Weighing the Week Ahead: Time for a Consumer Rebound?

This week’s economic calendar is light on really important data. As always, this invites pundit pontification on what last week’s news means for Fed policy. The fresh news will come from the consumer, especially the retail sales report on Thursday.

Next week’s theme will be:

Is it time for a consumer rebound?

Prior Theme Recap

In my last WTWA I predicted that market discussions would be all about jobs. In addition, I asked whether the news would reignite the interest rate debate.

This was right on all counts. The job discussion started with the release of the auto sales data: Good news for the company workers, encouraging for construction, and indicative better consumer employment. The story continued throughout the week, culminating with Friday’s employment report. In addition, the Fed/interest rate debate launched immediately and played out through Friday.

Feel free to join in my exercise in thinking about the upcoming theme. We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead.

This Week’s Theme

This week’s lighter calendar comes with the context of strength in the most important economic indicators. Finally, there are some strong reports in important indicators. Will there be more? I expect market observers to be asking:

Will consumer spending (finally) reflect the strength in employment?

The Viewpoints

There are two basic viewpoints, but the differences are very sharp.

  • The economy is weak, including jobs, income, and spending. Eventually this will drag down stocks, including those most closely tied to consumer spending.
  • Economic growth is encouraging. Cautious consumers have lagged in their spending, skeptical of the duration of the rebound. It is time for a change in this trend. (Ed Yardeni cites the possible shift).

Earned income proxy

And of course, any good news on the economy will be the immediate source of skepticism, since any move by the Fed will quash the rally. Josh Brown’s witty analysis should be required reading for “bad news pundits.”

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

Last Week’s Data

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

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

The Good

There was some very good news.

  • The Trade Plan prospects improve. This is a political football and therefore controversial. On a strictly economic basis, it is a policy almost universally favored by economists – and therefore market-friendly. (The Hill).
  • PCE inflation remains very tame at up 0.1% on the headline and 1.2% on the core. Staying below and gradually approaching the target implies a moderate change in Fed policy and a longer business cycle.
  • OPEC keeps production on track. While bad for some specific stocks, lower oil prices are beneficial for most.
  • Forward earnings growth has stabilized. Brian Gilmartin notes the trend and is optimistic. See his analysis for a complete discussion of sector contributions and what to expect.
  • Auto Sales — the best in ten years. This is a good sign for consumer spending as well is employment. Ford is skipping the normal summer plant closings.
  • ISM manufacturing beat expectations with a reading of 52.8
  • Construction spending increased 2.2%, to the highest level in six years.
  • Employment gains remained solid. The employment news showed strength on the payroll number, improved labor force participation, a better hourly wage, and reduced part-time work for non-economic reasons. Employment continues to show growth typical of a solid expansion. (Calculated Risk).

PartTimeMay2015

 

The Bad

The news also included some negatives.

  • ISM services missed expectations, recording the lowest reading in over a year at 55.7. Still a reasonable expansion.
  • Personal spending showed no increase.
  • Q1 productivity was revised down to -3.1%. This is mostly a reflection of the Q1 GDP adjustments, but it bears watching.
  • No progress on Greece – but we don’t really expect any until month’s end.
  • Factory orders were revised lower, showing a larger decline in April.

 

The Ugly

Information and analysis compression. In the baby boomer era, Walter Cronkite took note that most people got their news from television – and were therefore seriously uninformed. Boomers are still watching TV for news. I wonder what he would think now. More than 60% of millennials rely upon Facebook.

I guess this is more serious study than required by Twitter, since you can write a longer post. (This week saw a new record-holder for fastest to one million Twitter followers. You can probably guess who!)

Consumers of all information want to spend less time and avoid thought. This is a frightening prospect. Some ideas might be conveyed in 140 characters, but most cannot.

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. Normally I see a specific erroneous analysis and someone who provides refutation. Let us not be a slave to specificity.

Morgan Housel provides something more powerful that a single specific point. He explains how so many abuse historical interpretation to prove their point — whatever it is.

Take these two statements:

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

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

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

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

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

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

 

There is a lot of Silver Bullet refutation packed into this analysis. It is a guide to critical thinking about most of what you read – those two variable charts, simple historical analyses, and confusion of political beliefs with investor objectivity.

 

Quant Corner

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

Recent Expert Commentary on Recession Odds and Market Trends

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

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting market indicators. He recently noted an increase in his combined measure of economic stress, although the levels are still not yet worrisome.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (3½ years after their recession call), you should be reading this carefully. This week the ECRI finally admits to the error in their forecast, but still claims the best overall record. This is simply not true. I rejected their approach in real time during 2011 and also highlighted competing methods that were stronger. Until we know what is inside the black box (I suspect excessive reliance on commodity prices and insistence on unrevised data) we will be unable to evaluate their approach. Also see Doug’s important Big Four summary of key indicators, updated regularly.

Georg Vrba: has developed an array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal.

Fig-8.-6-5-2015

 

He gets a similar result from the Business Cycle Indicator. Georg continues to develop new tools for market analysis and timing, including a combination of models to do gradual shifting to and from the S&P 500. His latest idea uses the yield curve (2-10) as an indicator for stocks, bonds and recessions. You need to read the entire piece carefully for an explanation, but here is an example for the bond market indicator.

frr-fig3

The Week Ahead

There are fewer reports than usual this week, with a focus on housing.

The “A List” includes the following:

  • Retail sales (Th). Time for a consumer rebound?
  • JOLTS report (T). Especially important because of information on employment structure. Pundits fail on this.
  • Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.
  • Michigan Sentiment (F). Best take on job creation on potential spending. Any rebound?

The “B List” includes the following:

  • PPI (F). Inflation data remains of lesser significance. Until it heats up – and for more than a month or two – it will have little influence on Fed policy.
  • Business inventories (Th). April data will have some effect on Q2 GDP. Difficult to interpret.
  • Wholesale inventories (T). See business inventories.

It is a light week on the Fed schedule. We might get news from Greece, but I am not expecting much for a couple of weeks.

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

Felix continued a neutral stance for the three-week market forecast. The confidence in the forecast remains rather modest, reflected by the high percentage of sectors in the penalty box. Despite the overall market verdict Felix has generally been fully invested. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com. Felix appears almost every day at Scutify (follow him here).

Interested in intra-day trading? Alan Farley has plenty of ideas for finding setups. Plan to spend some time checking out links to explanations and other sources.

10 Reasons Traders Lose Money in the Market (Steve Burns at See It Market). The conclusion captures the essence, but the list items are well worth thinking about.

Long-term, successful traders have many common characteristics:  They religiously follow a plan, they have an edge over the majority of market participants, risk management and capital preservation is their number one priority, and they go with the flow of the price action rather than predict. They also admit they are wrong quickly, and never quit learning.

Insight for Investors

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

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

Other Advice

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

Featured Commentary

Check out part one of my new series on risk. Early reactions were good, and more comments are welcome. At least three more installments are planned.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time – at least — for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. I especially liked this link from Ben Carlson, on How to Tell If You’re Getting Bad Financial Advice.

Stock Ideas

The top conviction stocks from the funds selected as part of the Morningstar Ultimate Stock Picker team. Read the full article for more tables and discussion.

Ultimate Stock Pickers

 

Twelve takeover targets from Goldman. (Jeff’s comment: I look at these lists for ideas, but never buy just on takeover speculation. It is a nice kicker, and might show something about the overall attractiveness of the sector. Interesting reading).

 

Sector Themes

Five sectors in the “gravest danger” if rates rise. (Tim Clift, MarketWatch).

Oil to stay cheap? So says Fortune. Production is not being cut enough.

Market Outlook: More Bubble Talk

Here is an interesting contrast – another round in the Shiller vs. Siegel debate.

Final Thought

Last week might represent a 2015 turning point for economic data. After another soft patch to start the year, many factors seem to have changed. If the trend in the important data spreads to consumption, housing, and business investment, we might still see some robust growth as part of the current business cycle.

Meanwhile, my theme for this year – reversing last year’s winners and losers in stock sectors – continues to look promising.

Those on the right side of the macro trend can gain both from the overall market and the sector rotation.

Personal Note

I try to publish WTWA in time for Sunday reading, since I know that works best. Some events, like the wedding and funeral gatherings of the last two weeks, require a change in schedule. I hope to be back on track next week.

Weighing the Week Ahead: Will Job Gains Signal an Economic Rebound?

This week’s economic calendar is loaded with important data, featuring the employment situation report on Friday. The jobs story has been the most encouraging economic theme, with a recent assist from housing.

Especially in the context of the negative Q1 GDP report, next week’s theme will be:

Will strong employment gains signal a second half economic rebound?

Prior Theme Recap

In my last WTWA (two weeks ago, since I had a travel weekend) I predicted that market discussions would once again focus on rising interest rate and the effect on stock prices. That was a good call for the entire two week period. Despite generally weak economic data, the Fed seems to be on course for higher interest rates this year.

Feel free to join in my exercise in thinking about the upcoming theme. We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead.

This Week’s Theme

This week’s big data and event calendar comes at a time of intense debate over the state of the economy. In the context of the fresh, negative revisions to Q1 GDP each new piece of evidence is searched for any sign of a rebound. Were unusual factors at work in the first quarter? Should we expect a strong rebound?

Employment news has been the most encouraging of any of the economic data. This week’s reports include several which bear upon the employment outlook, culminating with Friday’s comprehensive employment situation report. I expect market observers to be asking:

Will employment growth signal a second-half economic rebound?

The Viewpoints

There are three basic viewpoints, but the differences are very sharp.

  • Recession is imminent – perhaps already arrived. (Thousands of hits in just the past week).
  • Recent weakness is temporary and explainable. The post-recession modest growth path continues. (Bonddad Rex Nutting).
  • A robust rebound may well be in store.

Even a good answer to the economic question leaves room to ponder what this means for the Fed and for markets. Recent FedSpeak suggests that the first rate increase is still on schedule for 2015. Will that come in the context of weak economy, despite the Fed claim to be data dependent?

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

Last Week’s Data

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

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

The Good

There was some good news in a very mixed week.

  • Travel consumption is strong. Myles Udland (BI) picks up on a Calculated Risk theme: Hotels—the best April ever! Nearly every metric analyzing hotel success is showing strength. My personal experience provides support. With more traveling than usual in the last month or so, I have experienced full flights and fully-booked hotels. People are meeting for many recreational reasons and they have money to spend.
  • Pending home sales beat expectations soundly with a bounce of 3.4%.
  • Consumer confidence improves modestly – on the Conference Board version. The Michigan sentiment survey is weaker, although the two usually track together. It is mixed news, but important. My favorite source for data on these series is Doug Short. His charts combine several key variables in one image.

dshort confidence

 

The Bad

The news also included plenty of negatives.

  • Gas prices moved higher by three cents, the sixth consecutive week of increases. See Doug Short for full story and charts). On the other hand, prices are a buck lower than a year ago (Calculated Risk for charts and data).
  • Weekly jobless claims increased to 282K. The four-week moving average also increased by about 5000.
  • No progress in Greece. This remains a wild card. Despite the impending payment deadline, I expect an extension of some sort to take place.
  • Durable goods continued the recent decline. Steven Hansen at GEI has a complete analysis with the expected charts and non-seasonal analysis.
  • GDP was revised into negative territory. Many take this at face value – bad news about economic weakness. Some emphasize the temporary nature of early year effects – including unusually bad weather and the port strike. Others note the apparent problems with Q1 seasonal adjustments in recent years. Doug Short does a nice job of illuminating the contribution of each GDP component. Look at the size of each color segment to see the changing nature of those effects. Q1 is not bad on personal consumption, but weak on next exports. Justin Wolfers (The Upshot) notes that the picture shows continuing modest growth if one uses Gross Domestic Income. He repeats his argument that this is a more accurate measure than GDP.

GDP components

 

The Ugly

The IRS data breach. Unlike private vendors, you have no way to avoid sharing data with the IRS. (Priya Anand, on consumer fraud for MarketWatch). Making matters worse we can now expect a raft of follow-on scams. Use care when evaluating those claiming to help with this problem. (NYT).

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, but nominations are welcome.

Noteworthy

When so many people have the wrong idea, there must be an investment angle. Most people think that storms affect cloud computing! Hmm….

Quant Corner

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

Recent Expert Commentary on Recession Odds and Market Trends

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

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting market indicators. He recently noted an increase in his combined measure of economic stress, although the levels are still not yet worrisome. Recently Dwaine wrote about the relationship between global leading indicators and US recessions, concluding that the signals helped for global recessions, but were less useful for the US. Here is the key chart:

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

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (3½ years after their recession call), you should be reading this carefully. This week the ECRI finally admits to the error in their forecast, but still claims the best overall record. This is simply not true. I rejected their approach in real time during 2011 and also highlighted competing methods that were stronger. Until we know what is inside the black box (I suspect excessive reliance on commodity prices and insistence on unrevised data) we will be unable to evaluate their approach. Also see Doug’s important Big Four summary of key indicators, updated regularly.

The Week Ahead

There are fewer reports than usual this week, with a focus on housing.

The “A List” includes the following:

  • The employment report (F). Still the big one for nearly all market followers.
  • ISM manufacturing index (M). Highly regarded as providing concurrent information as well as some leading qualities.
  • Personal income and spending (M). April data with an uptick expected.
  • ADP private employment (W). A good alternative read on the employment picture.
  • PCE price index (M). The Fed’s favorite measure.
  • Auto sales (T). Important and current private data.
  • Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.

The “B List” includes the following:

  • ISM non-manufacturing (W). Less history to this series, but covers more of the economy than manufacturing.
  • Beige book (W). Anecdotal information that the FOMC will use at its next meeting.
  • Trade balance (W). April improvement would help 2nd quarter GDP.
  • Factory orders (T). April data.
  • Crude oil inventories (W). Maintains recent interest and importance.

It is another big week for Fed speakers and possibly for news about Greece (good background here).

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

Felix continued a neutral stance for the three-week market forecast. The confidence in the forecast remains rather modest, reflected by the high percentage of sectors in the penalty box. Despite the overall market verdict Felix has generally been fully invested. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com. Felix appears almost every day at Scutify (follow him here).

The most amazing trader new of the week? It has to be Bill Gross. Just suppose that you identified the trade of a lifetime. And you were right! How much would you expect to make? “Well-timed, but not well executed” says Mr. Gross.

If you are serious about trading, treat it as a business. Check out each “product line.” As always, Dr. Brett is on target.

Insight for Investors

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

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

Other Advice

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

Featured Commentary

If I were to recommend a single source, it would be the advice on how to deal with a rising rate environment from Josh Brown and his colleague Michael Batnick. Their posts provide great analysis of how properly balanced portfolios have done in the past. Their advice is slightly different from my own. I prefer to avoid bond funds with my bond ladder, substitute covered calls on conservative stocks for enhanced yield, and still keep a smidgen of octane in the tank. That said, I agree strongly in concept.

tumblr_inline_nopw6hkHil1sba62w_500

 

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time – at least — for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. I especially liked this link from Ben Carlson, on The Four Pillars of Retirement Savings.

 

Stock Ideas

Beware of target date funds! (Jay Ritter at Fortune). Too much emphasis on bond funds. Old formulas might not work.

Time to sell Time Warner (TWC)? Philip Van Doorn has a nice article with a great point. When we are on the winning end of a takeover bid, we usually sell and move on. One member of our team is a risk/arb veteran, where he often played these trades with options. It provides a great opportunity for those who are true experts and can use leverage. It is a minefield for the average investor. If you are not an expert you do not belong in this trade! Do not try to squeeze out a few extra points.

Time to buy GE? Michael Brush explains the case. (We often own GE, hedged by short-term calls for extra yield).

Barron’s features Disney – not cheap, but with many new angles. It fits the expanding economy leisure theme.

 

Luck Helps

Ben Carlson recounts a great story:

In The Success Equation, Michael Mauboussin tells the story of a man in the 1970s who set out to find a lottery ticket ending with the number 48. He bought the ticket he was looking for and ended up winning the lottery using his lucky numbers. When the man was asked why he wanted that specific number on his ticket he replied, “I dreamed of the number 7 for seven straight nights. And 7 times 7 is 48.”

His post analyzes a history of the best and worst times to invest in stocks, analyzing the results. Here was the worst case, recommend reading for Hussman fans:

On the other hand, the worst period started in 1945 and ended in 1974 at the bottom of that nasty bear market in the mid-1970s. The ending balanced was just $774,000 or nearly $2.1 million lower than the 1999 end date. The crazy thing about these results is that the returns weren’t that bad in the worst period. From 1970-1999, the annual returns on this 75/25 portfolio were very good — 12.5% per year. In the 1945-1974 time frame the returns were a very respectable 8.6% annually. That’s a great return over three decades, but the low end point penalized the results.

 

Market Outlook

Here is an interesting contrast:

  • Investors cut US equity exposure to the lowest since 2008. (Reuters).
  • Warren Buffett is close to his highest stock allocation in twenty years. (Sizemore Insights).

Buffett-allocation

Who has done better over the last few decades……?

Top Calling

There are many worries — so many. It is easy to forget that these stories are very repetitive and very old. Ben Carlson provides a reality check.

Top

 

 

Final Thought

When many market participants believe the same thing, we know that changes will be interpreted through that prism. Many attribute all or most of the rally in stocks to “pumping” or “liquidity.” The rationale for how the increase in the Fed balance sheet affects stock prices is never stated very clearly, especially since the same observers usually deny the effectiveness of Fed programs. Somehow the various QE’s and ZIRP’s have affected stock prices without improving the economy along the way.

For investors firmly grounded in the fundamentals, neither the economy nor the Fed should be threatening to a portfolio of well-chosen investments. For those committed to catching short-term swings, it is more challenging. You have to guess the psychology of the market. History shows that the start of a tightening cycle is actually friendly for stocks. I have shown variants of this chart many times. This week’s analysis comes from Roger Thomas, who summarizes several charts (including the one below) with this observation:

Presuming Fed starts hiking rates this fall, if they follow the typical hiking pattern, the market would return about 6% over the next 3/4 year (done hiking next summer).

SP-500-Performance-During-Federal-Reserve-Tightening-Cycles-Past-13-

Some think that this tightening cycle will be different in a very negative way – big balance sheet, no past experience from increases starting at the “zero bound,” and a Fed that is dangerously late in changing policy.

Others, including me, agree that it will be different, but in the opposite way! This tightening cycle will be gentle and prolonged. I would not be surprised for this debate to continue for years, even after my Dow 20K target has been surpassed! (Bloomberg on Yellen plans).

Weighing the Week Ahead: Will the Interest Rate Spike Threaten Stock Prices?

This week’s economic calendar includes the most important housing data, but the market context will prove irresistible to the pundits. Stocks continue at the top of the trading range, and even broke through for a few minutes. Even more interesting is the bond market. Interest rates decisively broke their trading range and also showed a lot of volatility.

I expect the interest rate story to have legs in the week ahead, particularly considering the implications for housing. Putting that together with the stock market trading range, the theme will be:

Will the interest rate spike pressure stock prices?

Prior Theme Recap

In my last WTWA (two weeks ago, since I took a weekend off) I predicted that market discussions would once again focus on the Fed with special attention to the employment report. That was a good call for the next week and even for the following one. There is plenty of interest in when the first rate hike will come. Better than expected employment data brought opinions about the Fed move back into the June or September time frame.

Feel free to join in my exercise in thinking about the upcoming theme. We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead.

This Week’s Theme

This week’s light economic calendar competes for attention with the market context. The housing story has not been very exciting this year. Stocks continue to make new highs, to the amazement of many observers. Interest rates showed an upside breakout in spite of relatively weak economic data.

The interest rate story is a mystery, particularly for those who explain everything via Fed policy. Why the sudden spike in rates at the long end of the curve? What will happen to mortgage rates? And stocks are testing new highs. Analysts will be asking:

Will the spike in interest rates threaten stock prices?

The Viewpoints

This week’s theme is one of the most interesting we have seen this year, but it is also complicated. There is plenty of opportunity for debate. Let us split the topic into two parts – why rates moved higher and what it means for stocks.

Why the spike in rates? Here are the viewpoints.

  • It is all “technical” since rates broke the trading range. (WSJ. This explanation is popular, but it seems to beg the question).
  • The hedge funds did it. (WSJ).
  • There is no liquidity in the bonds (mostly thanks to central banks). John Authers (ft.com) has a nice, balanced presentation of this issue.
  • Regulation has increased bond volatility (Dealbook).
  • Demand for corporate bonds has increased, pulling up the government rates. “Davidson” via Todd Sullivan supports this idea, including the following chart:

unnamed-578x420

  • The bond vigilantes are sending a message to the Fed.

What is the implication for stocks? More opposing viewpoints.

  • Stock prices will crash as bond prices rise. (Wolf Street).
  • Stock prices will be fine as long as underlying growth in the economy and corporate earnings continue. (Ben Levisohn, Barron’s).

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

Last Week’s Data

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

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

The Good

There was some good news in a very mixed week.

  • The JOLTs report was strong. Some try to use this as a proxy for net job gains. It is not designed for that and is also “slower” than the regular monthly employment reports. It is better to look at job openings and separations, signs of structural unemployment, and most importantly – the quit rate. (A Fed favorite). 2.8 million people quit their jobs in March. Keep this in mind when you read about a 50K “miss” in the monthly job numbers. Doug Short has helpful analysis and his collection of great charts, including this one:

jolts

 

  • Bullish sentiment hit the lowest point in two years. This is bullish on a contrarian basis. Bespoke has the analysis and this chart:

AAII-Bullish-Sentiment-051415

  • Initial jobless claims hit the lowest four-week moving average since 2000. This is the best concurrent indicator of the job market, and it continues to show strength.
  • Earnings and revenue growth beat expectations on a year-over-year basis. Brian Gilmartin updates his look at the data while taking out energy stocks and Apple. Very interesting and positive results for both earnings and revenue.

The Bad

The news also included some negatives.

  • Gas prices moved higher by three cents, the fourth consecutive week of increases.
  • Industrial production dropped by 0.3% versus flat expectations. See Eddy Elfenbein, who notes the decline in mining and utilities. This is the fifth consecutive monthly decline.
  • Michigan sentiment missed expectations at a disappointing 88.6 for the May preliminary reading. These surveys provide information about spending and job gains that you do not see until later in the government data. Doug Short’s article and charts provide the best historical perspective and also show the economic correlation.

dshort michigan sentiment

 

  • The student loan story gets worse. More students are becoming delinquent on loans. (MarketWatch).

MW-DL818_delinq_20150512105617_MG

  • Retail sales missed expectations, coming in flat with a slight increase in the core rate. I am rating this as a negative, although analysts saw some positives in the data. Steven Hansen at GEI does his typical analysis of year-over-year, non-seasonally adjusted, and inflation adjusted results. His conclusion is more positive. Diane Swonk is also more upbeat, emphasizing the core results. Retail earnings news was mixed.

 

The Ugly

The Avon fiasco. Someone successfully posted a false filing on the government’s EDGAR system. It did not take much reading to see that the filing had inconsistencies and spelling errors. A little more checking showed false addresses. Those who traded first and read later learned a costly lesson. $91 million worth of stock changed hands in less than thirty minutes as the price spiked from about $7 to $8. An additional consequence is the reduced confidence in official government filings, which can apparently be hacked or spoofed pretty easily. (Dealbook, Reuters.)

The Silver Bullet

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

Quant Corner

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

Recent Expert Commentary on Recession Odds and Market Trends

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

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting market indicators. He recently noted an increase in his combined measure of economic stress, although the levels are still not yet worrisome. Recently Dwaine wrote about the relationship between global leading indicators and US recessions, concluding that the signals helped for global recessions, but were less useful for the US. Here is the key chart:

2015-05-06_1550

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

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (3½ years after their recession call), you should be reading this carefully. This week the ECRI finally admits to the error in their forecast, but still claims the best overall record. This is simply not true. I rejected their approach in real time during 2011 and also highlighted competing methods that were stronger. Until we know what is inside the black box (I suspect excessive reliance on commodity prices and insistence on unrevised data) we will be unable to evaluate their approach. Also see Doug’s important Big Four summary of key indicators, updated regularly.

Q2 Economic forecasts are dropping. The Atlanta Fed’s GDPNow shows growth below 1%. Tim Duy provides context and discussion. Matthew Klein (FT) notes the peculiar seasonal effects, with a regular rebound in Q3. We shall see.

Atlanta Fed Econ Forecast

 

The Week Ahead

There are fewer reports than usual this week, with a focus on housing.

The “A List” includes the following:

  • Housing starts and building permits (T). Still waiting for an uptick in this important sector.
  • FOMC minutes (W). Whether there is anything fresh or not, expect the pundits to find something.
  • Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.
  • Leading indicators (Th). Continued strength expected in this widely-followed measure.

The “B List” includes the following:

  • CPI (F). Remains of little importance until the time that inflation perks up.
  • Existing home sales (Th). All things housing are interesting, but less economic importance than new construction.
  • Crude oil inventories (W). Maintains recent interest and importance.

It is a light week for Fed speakers, but look for news from Europe from Chicago’s President Charles Evans. Earnings season is winding down.

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

Felix switched last week to a neutral stance for the three-week market forecast. That continues this week. The confidence in the forecast remains rather modest, reflected by the percentage of sectors in the penalty box. Despite the overall market vote Felix has generally been fully invested. We have had a little hedging with an inverse ETF and an inverse bond ETF, but we once again have several attractive sectors. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com. Felix appears almost every day at Scutify (follow him here).

Do your systems work in testing but not in actual trading? Why a Monte Carlo analysis will help you test your system. (System Trader Success)

Charles Kirk (small membership fee required) uses his chart show to tell us what to watch for next week. Charles is always flexible, watching for best and worst case indicators. Hint: The setups this week are mostly bullish, but they need to be triggered. No guarantees. Charles and Felix often see eye-to-eye.

Insight for Investors

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

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

Other Advice

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

Featured Commentary

If I were to recommend a single source this week, it would be the compilation of the Top 25 Downtown Josh Brown Quotes from Michael Johnston at ETF Reference. The list is great, but here are two favorites:

Everyone is a disciplined, patient investor, entirely focused on the long term. And then an hour goes by.

Before reading anything from a blogger, figure out his or her motivation for saying it. If the blogger is writing for traffic or page views, stop reading because your author doesn’t actually care about what he’s posted other than the included keywords (Paulson! China! QE2! Depression! Crash! Blankfein!). You are wasting your time on something disposable and written for maximum distribution.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time – at least — for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. I especially liked this article on the “4% rule” often used to guide the safe level of withdrawal from your account during retirement. Does it still work in a low-rate environment?

 

Stock Ideas

Hedge funds are dumping Apple. I am still buying as our price target marches higher.

What stocks are the favorites of millennials? How do these compare with those of boomers? Sally French (MarketWatch) has an interesting story with this table of first picks:

First Stocks

 

Market Outlook: Crash? Recession Already Here?

There has been another spate of claims that the US economy is already in a recession. This November post from Evan Bleker provides a helpful reminder about these forecasts. The market is up another 14% since the end of the chart.

saupload_OSV-Recession-201X

Are Stocks are Over-Hyped?

We have a contretemps among three prominent market writers. I urge you to check it out. I am not going the Silver Bullet route with this one, but I do have an opinion.

I have a comment here. Felix is paid for popularity (page views). I have met him in person at a conference where many were trying to learn and some already thought they had the answers. I had looked forward to chatting with him and was very disappointed to learn that he was part of the latter group. I have not been surprised that his advice was so poor. By contrast, Barry (whom I do not know personally) makes money only when he helps investors. Characterizing him as a “blogger and buy-side person,” as Felix does, downplays his stature. I do not understand Cullen’s conclusion. Most new clients that I see have an allocation that cannot possibly keep up with inflation and exhibits terrible market timing on their part. These come from reading journalists who scare them witless (TM OldProf euphemism). Most journalists who give it a try fail as money managers. It is something to think about as you do your daily reading.

There will be a time to shift dramatically from stocks to bonds. Not now.

Energy

Some energy stock ideas, even if oil prices drop. (“No brainer” choices from Mark Hulbert).

Practical Advice for Value Investors

Think long term. We’ve heard it before, but it is always good to keep in mind. Seth Klarman explains your biggest single investing advantage and also cites some favorite Buffett quotes.

But it can be very difficult. Even a great strategy can lag for extended periods. Most people lack the ability to identify good methods and the confidence to stay with them. John Alberg and Michael Seckler explain, including this great chart:

value_investing_vs_market

Watch out!

  • Before plunging into emerging markets. Alan Beattie (FT) explains that slower growth has a structural element this time – not just cyclical.

550546ec-fa23-11e4-b432-00144feab7de.img

  • Before seeking the coupons from high-yield bonds. Econompic presents the case against high-yield. The helpful article features many charts, including this one:

HYCorp

  • Before accepting a “life settlement.” (Investment News).
  • Before following economic forecasts from those without a good track record. (WSJ).
  • Before jumping into a leveraged ETF. (See It Market). Great advice.
  • Before expecting big things from “smart beta.” (MarketWatch).

Final Thought

My own investing is firmly linked to economic fundamentals. The market disparities cited this week mostly reflect trader or pundit lore. Here are the key points:

  • The interest rate spike has nothing to do with the Fed and little to do with liquidity. (See Ben Carlson).
  • Interest rate levels have only minor implications for stocks – at least until they move much higher. Stocks do very well in the first portion of interest rate increases, especially when stronger economic growth is reflected.

So why the bond mystery. I have offered this hypothesis in the past. It still deserves a more complete explanation, but I will share the outline.

Many players have a “carry trade” where US Treasuries are the investment, not the “funding currency” as has often been the case in the past. Some funds have put it on explicitly with leverage, maybe 15-1. Some have it without leverage. Some merely choose an “unusual” asset allocation. Some have a currency hedge, but others are “going commando.” This explains a lot.

Whenever the dollar drops, some of these players are stopped out or get a margin call. Here is some evidence from 361 Capital:

06_macro_small

Whenever US rates rise more than the funding currency, we see a similar effect. Traders are stopped out or get a margin call.

None of it really has anything to do with the strength of the US economy or the prospects for stocks, but it provides plenty of grist for the media mill.