Weighing the Week Ahead: Is this an Inflection Point for Both Stocks and the Economy?

The economic calendar is normal, but some of the results might not be released on schedule. If the government remains shut down, economic news may take a back seat to the political maneuvering. While we don’t know how that will play out, we can expect an important stream of corporate earnings reports. With competing news from several fronts, I expect pundits to focus on possible changes in direction. Many will be asking:

Should we be probing for an inflection point? In stocks, the economy, or both?

Last Week Recap

In the last edition of WTWA I expected a focus on earnings reports and the confusing impacts of the recent tax legislation. There was some of that, but much more attention on the shutdown saga. Even that could not compete with the public interest in the name for a baby.

The Story in One Chart

I always start my personal review of the week by looking at a great chart. I especially like the Doug Short design with Jill Mislinski updates and commentary. You can see many important features in a single look. She notes the new records along with other indicators. The entire post is well worth reading for the collection of charts and analytical observations.


The trading range for the week was still below 2%, but it was nearly covered in a single day. The moves seemed dramatic, but are still well below the long-term averages.

Personal Note

I am off next weekend. Wish me luck. I am the teammate of Mrs. OldProf and her favorite bridge partner. Much is expected! I will try to do an abbreviated update including the indicators.

The News

Each week I break down events into good and bad. For our purposes, “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 economic news leaned positive. I thought that the Beige Book might draw more attention, but it lacked significant changes. I recommend Steven Hansen’s summary – an effective and efficient way to get any important information.

The Good

  • Industrial production increased 0.9% after a small decline last month. This beat expectations of 0.4%.
  • Industrial sentiment is strong, setting records in some categories. The Corbin Advisors Survey has excellent information from sources not easily reached otherwise. The report is chock-full of interesting charts, helping you get a lot of information with a modest commitment of time. Here is a taste:

  • Rail traffic improved in the last reported week. Steven Hansen (GEI) focuses on the “economically intuitive sectors” to tease more signal from this indicator. Check out the charts and analysis in the full post.
  • Building permits were about even with the prior month at a SAAR of 1302K, but this beat expectations of 1280K.
  • Initial jobless claims plunged from 261K to 220K. The chart from Bespoke does a nice job of showing the recent detail as well as a longer-term trend.

The Bad

  • Michigan sentiment declined to 94.4 from the prior month reading of 95.9. While this is only the preliminary survey, it is a big miss from expectations of 97.
  • Sentiment is more bullish which is viewed as a contrarian indicator. Bespoke has the story.


  • Housing starts declined 8.2% from November to December and 6% on a year-over-year basis. Calculated Risk, the leading source on housing, cites this as confirmation of two important trends. First, multi-family starts are decreasing while single family increases. Second, the “wide bottom” in housing, which Bill accurately predicted years ago, continues to unwind. Here is the single-family chart.


  • NAHB Housing Index declined from the prior month and slightly missed forecasts. The NAHB emphasized that this remains a very strong reading. Jill Mislinski reports, including a helpful chart showing the close fit with the Michigan Sentiment survey.

The Ugly

The shutdown “negotiations.” Last week I said I was getting “more worried” about this topic. As I write this, there has been little progress, despite apparent widespread agreement about most of the pieces and the costs of a shutdown – even a temporary one. Part of this is built into the process, but part is due to the participants. Here is an important fact that I have not seen mentioned in any reports: The roots of this problem stem from the 2011 debt limit debate. That is the one that resulted in the so-called “Super-Committee” that was supposed to hammer out a spending compromise. The debt limit was raised, but without a compromise there would be sequestration of funds, balanced between defense spending and social programs. This was supposed to encourage participants to reach agreement.

My son Derek (now in law school at Iowa) helped me by writing an excellent profile of the committee members. I wrote the conclusion to that post and explained why I thought the process could work. They remained deadlocked. The failure of the Super Committee sparked a wide range of economic and market worries, which I reviewed at the time. Almost seven years later, and despite power shifts and changing characters, we are still living with the consequences from 2011.

Much of the current debate is about who is at fault. To decide that a citizen would need to have an accurate source of news, which makes this chart even more depressing. (Pew Research Center via Statista).


And a follow up on the Hawaii false alarm. It was not just a “wrong button.” It was a selection from a complex menu and it required extra confirmation. Two days later, Japan also issued a false alarm. These incidents are serious, harmful, and dangerous.

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.

The Calendar

We have a normal economic calendar, but without the most important economic reports. Many observers swear by the leading indicators. I am more interested in new home sales. The GDP report is backward-looking, but always interesting as a foundation for tracking the economy. Some of these reports may not be released on time if the government shutdown continues.

The most important news will once again be corporate earnings reports, especially discussions of outlook.

Briefing.com has a good U.S. economic calendar for the week (and many other good features which I monitor each day). Here are the main U.S. releases.


Next Week’s Theme

The normal calendar may be abbreviated if the shut down continues. Fed Speakers will not be on furlough, so they will continue on the speaking circuit. We are getting come clarity in corporate earnings, and the effects vary widely by sector. To some observers, it is time to expect a new direction. As usual, they disagree strongly on what that will be! The debate will raise the question:

Are we at an inflection point for stocks and the economy?

As usual, here is a typical range of opinion, from bearish to bullish. As an extra complication, the viewpoints are a mixture of technical analysts’ conclusions, market valuation and fundamentals, one-time tax cut effects, and lasting tax-cut effects. It is a bit clearer than last week, but not by much.

  • An over-valued stock market can be toppled by the slightest source of bubble pricking.
  • Regardless of long-term values, stocks are overbought and overdue for a pullback. The Fear and Greed Trader looks at both sides.
    • That is healthy, needed, and benign; or
    • This would be the first sign of a much bigger decline.
  • Stocks may be reaching the limits of growth (Scott Grannis). Except the tax cut effects may not be included, he notes. Recession Alert issues a similar warning based upon their S&P forecasting model.


  • Some economic indicators seem to be rolling over. Is this an inflection point, or the Q1 weakness seen in recent years?
  • There is a one-time tax cut for many companies, increasing S&P 500 earnings by 7 or 8 percent beyond current levels. (FactSet).
  • Investment stimulus from the cuts can foster economic (and earnings) growth beyond the initial effects. Apple, Inc., for example, has $252 billion in overseas cash, will pay $38 billion under the reduced taxes, and add $30 billion to its US investment plan. The cash may also fund additional buybacks and dividends.

To summarize, there could be an inflection point in stocks (either a correction or major decline) or in the path of economic growth. As usual, I’ll suggest my own interpretations in today’s Final Thought.

Quant Corner

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

Risk Analysis

I have a rule for my investment clients. 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

Despite higher stock levels, the earnings yield as actually increased. Brian Gilmartin’s coverage explains the change, which is reflected in our Indicator Snapshot.

The Featured Sources:

Bob Dieli: Business cycle analysis via the “C Score.

RecessionAlert: Strong quantitative indicators for both economic and market analysis.

Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.

Georg Vrba: Business cycle indicator and market timing tools. None of Georg’s indicators signal recession.

Doug Short: Regular updating of an array of indicators. Great charts and analysis.

Guests:

Jeff Hirsch, editor of the Stock Traders’ Almanac, notes that the current VIX level is not worrisome, despite descriptions of the “spike.” As I noted on Twitter, this article has plenty of sound information for those watching a much-misunderstood indicator.

Insight for Traders

Our discussion of trading ideas has moved to the weekly Stock Exchange post. The coverage is bigger and better than ever. We combine links to trading articles, topical themes, and ideas from our trading models. This week’s post discusses the challenges for traders in a bull market, with many still on the sidelines. We cite leading sources and update ideas from our models. Performance updates are published, and of course, there are updated ratings lists for Felix and Oscar, this week featuring the NASDAQ 100 components. Blue Harbinger has taken the lead role on this post, using information both from me and from the models. He is doing a great job, presenting a wealth of new ideas and information each week.

This week we featured advice from Brett Steenbarger, who showed how some traders were locked into a market viewpoint that provided little chance for gain. As is so frequently true with Dr. Brett’s posts, the message is useful for investors as well.

Imposing your trading “style” on markets regardless of regime can be hazardous to your wealth.  Assuming that all you need to do to make money is double down on your “style” and work on your mindset only compounds the problem.

Insight for Investors

Investors should have a long-term horizon. They can often exploit trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week it would be the Barron’s Roundtable issue. Individual investors will find it a refreshing overall perspective. I was impressed that so many good managers, representing quite different approaches, could all find stocks that are attractive, and even cheap, on an earnings growth basis. The website has some (but not all) of the picks, but you really need to read the full story to get the full picture. I found many interesting ideas, and you will, too.

Stock Ideas

I suggest investors join me in reading selections from the first-rate Seeking Alpha Positioning for 2018 series. There are many good ideas. If you missed my contribution, you can read it here. I give this piece special effort and appreciate that I am often hitting clean-up on this series.

The Internet of Things is a great place to go shopping, and the Consumer Electronics Show featured plenty of ideas. Some will gain traction, some will not, and all are exposed to possible problems. Barron’s mentions security specialists (Cisco and Fortinet) as well as storage leaders (Micron Technology).

“Memory and storage is at the sweet spot in what’s happening in IoT,” says Micron CEO Sanjay Mehrotra. The venerable company offers both flash memory and drives to manage and protect the vast amount of data floating among so many devices, earning it an important spot in the IoT ecosystem.

“If you don’t protect your devices, all that convenience adds up to nothing,” he says.

Blue Harbinger’s work always reflects careful and extensive research. While this preferred issue is trading at a slight premium, Mark likes the 10.9% yield, growing revenues, and shrinking debt.

As an investor, which would you prefer: Sprint, AT&T, T-Mobile, or Verizon? Hale Stewart’s analysis illustrates how to do such a comparison and it also provides a helpful conclusion.

Can a REIT investment centered on shopping centers be attractive? Colorado Wealth Management, with a careful look at fundamentals and plenty of charts, concludes that Taubman Centers (TCO) is on sale. One needs to look at the underlying assets and the quality of properties.

IBM? Stone Fox Capital balances the positives against the recurring complaints about lack of revenue growth and financial engineering.

David Fish has an update on Dividend Challengers, with 153 increases expected this quarter.

Interested in the DJIA? Peter F. Way’s method of analyzing real experts – those trading and hedging stocks each day – provides a risk/reward analysis for each of the 30 components.

Personal Finance

Seeking Alpha Senior Editor Gil Weinreich continues his excellent series. While theoretically aimed at advisors, there are many themes of interest for individual investors. This week included several great entries, but my favorite is his post on the role of luck in investing. He raises several great points, highlighting his own conservative approach as well as a Bitcoin post from Roger Nussbaum. Gil is using the Bitcoin story as an important illustration.

I strongly endorse the idea of risk control, which is why I have repeatedly advocated modest trading positions (if any) in crypto currencies. If you hit big on something, beware of thinking that you are a genius. Risk control means dialing back the size.

Abnormal Returns has a special Wednesday focus for individual investors. There are a variety of ideas, and nearly always something you will find useful. This week’s highlight of the BloombergGadfly is especially helpful. Many do not realize that well-known discount brokers are not fiduciaries. Your contact is probably getting paid more for recommending certain products – and you don’t know it.

Watch out for

High-yield debt. “Overhyped” says an analysis discussed by Joe McGrath of Institutional Investor.

Utilities. I understand that I am repeating this theme, but it is an important one affecting many. Even the small recent move in interest rates has had a dramatic effect on utilities. I agree with Lawrence C. Strauss, Don’t Chase High Utility Yields, a bond proxy that did not benefit from the tax changes. Some may be able to generate adequate growth and raise dividends, but you should not expect the stock price (and therefore total return) to keep up.


“Hidden risks” in ETFs (Enterprising Investor). Many do not accurately track benchmarks. Some international funds do not accurately reflect the expected country exposures. Mohammed El-Erian and BlackRock have both concluded that funds “over-promote” the liquidity in underlying holdings.

If the performance of ETFs that track specific indices can be that variable, what about the funds with more idiosyncratic objectives?

Take the iShares MSCI BRIC ETF (BKF) and the Guggenheim BRIC ETF (EEB) as cases in point. Both seek to provide diversified exposure to Brazil, Russia, India, and China, but how much of each? The iShares offering had 61.5% invested in China and 7% in Russia at the time of this writing, while Guggenheim’s fund had 20.2% in China, 13.9% in Hong Kong, and 18.1% in Russia.

You would think targeting just four countries would make the innate challenge of defining emerging markets simpler, but that’s just not the case. Fund structures can only mask the intrinsic complexity of markets, not eliminate it.

Final Thoughts

The confusing array of strongly-held opinions seems more intense than usual. It is probably augmented by the sharp partisan disagreement on many issues. For investors, this raises the stakes and challenges us to focus on meaningful data.

  1. Many investors probably cannot define “overbought” but it certainly sounds bad. If we simply said that the market showed more strength than it has in 20 years or so, that would be both accurate and less threatening. Overbought conditions can continue for months and deliver significant added gains. It is not a magical timing indicator.
  2. I do not see corrections as “healthy” but we should all accept the reality of the occasional 15-20% drawdown. There is no schedule for corrections and no established method for accurate forecasting. It is part of the inherent risk when one invests in stocks.
  3. Part of the explanation for market strength has been an improving economy and significantly higher earnings.
  4. The tax cuts will provide a significant earnings boost for some sectors, helping to support the overall market. That is a major positive for the year ahead.
  5. Additional economic growth can come from increased business confidence and repatriation –both factors that will increase investment. It might also come from an infrastructure bill, if we could get some compromises out of Washington.

On balance, the prospects look good. The inflection point may prove to be another leg up for the economy and earnings. The notion that good things must end is a powerful, intuitive feeling. Some day it will be true, but it has nothing to do with the age of the bull market. At the first sign of weakness, I expect to see a bull market in fear!

When the volume of the noise increases, reliable risk indicators become even more valuable.

I’m more worried about:

  • Spillover from the shutdown. The inability to find a compromise has an immediate economic effect. If it reduces confidence, that effect will be magnified.
  • The “rolling over” psychology. Many economic indicators currently signal great strength. Some are beginning to show a slower rate of growth. If reasonable strength is maintained it is not really a cause of concern. News reports, however, will start to talk about slowing growth and economic weakness. Elevated expectations may be missed. This can also be something of a self-fulfilling prophecy as confidence is reduced.

I’m less worried about:

  • The Fed. There are no signs of sharp policy changes that would block economic growth. The measured reduction in the balance sheet is not a cause for concern.
  • Bitcoin volatility and the market. Many believed that a selloff in Bitcoin would be a problem for stocks in general. After last week there seems to be little support for that hypothesis.

[Do the economic challenges seem complicated and threatening? Need a year-end tune up for your portfolio? This is the time to schedule a free consultation, read my paper on the top investor pitfalls, or both. If you are concerned about major declines, you might be interested in my paper on risk. Just write for our free information on these topics. While they describe what I am doing, the do-it-yourself investor can apply the same principles. Both the concepts on recessions and how we used it to forecast Dow 20K are available for free from main at newarc dot com].

Stock Exchange: Are You Still On The Sidelines?

The Stock Exchange is all about trading. Each week we do the following:

  • Discuss an important issue for traders;
  • highlight several technical trading methods, including current ideas;
  • feature advice from top traders and writers; and,
  • provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some ideas, please join in!

Review:

Our previous Stock Exchange asked the question “will market sentiment turn bearish soon?” We reviewed the continuing market rally, and warned against complacency in trading. If you missed it, a glance at your news feed will show that the key points remain relevant.

This Week: Are You Still On The Sidelines?

The stock market has been “off to the races” to start 2018, and that is creating an uncomfortably eerie feeling for many traders. Perhaps still emotionally scarred from the terrible start to 2016, some traders are missing out on the gains, choosing to instead sit on the sidelines.

According to famous hedge fund manager, Victor Niederhoffer:

“The stock market has had one of the biggest rises in the first two weeks in history and based on past years, it is due for a pull back.”

Niederhoffer shares a total of ten interesting observations in this recent article: Nobody Asked Me, But…

However, according world renowned independent trader and mentor, Charles Kirk:

“it still remains a bull market until proven otherwise. While we recognize the market is long overdue to see corrective price action, we are not seeing evidence of it in the price action other than very high levels of strength that can bring it on.”

Mr. Kirk’s private membership for investors and traders is an excellent way to learn if you can get into his class. Interestingly, Kirk goes on to say:

“This quant study most quoted in social media last week was this – when the first five days of a new year are up +2% or more the full year the follows has been higher 15 out of 15 times with an average +18.6% yearly return * Meanwhile, frothy market conditions remained the top focus by the quants again this week as study after study after study after study suggest potential for short-term consolidation but higher highs beyond it.”

Perhaps it is this short-term consolidation that many traders are waiting for as an opportunity to get off the sidelines.

Taking a different view on the right time to get off the sidelines is this article from The Trade Risk, which suggests “end of day trading is superior.”

Further still, this article from Adam H. Grimes suggests there are no shortcuts to becoming a world class trader. Grimes says experts know how to:

“cut through the garbage and to reduce any discipline to its most essential points.”

His article goes on to say:

“If you truly want to excel at something… You will spend hours, days, weeks, and years refining small elements of your approach. Some of this just takes time, and there are no shortcuts.”

Model Performance:

Per reader feedback, we’re continuing to share the performance of our trading models, as shown in the following table.

Importantly, we find that blending a trend-following / momentum model (Athena) with a mean reversion / dip-buying model (Holmes) provides two strategies, effective in their own right, that are not correlated with each other or with the overall market. By combining the two, we can get more diversity, lower risk, and a smoother string of returns.

And for these reasons, I am changing the “Trade with Jeff” offer at Seeking Alpha to include a 50-50 split between Holmes and Athena. Current participants have already agreed to this. Since our costs on Athena are lower, we have also lowered the fees for the combination.

If you have been thinking about giving it a try, click through at the bottom of this post for more information. Also, readers are invited to write to main at newarc dot com for our free, brief description of how we created the Stock Exchange models.

Expert Picks From The Models:

This week’s Stock Exchange is being edited by Blue Harbinger (Blue Harbinger is a source for independent investment ideas).

Holmes: This week, I bought Melco Resorts & Entertainment (MLCO). This stock’s recent dip is the sort of setup I like to see. From the chart below, you can see the dip, and you can see it has attractive upside over the next six weeks.

Blue Harbinger: Interesting pick, Holmes. I do see the dip, and I know you bought earlier this week (as you always do), so you’re off to a good start on this trade. Can you give us a little more color on why you like it?

Holmes: As you know, my style is based on dip buying and mean reversion. However, you may not be aware that I’m really into protecting assets, too. My process drastically reduces vulnerability to drawdowns while attempting to stay invested for the longest possible period of time. I use a mix of trading techniques (including profit taking, stops, and trailing stops) and technical analysis.

BH: Well you are in good company on this pick, Holmes. Morgan Stanley lifted its long-term industry-wide revenue forecast and price targets on key casino stock names, such as Melco. Lots of stocks across this Macau casino group are higher this week. And why shouldn’t they be as the economy remains strong and per capita income rises. Here is a look at the FastGraph.

Holmes: You’d think it’d be challenging to find good “dip-buying” opportunities considering the market has been so strong lately, but it’s not—there’s still lots of good trades out there.

BH: Thanks, Holmes. I’ll check back with you on this trade next month, considering your typical holding period is about six weeks. How about you, Road Runner—what have you got this week?

Road Runner: This week I like Ensco (ESV). Are you familiar with this stock, Blue Harbinger?

BH: I am familiar. Ensco is an offshore drilling company with a market cap just below $3 billion. And with the strength we’ve seen in oil prices in recent months, it’s not surprising you’d like this type of company.

RR: As you know, I like to buy stocks that are at the bottom of a rising channel. And based on the following chart, you can see why I like Ensco.

BH: Well, you’re arguably in good company on this trade, Road Runner—apparently David Einhorn of Greenlight Capital also recently initiated a position in Ensco. This company was unprofitable through the first three quarters of 2017, but it announces fourth quarter earnings next month, and the market could be in for a pleasant surprise, unless you’re one of the short sellers (currently about 15.8% of the shares are sold short, and that’s down from over 30% in October). For your reference, here is a look at the Fast Graph.

RR: I am aware of oil prices and the short interest. My typical holding period is about 4-weeks, so I’ll likely be out of this stock before the company’s next earnings announcement. And worth noting, options expiration is this Friday, and that could cause some exaggerated market moves too.

BH: Interesting information. I’ll check back with you on this one in about 4-weeks. Anyway, how about you, Athena—what have you got this week?

Athena: This week I sold my shares of Sprint Realty (SRC). If you recall, I bought the shares back on June 26, 2017.

BH: Based on the above chart, it looks like you did alright on this trade. Remind us, Athena—what is your trading style?

Athena: I am a momentum trader. I typically hold my positions for about 17-weeks, although this one was a bit longer. For risk control, I use price targets and stop orders.

BH: Well it’s interesting to see you trading a big dividend REIT (SRC yields 8.8%). And it looks like you bought shortly after it announced unusually high credit losses and lowered AFFO guidance. I’d likely have stayed away from a low quality REIT like SRC, but I’m glad to see your trading approach was successful.

Felix: I have no stock picks this week, but I did run the Nasdaq 100 stocks through my model, and I’ve ranked the top 20 in the following list.

BH: That’s an interesting list, Felix.  I see a lot of the usual aggressive growth suspects on your list, such as chipmakers Nvidia and Micron, and FANG stocks Netflix and Amazon. I’m assuming you’re a momentum trader? And apparently you’re not afraid the market is frothy?

Felix: Correct. I am a momentum trader. And I’m not afraid the market is frothy. I typically hold my positions for about 66 weeks—which is much longer than the other models. I exit when my price target is hit, and I use stops and macro considerations to control risks. And did you happen to notice my strong performance in the performance table earlier in this report?

BH: Nice job, Felix.  Not surprised your style is shining in this market. How about you, Oscar—what have you got this week?

Oscar: This week I’m sharing my top 20 rankings from my Diverse ETF universe.

BH: I love this list, Oscar. You have all kinds of momentum ETFs on your list ranging from the inverse volatility index (XIV) which is a trade that’s been absolutely winning for about 2-years straight now, to the online retail ETF (IBUY), to the semiconductor ETF (SOXX). This is good stuff, Oscar. Thanks for sharing.

Oscar: You’re welcome. And in case you’ve forgotten, I am a momentum trader, and my typical holding period is about six weeks. I use stops to protect against downside, and I exit by rotating into another sector.

Conclusion:

It’s easy to say you’re waiting for a pullback before you enter the market. Unfortunately, that’s a strategy that hasn’t worked all too well lately considering the market’s strong start to 2018 is essentially a continuation of its strong performance in 2017. As you can see in our earlier performance table, our “dip-buying” strategy (Holmes) has put up positive numbers in recent months, but not nearly as positive as our momentum traders. In aggregate, we prefer a blended approach including both momentum and dip-buying strategies. And we’re not sitting on the sidelines with our capital because we believe we can continue to generate strong trading profits whether or not that market pullback arrives anytime soon.

Background On The Stock Exchange:

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

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

Stock Exchange Character Guide:

Character Universe Style Average Holding Period Exit Method Risk Control
Felix NewArc Stocks Momentum 66 weeks Price target Macro and stops
Oscar “Empirical” Sectors Momentum Six weeks Rotation Stops
Athena NewArc Stocks Momentum 17 weeks Price target Stops
Holmes NewArc Stocks Dip-buying Mean reversion Six weeks Price target Macro and stops
RoadRunner NewArc Stocks Stocks at bottom of rising range Four weeks Time Time
Jeff Everything Value Long term Risk signals Recession risk, financial stress, Macro

Getting Updates:

Readers are welcome to suggest individual stocks and/or ETFs to be added to our model lists. We keep a running list of all securities our readers recommend, and we share the results within this weekly “Stock Exchange” series when feasible. Send your ideas to “etf at newarc dot com.” Also, we will share additional information about the models, including test data, with those interested in investing. Suggestions and comments about this weekly “Stock Exchange” report are welcome.

Weighing the Week Ahead: A Confusing Earnings Season

The economic calendar is normal, with a holiday-shortened week and some ongoing political worries. Competing with the Washington Circus will be Q417 corporate earnings reports. The former topics will have greater news interest, but investors should be digging into the earnings reports. The earnings story is always a tasty stew – expectations, results, differing measures, revenues, and future expectations. The tasters are free to report their impressions. Sound benchmarks are elusive. This season has an extra ingredient – the tax cut effects. I expect the punditry to be looking ahead, and asking:

How should investors interpret Q4 earnings updates?

Last Week Recap

In the last edition of WTWA I expected a focus on inflation effects. While that generated some attention and headlines, the modest PPI and CPI reports stilled any imminent worries. Many sell-side firms and columnists continued to describe their worries for 2018, our theme of the last two weeks.

The Story in One Chart

I always start my personal review of the week by looking at a great chart. I especially like the Doug Short design with Jill Mislinski updates and commentary. You can see many important features in a single look. She notes the new records along with other indicators. The entire post is well worth reading for the collection of charts and analytical observations.


The trading range for the week was about 2%, below last week’s 2.6%, but higher than in recent months.

The News

Each week I break down events into good and bad. For our purposes, “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 economic news was good. Before the inflation numbers I published a guide to assist interpretation. Many seemed to find it useful, and one of my plans for the new year is to more analysis of economic indicators.

The Good

  • JOLTs was another positive report. As usual, none of those (even my best sources) did a good job on this release. It is NOT a good source for overall net jobs growth. The monthly employment situation report is better designed and timelier for this purpose. This is a typical case of taking the subject of greatest interest and citing anything that might be relevant.

    The significance of JOLTs is labor market structure. It tells us about shortages, mismatches, and the business cycle. The voluntary quit rate is a sign of confidence by current employees. The openings to unemployment rate is a key measure of labor market tightness. The Beveridge curve interprets the data in the most useful way. I continue to be disappointed that no one covers this report in the most informative fashion.

     

  • PPI Headline and core PPI were both -0.1%, far below expectations and the prior month. Some observers see this as a negative, since it is below the 2% Fed target. That target is designed to reflect a reasonable level when there is suitable growth. If we are getting good growth with lower inflation, that is a positive.
  • CPI registered a headline increase of 0.1%, below expectations, while the core was up 0.3%. The core was up 1.8% on a year-over-year basis. The fixation on a single reading that might exceed 2% is misguided.
  • Pent-up demand for Housing according to the KC Fed, via Calculated Risk.

  • Inventories increased to 0.8% on wholesale goods and 0.4% for businesses. Both numbers were higher than expectations and big increases over the prior month. Inventories are a favorite target for pundits. Bulls claim that businesses are stocking up for anticipated demand. Bears say that they are stuck with unwanted goods. How can one tell? New Deal Democrat, in his fine weekly compilation of high-frequency indicators, suggests the following:

    November data included business inventories, which increased slightly at all levels, but were outpaced by strong sales, meaning that the inventory to sales ratio declined to a 2.5 year low.

 

The Bad

  • Initial Claims rose to 261K, above expectations of 248K and the prior week’s 250K. (Calculated Risk).


  • NFIB Small Business optimism dropped from 107.5 to 104.9.
  • Framing lumber prices up sharply, 22% with CME future more than double that rate.
  • Wage growth still lagging Atlanta Fed via The Daily Shot.


 

The Ugly

The Hawaiian false alarm. We now know that it was caused, at least partially, by one person “pushing the wrong button.” There is a sophisticated detection system, reports CNN.

The detection triggers an instant Strategic Command, or STRATCOM, assessment process. The assessment looks at where the launch is, the potential type of missile, trajectory, apogee, distance and potential targets in the path of the missile.

Top military commanders join a conference call, with the top priority being to decide whether the missile is a threat to the US or its allies.

If the missile is a threat, the president is brought in and response decisions are made. NORAD (the North American Aerospace Defense Command), STRATCOM, intelligence agencies and the National Security Council are involved in the decision-making.

The many affected people did not get a correction for 38 minutes as they gathered, wept, and prayed with family and friends. Like me, some were probably reminded of this iconic image of Slim Pickens:


Noteworthy

Are you smarter than a Dolphin? You will enjoy the fascinating story of Mississippi resident (Institute of Marine Mammal Studies), Kelly the Dolphin, who has taught other dolphins and “trained the humans.”

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.

The Calendar

We have a normal economic calendar, but a holiday-shortened week. The housing data is most important, and Michigan sentiment is also of interest. FedSpeak and the Beige Book will provide an excuse for commentary on a topic where every pundit, news anchor, and blogger has an opinion: The Fed. (See Fed authority Tim Duy if this is your personal concern). The approaching expiration of the debt limit extension is important.

Most important of all will be corporate earnings reports.

Briefing.com has a good U.S. economic calendar for the week (and many other good features which I monitor each day). Here are the main U.S. releases.


Next Week’s Theme

The normal calendar in a shortened week has an emphasis on housing. With Fed Speakers on the road and the Beige Book release, some pundits will choose to discuss the Fed. The looming government shutdown will attract plenty of attention. For investors, the Q417 earnings season, now in full swing, provides the most interesting fresh data. There is always room for interpretation, but this season also adds the complexity of the tax cut effects. More than ever, investors will be listening to earnings conferences with the hope of discovering new opportunities. Many will be asking:

How can we find meaning in the complex earnings story?

 

As usual, here is a typical range of opinion, from bearish to bullish.

  • Earnings expectations are always too high in the early days but too low at the time of reports. Even a high “beat rate” will mean nothing.
  • Earnings are manipulated and therefore meaningless. Look for companies that boosted results via “financial engineering” like stock buybacks, goodwill write-offs, and the like.
  • Current earnings have little effect on the important long-term ratios, like CAPE. Only one quarter from ten years ago will drop out of the calculation.
  • Forward earnings have a good correlation with stocks. This metric is looking very positive.
  • Forward earnings estimates have defied the normal pattern – getting stronger rather than weaker.
  • Forward earnings do not yet reflect possible tax cut effects.

The uncertainty makes this the most important earnings series in many years. As usual, I’ll confine my own interpretations to today’s Final Thought.

Quant Corner

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

Risk Analysis

I have a rule for my investment clients. 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


 

Recession odds remain low and many economic indicators are improving. The WSJ took note of the anticipated inflate rate of 2%.

The Featured Sources:

 

Bob Dieli: Business cycle analysis via the “C Score.

RecessionAlert: Strong quantitative indicators for both economic and market analysis.

Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.

Georg Vrba: Business cycle indicator and market timing tools. None of Georg’s indicators signal recession.

Doug Short: Regular updating of an array of indicators. Great charts and analysis.

 

Insight for Traders

Our discussion of trading ideas has moved to the weekly Stock Exchange post. The coverage is bigger and better than ever. We combine links to trading articles, topical themes, and ideas from our trading models. This week’s post considers sentiment indicators, and a possible bearish turn. What does that mean for traders? Or for our cast of characters? Model performance updates are published, and of course, there are updated ratings lists for Felix and Oscar, this week featuring the DJIA components. Blue Harbinger has taken the lead role on this post, using information both from me and from the models. He is doing a great job, presenting a wealth of new ideas and information each week.

One of my favorite sources, HORAN Capital Advisors, also notes recent sentiment readings. David Templeton’s analysis suggests that this indicator is more actionable at market bottoms. Take a look at the full post.


Insight for Investors

Investors should have a long-term horizon. They can often exploit 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 Jake Varn’s (Bipartisan Policy Center) analysis of what to look and hope for in an infrastructure bill. This will be the breaking issue in a few weeks. Will 2018 be the year of infrastructure? Structured as a list of New Year’s resolutions – faster permitting, building capacity, better asset management, improving financing mechanisms – are all sensible. They seem like ideas anyone would support. The last resolution? Get Started. I hope this is not a hurdle too high for our leadership.

If you read this excellent post, you will know what to watch for as these ideas are discussed. You will also be well-prepared to find some stock ideas linked to the progress.

 

Stock Ideas

I suggest investors join me in reading selections from the first-rate Seeking Alpha Positioning for 2018 series. There are many good ideas. My own annual contribution will appear soon. I give it special effort and appreciate that I am often hitting clean-up on this series.

Korea? Barron’s “Preview” column mentions this idea. N. Korea is sending participants and cheerleaders to the Olympics. Stocks are beaten down and cheap compared to US shares. S. Korea shares are depressed for these and various other reasons. Is this a time to buy when the market is fearful?

Aflac? Eddy Elfenbein, a long-time holder of the “duck stock” explores both the fraud allegations and the company’s response. His analysis it great material both for those who hold the stock and those wondering whether it is a dip to buy.

Beaten-down stocks? Jon C. Ogg (24/7 Wall St) provides a shopping list (here and here) for your consideration.

Trading versus Investing?

I have always made a distinction, mostly based upon time frame, between trading and investing. I have split my weekly updates to reflect this, but some ideas still hit the “seam.”

Brett Steenbarger trades, advises traders, and writes great books to help them. His posts are often valuable for investors as well. This week his post provided another good example, discussing how strengths might become weaknesses.

The risk prudent trader can become risk averse.

The active trader can become overactive and distracted.

The competitive trader can become frustrated and unfocused.

The creative trader can flit from one idea to another, one system to another, never developing expertise.

The disciplined trader can become rigid and unable to adapt to a change in the market.

In all these cases, strengths can become vulnerabilities.

Substitute “investor” for “trader” and you will see the point.

Hale Stewart, often cited here for deep fundamental analysis of individual stocks, has a new series with plenty of charts. Is this a technical emphasis? Here is how he explains it:

Before I move onto the charts, let me explain how I use technical analysis. I don’t like covering charts with trendlines and retracement levels. I use the Miles Davis or Jim Hall approach: do everything you can to distill the movements down to their essence. Most technical indicators simply confirm what the chart is telling you. Only the MACD really provides any meaningful data. In my experience, price movements, EMAs, and volume usually provide all the information you need.

I can relate to this. When choosing my stocks for fundamental programs I always (like everyone else) look at a chart. I use my own ideas (from 30 years of experience) and it seems to work well. It is not complicated. I read Hale’s charts with a similar attitude. Take a look at one where he identifies a bullish formation.

 

Outlook

Once again, you will be ROFL after reading Alan Steel’s “Revelation Game” post. Searching for investment gurus via Google, he finds a candidate. Here was the result:

According to the Skeptic Ink psychic network, of Nikkis 540 predictions in 2016 (there were some duplicates) she claimed 37 hits, meaning a raw success rate of approximately 6.85%.

And while she doesn’t compete well against a coin flip, her predictive nous is far cry more accurate than the aforementioned global strategist at Societe Generale, whose accuracy even when compared to the psychic world makes legendary perma-bear and investment pauper Joe Granville look like Warren Buffett.

Alan concludes with the key point: Many people follow this advice.

It is confirmation bias in action.

Barron’s roundtable edition is usually worth the price of the issue. (I am a long-time subscriber). This week is part one, with a strong consensus among participants about solid economic prospects. We’ll see the stock picks next week.

Personal Finance

Seeking Alpha Senior Editor Gil Weinreich continues his excellent series. It is helpful both for investors and advisors. This week, as usual, included several great entries, but my favorite is his discussion about the transition to retirement. As usual, he combines his always-helpful conclusions with links to useful posts.

Watch out for

The free lunch (actually often a dinner) for potential investors. This article revealed one way that it might not really be free. Quelle surprise! Mrs. OldProf gets a constant flow of these invitations, routing them directly to the recycling bin and suggesting that I take her out instead. I guess that means that the “free lunch” is actually an extra expense for me.

Utility stocks. The valuation levels from the crowded trade make them vulnerable to interest rate increases. Bespoke tracks the recent effects.


The cryptocurrency space. Must I keep writing about this? I guess so. More average people want to discuss this rather than stocks. Young baggers at the market endorse one type of crypto as a “can’t miss.” A Wall Street consultant firm reports on the impending crash.

I certainly do not know where Bitcoin will trade next week, but I do warn investors to be cautious. Make this part of your “fun money” or trading portfolio. The fundamental valuation eludes even the top experts.

 

Final Thoughts

Here is what I expect from earnings season.

  • Earnings expectations were already rising this year, reversing the normal pattern. As always, we turn to the leading sources on earnings.
    • Brian Gilmartin calls it the “earnings underbid.” He has a great explanation of the tax effects, with this summary:

      Here is my two cents: it wont be that easy this quarter with the changes in the deferred tax asset and then any subsequent boost from share repurchases after December 22nd, or the date the Tax reform bill was signed.

      I think these Q4 ’17 reports will quite “noisy” and analysts will have to adjust numbers to reflect operating results.

      The other thing to note too is that I think the deferred tax assets / liabilities and any charges, will be “non-cash” and more GAAP related.

    • John Butters notes that negative guidance is below the five-year average while positive guidance is strong. Here is his analysis by sector.


  • These figures represent data before the tax cut effects. Analysts returning from vacation are still scrambling to identify specific effects on earnings and adjust estimates.
  • While these specifics are elusive, we can count on Eddy Elfenbein to describe the overall impact in understandable terms.

    The tax law lowers the corporate rate from 35% to 21%. Effectively, what that means is that the U.S. government is a silent partner in every American business.

    Previously, they had an odd relationship with the partners as the government owned no part of the business yet was entitled to 35% of the final cash flow. All the other shareholders got the other 65%.

    With this new law, the shareholders’ stake rises from 65% to 79%. They get an extra 14% at no cost. Imagine if you had a silent partner who said to you, “here, take my 14% and you don’t owe me anything.” Of course, that’s not literally what’s happened. But effectively, it’s pretty darn close.

    This is a huge benefit for shareholders. It’s almost like overnight you got 20% more shares of all your stocks. This is especially good for many of our Buy List stocks because they’re very profitable. That’s why they pay a lot of taxes.

    I tend to be skeptical of any models that try to determine a fair price for the entire market. This is an instance where the entire climate has changed. If I were a modeler, I’d have to update several of my variables (and not a few of my constants).

This is a dramatic illustration of the limits of backward looking valuation models. Do we care about what earnings were ten years ago? Or constants derived from 19th century data?

The successful investor realizes that people select individual stocks based upon expectations for future earnings and cash flow. The overall market should be evaluated in the same way.

I’m more worried about:

  • The potential for a government shutdown. There are many routes to compromise, but they seem to be paths not chosen.
  • Consumer sentiment. This is an economic driver that plunged after the 2011 debt ceiling negotiations, and that was despite the typical 11th hour result. Sentiment can be a cause of economic strength or weakness, not just a consequence.

I’m less worried about:

  • North Korea. Despite the bluster, the North/South talks are a positive indicator. Perhaps the Olympics will be as well.
  • The global economy. The strength in the US is being matched around the world.

 

[Do the economic challenges seem complicated and threatening? Need a year-end tune up for your portfolio? This is the time to schedule a free consultation, read my paper on the top investor pitfalls, or both. If you are concerned about major declines, you might be interested in my paper on risk. Just write for our free information on these topics. While they describe what I am doing, the do-it-yourself investor can apply the same principles. Both the concepts on recessions and how we used it to forecast Dow 20K are available for free from main at newarc dot com].