin in nearly a decade, according to Bespoke Investment Group.  (Click through for the fine graphics).  This is unusually good news, and eventually it will matter.

Some celebrated the weekly decline in initial claims.  This reverses a couple of weeks of poor data.  I disagree.  The weekly series is just too noisy.  Next week’s data will be distorted by weather, as will next month’s payroll employment data.  (The payroll survey is done during the week including the 12th of the month).

The
Bad.

The trade balance was a bit worse than expected and inventories a bit lower.  The revisions will make the 4th quarter GDP increase lower.  The revisions to the initial estimate of GDP come as we get more data.  The news is not good, but neither is it some big conspiracy as some maintain.

Regular readers know that I find the University of Michigan sentiment indicator to be important and helpful.  This month’s reading was lower than expected, and certainly not at the bullish levels of the ISM.  This is a helpful indicator for employment and job creation, so the report was bad news.

The bond auctions were weak, with long-term rates moving higher.  The ten-year has moved to about 3.7% and corporate spreads have also widened.  This is bad for stocks, since corporate bonds are a viable asset allocation alternative.

The news about Greece is certainly a negative.  Regardless of the outcome, investors need to worry about the extent of sovereign debt problems in Europe and what it means for the U.S.

Briefly put, there was plenty of negative news.

The Ugly.  Volatility!  When the market makes major moves lower on little news, and seems dependent on Germany’s attitude toward Greece —– well,  that is a problem.

Much of this translated into a stronger dollar.  While I have demonstrated that a strong dollar is just fine for stocks in the long run, the current relationship is a strong negative correlation.  The hot money sees a pattern like this and it becomes a self-fulfilling prophecy — at least until it quits working.

The Week Ahead

My focus for next week is on Wednesday.  Building permits are a good leading indicator of construction activity.  (These cost money and reflect actual plans).  Industrial production is also important.

I do not find the “leading” indicators to be very helpful nor am I concerned about the PPI and CPI right now.  I do not expect any surprises from the Fed minutes.

The European news and the dollar will continue to be important.

Our Trading Forecast

Our
own indicators (see our regular ETF updates for an explanation) continue as bearish, and that was our vote in the weekly Ticker
Sense Blogger Sentiment Poll
. Here is what we see:

  • Only 13% (down from 67% two weeks ago) of our ETF’s have positive ratings.  This is extremely weak.
  • The median strength is -22 (down from -15 last week), very negative.
  • 87%  (up from 35% two weeks ago) of the sectors are in the “penalty box,”
    showing much higher risk than
    in recent weeks.
  • Our Index Package has a negative rating.  We own SH and DOG, the
    inverse ETF’s for the S&P 500 and the DJIA.

A Helpful Insight

This is a good time for investors to think about long-term needs and goals.  There are some simple solutions for those who are afraid of a repeat of 2008.

I had some reader questions after last week’s update, wondering whether asset allocation models had triggered.  Mine have not.  The “correction” is still relatively small when compared to the recent gains.

We watch the asset allocation carefully for clients, and the indicators are closer to a conservative stance, but not there yet and certainly not short.

The average investor can try to do this at home.  There are plenty of ideas online.  You need to find a good method, continually update your indicators, avoid emotion, and execute the trades in a timely fashion.  Few investors can do this, even when trying to follow a “lazy” portfolio.   That is one reason why they trail the market by 4 percent a year while top advisors beat the market by solid margins.

Unless you are exceptional on these fronts, you might look for a good financial advisor.  If you do, insist on someone who has personal service —  who understands your specific needs, risk tolerance and requirements.  If the fees were low enough, and the stock picks were good enough, this would be better than you could do on your own.  Over many years, it might be the difference between a comfortable retirement and a few more years of work.

Whatever you do, you should still pay careful attention to your investments.  We no longer live in a “buy and hold” world.

I’ll try to answer a reader question each week in this article.

Keep the questions coming!

The Week Ahead: Fasten Your Seat Belt!

Professional investment managers never get far from the market.  When I was recovering from surgery a few years ago, I asked the nurse for an extra pillow.  Since I was supposed to be resting, she was suspicious.  "Why?"  My explanation — that I couldn't see the tape — fell on deaf ears.  In fact, she turned off CNBC.

Nearly everyone uses the weekend for some extra reading and planning.  Trading is easier when you have thought about possibilities in advance.  In this new series I am going to write down a few weekend thoughts.  Essentially, these are my own notes.  It is not a complete market commentary.  There are plenty of those already.  I am going to summarize a few points from the prior week.  I will highlight what I am watching for in the coming week.  I will often highlight some research that might otherwise get missed.  Finally, I will present our own trading indicators from our sector model.

I am not going to make a complete argument for each conclusion, as I usually do.  Regular readers will generally understand the reasons from past articles.  If there are interesting questions or comments, I will do a full article on the topic later.

This weekly piece is intended to be brief.  I will try to focus on the things where I hope to add value.  Especially while I am developing this concept, I invite comment and suggestions.

Last Week's Surprises

I liked the take from Neal Lipshultz, Unlikely Events Deliver Hellish Week For Stocks.  While many have been forecasting a market correction for months, no one guessed the unlikely stew of challenges.

The Good.  Corporate earnings continue to surprise positively.  For those who are skeptics about forward earnings (also solid) you cannot say that expectations are inflated when the companies keep beating.

Brown's victory in Massachusetts means that the Dems will have to do some horse-trading on taxes to avoid a filibuster.  This is market-friendly, although few seemed to notice.

The Bad.  Initial jobless claims ticked higher, and I am not buying the seasonality and short week arguments.  We need to see improvement here.  I did not mind the new home sales as much, since I like building permits as a leading indicator.

The Ugly.  President Obama's comments on regulation did not have the proper tone or timing.  The market punditry has a political agenda, leading to over-reactions.  Normally a President gets four years.  The voting public has a clear track record:  A poor economy and a shooting war are both very bad.  The electorate does not give good grades for effort, just for results.  Coakley was the first victim.  Fed Chair Bernanke could be the second.

The Week Ahead

The calendar is full.  Here is what I am watching:

  • Economic data.  I'm watching new home sales (difficult to interpret with the changing pattern of incentives), initial claims, and the Chicago PMI on Friday.
  • Bernanke.  The Senate will probably have a vote on his confirmation next week.  Voting against him is an easy way for a Senator to demonstrate that he does not like the Fed or money creation, does not like "bailouts", does not like past Fed policy, or is generally unhappy with the world.  Dumping Bernanke would be foolish and send a terrible message.  Fans of Austrian economics are not going to get a better candidate, so why bother?  I expect confirmation after some posturing all around.
  • Obama's State of the Union.  A week ago we might have expected a different speech.  Now there are some genuine questions.  Will he push health care?  Will he attack Wall Street?  Will he emphasize jobs and the economy?  I am confident that he will have a good delivery, but I am not confident that his team will come up with the right message.  Given the circumstances, this is more important than usual.
  • The Fed Meeting.  This is almost an afterthought.  There is a lot of misplaced attention on the Fed exit strategy.  There will not be any changes until the economy shows further improvement.

Some Helpful Insight

I try to track information that will be helpful in assessing the big picture.  The problem with these "big picture" issues is that they often have little relevance in the investment time frame.  They are basically unsolvable problems within any normal trading horizon.  One of the current topics is unemployment and how long it will take to achieve "normal" levels.

The research team at the Atlanta Fed estimates that it will take monthly job growth of 121K just to keep unemployment rates at the 10% level.  This includes an estimate for discouraged workers returning to the work force as well as new entrants.  It is a tall order, and a number to keep in mind.

Our Trading Forecast

Plenty of experts see last week's market decline as the start of something big.  Charles Kirk has his finger on the trigger (become a member at a modest price for an instant payoff):

Bottom line – we have a market that is in a major pullback and is now
threatening to move into a large-scale correction aversion phase
.

Bespoke Investment Group shows a long-term trend for a rebound after selling like this week's although recent results were not so good.

Our own indicators (see our regular ETF updates for an explanation) remain bullish, and that was our vote in the Ticker Sense Blogger Sentiment Poll.   We are now using our universe of about 60 highly-liquid ETF's with reduced correlation among individual entries.  Here is what we see:

  • 89% of our ETF's have positive ratings.  This is very strong.
  • The median strength is 23, a modest positive.
  • 44% of the sectors are in the "penalty box," showing lower risk than in recent weeks.
  • Our Index Package has a positive rating, and the QQQQ's are a buy.

I'll try to develop these indicators with more context in coming weeks.

To summarize, we are using the selling as an opportunity.  The model will give a "sell signal" at some point, but it is still within normal ranges, given the time and extent of the move.

A Final Thought

I tried to explain last week why long-term traders should use volatility to their advantage.  Instead of avoiding stocks where politics has caused selling, it is better to recognize when the speeches will have little effect and grab the opportunity.  I wish I had not used the highly-charged Goldman Sachs as my example, since it detracted from the main point.