Stock Exchange: The Role of Valuation in Trading

 

Investors who use valuation do it in an absolute sense — the way we do in our Great Stocks program — but what about traders. When the market sets a price that is much different, it reflects broad-based opinion that the typical valuation method is not accurate. Our models sometimes pick that up. Our trading model picks are based upon technical factors, but these often reflect valuation versus the past or versus other stocks/sectors.

Our guest expert this week is Robert Marcin, the founder and general partner of Defiance Asset Management. Formerly, Marcin was a partner at Miller, Anderson & Sherrerd and a managing director at Morgan Stanley, where he managed the MAS Value fund  (currently Morgan Stanley Institutional Value). We invite our readers to follow him on Scutify.

This
Week—Oscar Eats Out

This week’s picks are especially interesting from a value perspective. Our technical models often sense a change in valuation – which they find attractive. Robert has a different take.

 

Oscar

Oscar: This week, I like the restaurants sector. We’ll use Bloomin’ Brands (BLMN) as an example:

Price has been highly variable, though its current price matches up almost exactly with its 200 day moving average. That’s part of the reason why I would move to make this part of a restaurants sector holding for the next month. I predict modest gains, likely near the $20 level.

Robert: Bloomin Brands is an inexpensive stock but with little fundamental catalyst to drive shares higher unless it’s simply broad restaurant exposure one is looking for.

Oscar: I am shooting for the broad exposure, but I like the price here too.

Robert: The stock is cheap at 12.5x’s earnings and 7x’s ev/ebitda, but with little growth in revenues or earnings forecasted, there’s not a lot of conceptual appeal here for a sustained move higher.

Oscar: How about my $20 target? What are my risks here?

Robert: The stock is still down a bunch and can bounce back toward the old highs of mid $20s, but a holding company for Outback, Carabbas, Bonefish and Flemings doesn’t sizzle like the latter’s steaks. Risk here includes high debt and restaurant industry overcapacity which seems to have hit entire category with price discounting.

Oscar: Ouch. The stock may not sizzle, but that was quite a burn.

 

Felix

Felix:

I’m comfortable with my current holdings, so I’d like to look back at my first pick of the year. On 1/5/17, I got into Shopify (SHOP) around the $50 range. Since then, the returns have far exceeded expectations. Let’s take a look:

We’re currently sitting around $64.84 after only two short months. The 50 day moving average, of course, has spiked accordingly. While I generally try to hold positions for months (if not years), I might reevaluate here in light of recent gains.

Robert: This is the pure play growth company in the group with its business model of cloud based multi channel commerce platform services still expanding rapidly. Some 400,000 small and mid sized businesses/startups who want access to ecommerce and retail get their services for modest monthly fees and sell sell sell to the world on most major internet platforms.

Felix: Sounds like a glowing review! Jeff is usually a bit tougher on us.

Robert: Well, now that you mention it…Revenue growth has been 100% per annum but is now slowing down to 50% as the company hit $400ish mm in sales last year and are projected to hit $600 mm this. The stock is expensive at 10x’s sales with the company at break even levels as it spends/invests to grow.

Felix: Expensive? I’ve been sensing a lot of growth in this sector. Don’t you think this one has a little room to run?

Robert: As a pure play, beat and raise growth company, the stock clearly has the hearts and minds of growth and momentum investors. IF one is bullish on stocks, there’s no reason this standout should stop here if their growth continues at such a torrid pace. Primary risk here is very high valuation.

 

Holmes

Holmes: After searching more than 700 stocks for the last 5 trading days…I have not found a single stock that fits in my risk/reward schema. So, this week I’m sitting on the sidelines hoping some of my previous picks will carry the load.

I don’t attach any meaning to not finding a name this week. But I do think this might be hint for me to head out for a long overdue vacation.

J:  I thought you just came back from vacation.

H:  And I thought you were off this week.

Athena

Athena: My momentum play this week is Citigroup (C). Here’s the chart:

As usual, I’m buying after a recent pop, with hopes of another spike over the next couple weeks. February was a good month, and the 200 day moving average suggests a continued rate of steady growth.

Robert: Citi is my favorite of the bunch. Its’ a cheap stock 10x’s eps and .9x’s book value) with improving fundamentals and a chart that seems ready to break out. The bank has a wonderful, global franchise as well as strong domestic businesses also, yet has been under earning vs peers so there’s profit margin expansion potential here.

Athena: Well alright! Anything I’m not seeing here?

Robert: This company should benefit from Trump Administration regulatory reforms and Fed’s rate hiking process as well. Also, legal expense seems to have peaked and should decline adding more to bottom line. It’s at the high end of a range, but I would expect it to break above $60 convincingly and run from here.

Athena: What kind of risks might I have here?

Robert: Risks include a low dividend yield vs peers and negative impact from trade wars/restrictions as its most internationally exposed.

Athena: I can deal with that – for two weeks.

 

Background on the Stock Exchange

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

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

Questions

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

Conclusion

Finding value stocks is difficult work. By definition, you’re looking at positions that are currently unloved. It can take time before the market catches up with the potential you see in the stock. The key question is whether you can afford to ride it out until the market agrees with your assessment.

It often seems that short-term traders are ignoring a stock’s fundamentals.  This week’s examples illustrate that value is sometimes reflected in the charts.

Weighing the Week Ahead: Possible Stimulus and How to Pay

It is a short week without much new data. Even FedSpeak is on holiday. The big story will continue to be the Trump transition. I expect the punditry to be asking a dual question:

How much economic stimulus and how to pay?

Last Week

Once again, last week’s economic news was nearly all good, but not the focus of discussion.

Theme Recap

In my last WTWA, I predicted that it would be “all Trump, all of the time”. And so it was. Speculation about the effect of Trump policies is rampant, usually wrong, and revised daily. This is profitable for media sources and the punditry, so we can expect it to continue.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. He captures the continuing rally as well as the late-week weakness (despite options expiration).

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

The News

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

This week’s news was quite good. If I missed something for the “bad” list, please feel free to suggest it in the comments.

The Good

  • Jobless claims decreased to 235K, the lowest since 1973 despite a larger labor force. (Eddy Elfenbein) Amazingly, some are looking for any modest uptick in this series to be some sign of disaster.
  • Heavy truck sales slump over? (Calculated Risk)
  • OPEC might be on track for a deal on production limits. The market is skeptical, so this would be a real plus for oil prices. Daniel Dicker at OilPrice.com explains the rationale. MarketWatch also notes the possibilities. (See also OPEC news below under “bad”)
  • Earnings continued to show the strength we have been reporting for several weeks. The earnings recession is over.
  • Small business optimism is higher. Since uncertainty and weak confidence has been cited as a drag on business investment, it will be interesting if this indicator starts to show more strength.

  • Housing starts beat expectations with a shift from multi-family to single-family. Calculated Risk has been right on target with this trend, as well as the overall growth rate.
  • Retail sales were strong up 0.8% on top of upward revisions for the prior month. The reports handily beat expectations. See Doug Short’s Big Four update in the Quant Corner.

 

The Bad

  • Industrial production continues to lag with a flat report instead of the small expected increase.
  • Pre-OPEC actions. The market still seems to appreciate higher oil prices. Iran and Iraq continue to increase production in front of the meeting. (But see OPEC above).

The Ugly

Fake News – and the reaction. The bogus news sites had more traffic than legitimate ones during the election campaign. This led Google and Facebook to change policies, prohibiting sites that traffic in lies to make money.

Do we need social media sites as editors, deciding what is fake and what is not? Izabella Kaminska explains the consequences:

The rot at the core of media has little to do with the propagation of fake news on the fringes. Alternative news sites and underground press with questionable journalistic practices have been a phenomenon since forever. In free societies, the public sphere tolerates single-issue publishers, special interest groups or anti-establishment newsletters, because we know that for every outlet which propagates nonsense there’s another that might be ahead of the curve on a topic of great cultural, commercial or political significance.

Accepting the fringes — which includes fake news — is what liberty and a free press is about. It’s our greatest strength, especially when positioned within the constructs of a fair and reasonable slander, libel and defamation framework. Suppressing marginal views is not the answer.

Tyler Cowen observes that this is little different from misleading forwarded emails.

There is no easy answer, but we must start by asking whether it is really a problem. We expect consumers of information to discriminate.

The investment world has seen an avalanche of lies and deceptive information from the most popular sites. The lesson from losing money does not seem to have much effect. This is a bad omen for issues where there are less direct financial consequences.

 

The Silver Bullet

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

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

The Calendar

We have a normal week for economic data, with most of the reports concentrated on two days before the holiday.

The “A” List

  • New home sales (W). Important sector for improved economic growth.
  • Michigan sentiment (W). Strength continuing after the election?
  • FOMC minutes (W). Probably no surprise. Confirmation of a tilt to a hike in December?
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Existing home sales (T). Not as important as new homes, but still a good read on the market.
  • Durable goods (W). Volatile series. Any signs of strength in a sluggish sector?
  • Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

Earnings season is ending. The limited Fedspeak is early in the week.

Next Week’s Theme

 

This should be a very quiet week. There is little data. Most of the A-Teamers will be taking some time off. (Not me. A competitor used to suggest “Talk to Chuck.” He must have been hard to get on the line, but you can still “Talk to Jeff.”) We can expect more Trump speculation from the B-Team. It can’t be worse than we have already seen.

Analyzing the Trump effects requires a good analytic framework and a non-political approach. I hope these concepts will be familiar to regular readers. I was delighted to read a great piece from Prof. Aswath Damodaran, covering both themes. He produces this excellent diagram:

That is a lot on the plate for the punditry. It is all requiring some digestion. (Sorry, I can’t help it. At least I took it out of the title!)

I expect the initial focus to be on taxing and spending.

How large will the stimulus be, and how will it be financed?

I am always delighted when a theme I am working on is delivered to me in Barron’s on Saturday morning. Their cover story is Taming Federal Debt: The Case for 100-Year Bonds. The argument is very good and this chart is especially helpful:

Barry Ritholtz joins in, suggesting what he calls “The Last Best Chance for Fixing Roads and Refinancing Debt.” He offers many points supporting the desirability and probability of a major debt refinancing.

There is a lot of complexity facing investors. Right now, the stimulus plan is probably the most important. As usual, I’ll have a few ideas of my own in today’s “Final Thoughts”.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

The increased yield on the ten-year note has lowered the risk premium a bit. I suspect much more to come. By this I mean that the relative attractiveness of stocks and bonds will continue to narrow.

The Featured Sources:

 

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

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

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

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

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has several interesting approaches to asset allocation. Try out his new public Twitter Feed. His most recent research update suggests some “mixed signals” from labor markets.

Doug Short: The World Markets Weekend Update (and much more). It is time for another look at Doug’s Big Four, the most important indicators for recession dating. The NBER looks for a significant drop from a peak. All but one are still rising, with industrial production the laggard.

New Deal Democrat provides more reassurance. His long-leading indicators have now filtered into the shorter-term measures, especially the most recent housing results. Like our other sources, he now sees no recession for 9-12 months.

 

How to Use WTWA (especially important for new readers)

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

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

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

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

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

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar holds several aggressive sectors. The more cautious Holmes also remains fully invested, but has done a lot of profit-taking and position switching. Now joined by Athena, the group has a regular Thursday night discussion which they call the “Stock Exchange.” This week’s question was about how to spot a good chart. You might be surprised at the answer. You can see that discussion as well as the most recent ideas for consideration – and you can ask questions!

Top Trading Advice

 

Brett Steenbarger is on the verge of retiring our award for best trading advice. Every trader should be reading him daily, as well as his books. Readers will not agree with every conclusion, but it will get them thinking about the right issues. It is a challenge to pick the best post each week, but I’ll try once again.

His analysis is right on target for this week’s issues. He notes the short-term effect of the election as well as the long-term concerns. As a trader, he is aware, but flexible. You could also check out posts on how to react to a big winning day and how to align with market cycles.

Adam H. Grimes has a nice post on losses – not the normal expected losses, but the big ones. He suggests five reasons, which are worth your consideration. The one that I see most often is #3, taking trades of the wrong size.

 

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Bill McBride’s cold-water splash in the face for those who have been spending too much time on the wrong sites: The Cupboard is Full. It is a nice, objective summary of overall conditions. His summary hits the high spots, citing the relevant data and providing his customary charts. Here is his conclusion:

Sure, there are problems. Not everyone has participated in the current expansion. Wealth and income inequality are record extremes. There is too much student debt. And climate change is posing a real threat to the economy in the future. I could offer proposals to address those issues without negatively impacting the current expansion, and we will see if those issues are addressed in the coming years.

However, the bottom line is the cupboard is full. The expansion should continue for some time. What could possibly go wrong?

Here is an example of the several helpful charts, how population will drive housing expansion:

Meanwhile, plenty of financial, cyclical, technology, and homebuilding stocks are trading at recession pricing.

Backing up this conclusion is (yet another) great entry by “Davidson” via Todd Sullivan. He emphasizes the significance of single-family housing for the overall economy. Here is a key quote:

Housing Starts and financing go hand-in-hand. The T-Bill/10yr Treas spread used by banks in mtg lending decisions narrowed to 1.2% in July 2016 indicating a potential slowing in housing which this data reflects. This morning this spread has widened rapidly since the election to 1.8% and the trend looks higher. 10yr rates should continue to rise faster than T-Bills and this will confound many forecasters.

The election of Trump has not yet been factored into housing. I would buy TOL and LEN at current levels with their excellent CEOs. Single-Family Housing starts should be higher by June 2017 after Trump strips away some of the impediments to mtg lending.

 

Stock Ideas

 

Time for energy investments? Brian Gilmartin makes the case with his objective, earnings-driven analysis. He also cautions:

What we hear from the new Administration will matter.

There is a lot of angst over the sector now, with the choppiness of crude trading, what the new Administration does with solar credits, etc.

Give it more time.

Our trading model, Holmes, has joined our other models in a weekly market discussion. Each one has a different “personality” and I get to be the human doing fundamental analysis. We have an enjoyable discussion every week, with four or five specific ideas that we are also buying. This week Holmes revisits a pick from about a month ago, DexCom (DXCM). On the last round Holmes stopped out for a small loss, avoiding a bigger decline. With a new bottom Holmes is trying again. Check out the post for my own reaction, and more information about the trading models.

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

Time for biotech? Bret Jensen makes the case for several stocks, including one of our favorites, Cara Therapeutics (CARA).

And an evaluation of the “bump from Trump” from VanEck.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, you should join us in adding this to your daily reading. Every investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading. My personal favorite this week is the very practical discussion of what burglars are looking for in finding a house to rob.

Stickers do not help much, but big dogs do. Your hiding places are not helpful. They know all of them. This surprised me the most:

“NRA sticker on car bumper = Lots of guns to steal,” wrote one burglar.

Seeking Alpha Editor Gil Weinreich’s Financial Advisors’ Daily Digest is a must-read for financial professionals. The topics are frequently important for active individual investors. That is especially true this week as he highlights key questions, among others, about what advisors do and their effect on performance. I especially his post with analysis and links you can use to see whether you would benefit from an advisor. Here is a key quote:

A true leader educates clients on what are the key principles that should define their financial decision-making: how does one invest, how one can increase his savings rate; spending restraint, etc. The best advisors do this. The worst follow the same trends as Johnny-come-lately investors. I still recall Wall Street Journal articles in the aftermath of the dot-bomb detailing how many brokers made it big promising the moon and stars to all-too-eager clients.

This is very true. In my first interview with clients I try to align expectations with reality, especially in keeping risk under control. One woman had $2 million to invest and needed to turn it into $6 million in three years. I suppose she found someone who told her that he would do that.

Here is another test. If you can deal with the challenges in my latest paper, The Top Twelve Investor Pitfalls – and How to Avoid Them, you can fly solo. Readers of WTWA can get a free copy by sending an email to info at newarc dot com. We will not share your address with anyone.

Market Outlook

Plenty of sources, mostly of the permabear variety, cited low interest rates as bad news for stocks. Now that rates are moving higher, that is also supposed to be a negative. Scott Grannis effectively explains this relationship –A bond bear market is bullish for stocks.

I’ve been arguing for years that higher interest rates won’t be a problem, since they would be symptomatic of stronger growth. Higher rates won’t lead to an exploding deficit, because the stronger growth that pushes interest rates higher will also work to reduce the deficit by boosting tax revenues. Interest rates have been low because the market has had a very pessimistic view of the future growth potential of the U.S. economy.

I agree!

Watch out for…

“Cheap” put protection. The oft-cited advice to buy puts when markets are calm is misguided.

Mixing up your politics and your evaluation of the business cycle. (The Capital Spectator).

Coal stocks. The President-elect may not be able to deliver on this front as along as natural gas prices are so low. (MIT Technology Review)

Final Thoughts

 

The stimulus/infrastructure theme is getting a lot of attention. PBS had a pretty objective analysis of the needs, labor shortages, and implementation problems.

My conclusion is that something major on infrastructure needs will be approved. Here are three key reasons:

  1. Congress loves to spend money and point to the effects in specific districts.
  2. It is easy to imagine a bipartisan coalition. This week showed support from the GOP side via Barron’s and the Dem side via Barry Ritholtz. The philosophies are in alignment.
  3. It is the right thing to do. There are important needs. The exact term of new bonds is up for debate, but locking in low rates seems pretty obvious.

Time Frames encourage a wide range of conclusions. Many are predicting that Trump policies will all end badly – eventually.

Moody’s Mark Zandi has downgraded economic forecasts.

The firm’s “outlook for the U.S. and global economies has been shaken up by the shocking election of Donald Trump as president of the United States,” writes Zandi in the firm’s latest monthly economic outlook. “Based on our analysis to date, the economy under President Trump will likely perform a bit better in the near term but ultimately it will be diminished.”

Zandi is projecting that GDP growth under four years of President Trump will be less than 2% per year, below the 2.2% he had been forecasting before the election. “That is not a big difference in any given year, but it is meaningful over a four-year period,” writes Zandi.

Ed Yardeni, in a thoughtful analysis, asks, “Is Trumponomics Inflationary?” His analysis does not have an easy conclusion, but deserves some thought about each point.

David Rosenberg sees increasing inequality, paving the road to ruin. He sees skewed tax effects and a shortage of skilled tradespeople for proposed programs.

My own perspective for investors is about one year ahead. None of the key issues permit longer forecasts. The immediate stimulus effects will be positive. Investors should do a regular reassessment of progress.

Digestion. There is plenty to do. Here are the key issue areas in my planning for the Trump administration. Each requires study of political dynamics as well as overall impact. Most of the punditry is still reaching far beyond what they know, writing on deadline, driving too fast for the reach of their headlights.

I am starting with the most general and important themes. I welcome suggestions about interesting topics or themes I have omitted. In each case I am evaluating probabilities, impacts, and stocks affected.

  • Stimulus
    • Infrastructure
    • Tax cuts
    • Financing
  • Sectors
    • Health stocks – biotechs, pharma, insurance, hospitals — all different
    • Energy
    • Construction
  • Trade policy
    • Exporters
    • Importers – corporate and consumers
  • Immigration
  • Law and Order
  • Defense

And finally, Happy Thanksgiving to readers of WTWA. I hope that my work has given you a little more to be thankful and happy about.

Things I Don’t Care About — And Neither Should You!!

One of the biggest challenges for investors is filtering out bad, useless, or even costly “information.”  I have a method for screening out the noise and using my time more effectively.  Part of it is keeping the TV on mute and using TIVO to check out anything that is really significant.  You can also just skip articles that obviously do not meet the test.

Here is a good starting list of what to ignore.  Feel free to suggest additions.

  • The Hindenburg Omen – or any other method using BO (i.e. backtested overfitting) and failing the smell test.
  • Commentary from people who are famous for being famous – their websites confuse media appearances with credentials.
  • Tobin’s Q – a great idea fifty years ago, but not relevant for modern companies.
  • Bond guys opinions about stocks – don’t ask your barber if you need a haircut (Warren Buffett)
  • Stock guys opinions about bonds – see above.
  • PMI data lacking multiple business cycles – you have to start somewhere, but we do not need to believe it.
  • Recession predictions from some “expert” who cooked up a model last week – too few cases, too many variables.

You can save many hours and also avoid some bad decisions by rejecting this useless and harmful noise.

Test Your Employment Report IQ

It is Labor Day – a good time to think about jobs. Employment is the most important element in economic growth and also for future Fed decisions. Each month the employment situation report is the subject of intense discussion. It helps to understand the data.

This will be most effective if you attempt to answer each question before checking the answer. The quiz is a little wonky; if it were not, everyone would know it. If you are right on even half of these questions, you will be doing better than most of the “experts.” No peeking!

For answers where a number is called for, take credit if you are within 25% of the actual answer.

Questions

  1. If initial jobless claims are nearly 300K per week, and payroll employment gains are less than that per month, how can employment be getting better?
  2. How many new jobs are created each month?
  3. Is the “birth/death” model the most important method used by the BLS to account for new jobs?
  4. How accurate is the estimate of new job creation?
  5. What is the sampling error (i.e. “margin of error” defined as +/- 90%) for the monthly payroll employment report?
  6. How many times is the original payroll report revised?
  7. Do these revisions eliminate the sampling error?
  8. Is it more accurate to look at “internals” like job growth in a sector, than to go by the overall change in jobs?
  9. What is the aggregate annual impact of seasonal adjustments?
  10. Do Fed members and political leaders know the results in advance?
  11. What year was the high point in labor participation?
  12. What was the level?
  13. How many people who actually want jobs, whether or not they are looking, are currently unemployed?
  14. What is the duration of unemployment?
  15. Does the BLS have discretion in determining or announcing the monthly results?

Answers

1. Initial jobless claims are a report of job losses. The payroll employment report is a net number – gains minus losses for the month. This distinction is frequently missed, even by leading economists whom you see on TV.

2. Over 2.6 million jobs were created per month in the most recent report, Q4 2015. About 2.3 million jobs per month were lost. The net gain for the quarter was about one million, much smaller than the gross increase of 7.8 million. http://www.bls.gov/news.release/cewbd.nr0.htm

 

3. No. The BLS does not receive responses from those who have gone out of business, but it treats non-respondents like the rest of the sample. They make an assumption that enough new businesses are formed to offset those that dropped out. This is the “imputation step” which is four times as important as the birth/death adjustment.

4. The estimates of both overall employment and new job creation have been very good, but this still means deviations of 50K to 125K jobs each month. The chart below shows that most of the monthly variation comes from continuing businesses and is captured in the sample. Business births and deaths are largely offsetting.

5. The sampling error for the net change in jobs is about +/- 100K.

6. There are three revisions. The first two occur on the two months after the initial report. These reflect additional survey responses, not any sort of correction. More than a year later, the results are benchmarked to actual counts from state employment agencies. The Quarterly Census on Employment and Wages covers 98% of private employment, so this is a good count.

7. The first two revisions do not eliminate sampling error. The benchmark revisions are actual counts, not a sample, but the QCEW reports are not very current.

8. A lot of discussion is focused on the “internals” of the report. People never mention that each of these subgroups is part of the sample, and also subject to sampling error. Depending on the size of the group, it can be much larger (proportionally) than for the overall net job change.

9. This is a trick question and the easiest of the quiz. Despite the spinning you hear each month about seasonal adjustments, they are cited only when it proves the pundit’s point. The aggregate annual effect of adjustments is zero.

10. The President, Vice-President, the Council of Economic Advisors, and the Fed Chair get the report the afternoon before it is announced. It is a tightly-controlled process, with results not even known until a day or so before Jobs Day. https://www.washingtonpost.com/national/jobs-day-an-economic-and-political-obsession/2012/03/09/gIQADZPW1R_story.html

11. The peak in labor force participation was in early 2000.

12. The level was about 67%. Looking only at those aged 25-54, the level was 84%.

13. The number of unemployed who want jobs and instead work part time or have become discouraged is 7.8 million, about the same as the number counted in the reported unemployment count, or over 15 million total. The oft cited much higher numbers of people “not working” include (among others) people who have retired, are still in school, or have chosen to work raising a family.

14. About 2 million people, or 26% of the total, have been unemployed for 27 weeks or more.

15. The employment reports are the result of a detailed process that is changed infrequently and only after great public debate. Partisan politicians are not involved in compiling the data. The language chosen is the subject of internal debate, but only covering a modest range of choices. It sounds like it is written by a committee with a limited vocabulary – and it is!

Conclusion

I hope you enjoyed the quiz. Whether or not you did well, you should now be a more discerning and skeptical consumer of jobs report punditry.

Sources

In addition to specific sources named above, much of the material here comes directly from the Technical Notes of the various surveys, including the following:

http://www.bls.gov/web/empsit/cestn.htm

http://www.bls.gov/bls/empsitquickguide.htm

Weighing the Week Ahead: Will the Fed Get the Signal for a September Rate Hike?

This week’s calendar is loaded with important data. Now that the Jackson Hole Fed Conference is over, can we expect a policy change soon? Every data report this week will get special scrutiny. Will the Fed get the signal to hike rates?

Last Week

The important economic news was pretty good, but interest focused on Chair Yellen.

Theme Recap

In my last WTWA, I predicted a weeklong focus on the Fed conclave at Jackson Hole and the implications of Chair Yellen’s speech. This was the story from CNBC’s opening on Monday through the Fast Money group on Thursday after the close. There was an interlude for the “squatty potty” story, but even CNBC cannot talk about the Fed all of the time. Jane Wells is a good sport about such assignments and seems to enjoy “suiting up” for the occasion. I congratulate her on her new status as “special correspondent.”

The Story in One Chart Short

I always start my personal review of the week by looking at this great chart from Doug Short. The overall range is very narrow, with stocks remaining near record highs. It shows the effect from the Yellen speech, the Fischer comments, and the final verdict. It was all pretty muted. Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

 

The News

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

The Good

 

The Bad

  • Q2 GDP rose only 1.1% according to the revised calculations.
  • Existing home sales declined 3.2%. Calculated Risk has the story.

The Ugly

Budget projections. Left unchanged, the U.S. federal budget will increase in relation to total economic output for the first time since 2009. Econintersect.com does a great job of highlighting key reports from a wide variety of sources. This analysis from the non-partisan Congressional Budget Office includes a revealing chart of what is in prospect.

 

Perhaps one of the Presidential candidates will reach agreement with Congress to address this.

On a personal note, I used to teach a public finance course with a unit on budgeting. One of my favorite lectures included the progression of projections. What started out as “balanced” on a five-year projection always turned into a deficit when “year zero” was reached. I taught those classes a long time ago, but nothing has changed.

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week. Nominations always welcome! For ideas, go to your favorite conspiracy site and look for people doing data mining and/or poets writing about economics.

The Week Ahead

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

The Calendar

We have a huge week for economic data. While personally I watch everything on the calendar, you do not need to! I highlight only the most important items in WTWA. Focus is essential.

The “A” List

  • Employment situation (F). Another strong report? Will this tip Fed policy into a rate increase?
  • ISM index (Th). Great concurrent read on the overall economy with some leading aspects.
  • Personal income and spending (M). You have to earn it before you can spend it! July data, but both are important.
  • Consumer confidence (T). The Conference Board version helps to assess both job creation and spending plans.
  • Auto sales (Th). One of the best non-government reads on the economy.
  • Core PCE prices (M). This – not CPI – is the measure the Fed uses to evaluate the 2% inflation target.
  • Initial claims (Th). The best concurrent indicator for employment trends, but less attention during “employment week.”

The “B” List

  • ADP employment change (W). A good independent indicator of private employment growth. Deserves more respect.
  • Pending home sales (W). Everything about the housing market is important, but pending sales are a bit less significant than other measures.
  • Chicago PMI (W). The most important of the regional measures.
  • Construction spending (Th). Volatile July data is important for the long-term trend.
  • Trade balance (F). July data, widely misunderstood, but important for Q2 GDP.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

The big news is the employment situation reports, especially coming right before Labor Day.

Next Week’s Theme

This week brought us another week of quiet trading, but the Fed conference may have teed up a policy shift. While the speeches were short on the specifics craved by traders and the punditry, the basic message was a bit more hawkish. The Fed expects an improving economy and tighter labor markets. This week’s data – and especially the employment report – will get special attention. Everyone will be asking: Will the Fed get the signal for a rate hike?

After Jackson Hole, there are three basic positions:

  1. Negative rates. While discussed, both Yellen and Fischer made it clear that this was not a serious option – at least not right now.
  2. Steady as she goes. Look for more economic strength before raising rates. Then move cautiously and slowly.
  3. Adopt a higher inflation target. Some believe that the long end of the curve will increase only when inflation expectations move higher. This means that the Fed must commit to stimulative policy even if inflation moves above the current 2% target. (Mark Thoma has an excellent description).

Regardless of the chosen position, there was general agreement that monetary policy was being asked to do too much. The neutral sounding calls for help with fiscal policy really means a call for Keynesian stimulus.

Opinion was clearly divided in the Jackson Hole showdown as well as the ensuing discussion. Feel free to add your own thoughts in the comments, including anything I have missed.

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

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 

The Featured Sources:

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

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

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

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

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

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

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

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index. Here is Doug’s latest update (including the recent retail sales data) of the Big Four indicators followed by the non-partisan, non-governmental NBER in dating recessions.

 

How to Use WTWA

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

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

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

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

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

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested, including several aggressive sectors. The more cautious Holmes also remains fully invested.

Top Trading Advice

What are the distinguishing characteristics of top traders? Brett Steenbarger identifies five. How many describe you? My favorite is this one:

*  Successful traders know when to not trade – They wait for opportunities; they pull back their risk taking when they’re not perceiving opportunity.  It’s not that successful traders are always successful.  It’s that their success springs from knowing how to not lose when they’re not seeing the ball well.

 

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Bill Kort’s Apocalypse Now. He notes the media penchant for finding disaster lurking behind every corner. This may well be the single most costly mistake for investors. He does a nice job of linking it to this week’s issue:

Sure, there are apocalyptic events in the stock market, but the media makes them sound almost routine even though they are few and far between. Market attention via the media has been wrapped around another Fed fund rate increase as a catalyst for such an event. It is very doubtful that a quarter-point increase in the rate would be a disaster. In fact, worry over a Fed rate increase at this point is “much ado about nothing”.

Stock Ideas

Chuck Carnevale continues his helpful sector-by-sector review of dividend growth stocks. His articles are always a great source of ideas. I review them all, and you should, too.

Barron’s identifies the “ten best dividend stocks” noting valuation as well as yield. I like the list, because most of the names are those we often hold in our enhanced yield program. (We write near-term calls to get even greater yield from strong stocks). These are all interesting choices.

Holmes will begin contributing an idea each week, a stock we bought for clients a few days ago. I will mention it here and Holmes will also post it each Friday at Scutify.com. While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas may be a starting point for your own research. Holmes may exit a position at any time, and I am not going to do a special post on each occasion. If you want this information, just sign up via holmes at newarc dot com and you will get email updates about exits. This week’s Holmes pick is Level 3 Communications (LVLT).

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are several great choices worth reading, but my favorite is this advice from Morningstar’s Christine Benz, Retirement-Planning Assumptions: Yes, You Can Be Too Conservative: The risks of oversaving and underspending are real, too.

However, I think there’s a risk–albeit an under discussed one–that well-meaning retirees and retirement-savers can take caution too far. For example, I’ve run into 75-year-old retirees who, in the interest of playing it safe, are spending just 2% of their portfolios annually; at that pace, they’re very likely to leave a very large kitty behind. That may be what they want, but it may not be. In a similar vein, I’ve met 40-year-old accumulators who tell me that they’re certain Social Security won’t be there for them, or that they’re assuming their portfolios will return just 2% in their 25-year runway to retirement.

I see this so frequently. Many retirees are in a solid position to enjoy life, and they should do so!

Bond Funds and Bond Ladders

If interest rates rise, there is plenty of risk in both bond funds and stocks (utilities and classic dividend stocks) that are bond proxies. A bond ladder provides more control. Larry Swedroe, director of research for The BAM Alliance, explains the many advantages. I especially like the discussion of avoiding the impact of hot fund flows.

There’s another little-discussed benefit of owning individual securities. With a mutual fund (or ETF), after a period of falling interest rates, “hot money” chasing recent performance will typically buy into the fund. The fund, therefore, must buy more bonds in a low-rate environment, thus lowering the average rate for all investors. Then, if rates begin to rise, the hot money will often leave, forcing the fund (and long-term investors in it) to suffer trading costs and capital losses that can’t be “waited out.”

On the other hand, an investor who holds individual bonds and is satisfied with the yield to maturity when the bond was purchased, is not subject to the same problem (that is, other investors cannot force him to sell at depressed prices).

I strongly agree with this approach. For clients who are preserving wealth, we recommend bond ladders as a foundation.

 

Watch out for….

Target date funds. John Authers (FT) explains that if you do not adjust allocations for relative valuations, you can get seriously off course. If you have a financial advisor, this is a basic task. If not, you should verify that the TDF is doing what you want.

Over-reliance on the Shiller CAPE ratio. Acclaimed valuation guru Aswath Damodaran explains why this approach is potentially dangerous, often leading investors astray.

Refinery stocks. Names that may seem cheap on a long-term basis may be under pressure from other factors. Paulo Santos explains the current risks. Few understand this market. We did well when oil prices crashed since many ETFs just lump refiners in with the general oil sector. Quite wrong.

Volatility derivatives. Trading volume has exploded in these products. Traders who are “scared witless” [TM OldProf Euphemism] read a blog post explaining that this is a great way to hedge. Hardly any realize how much the odds are stacked against them. Mark Melin’s article at ValueWalk does a great job of explaining these issues. The chart below summarizes the key point – contango in the futures contracts. If you do not understand the significance of this, you need to do a lot more study before trading these products!

 

Final Thoughts

The biggest story, now joined by major media sources, is the failure of the Fed efforts at more transparency. Everyone seems to agree that more information has not improved clarity about policy. I have sometimes joined those questioning the communication methods, but always emphasizing a key point:

Transparency ≠ Clarity

If the Fed is data dependent, and the data paint a mixed picture, the immediate policy implications cannot be clear.

Each day I see commentary suggesting that economic data are very weak, but the Fed should be raising rates. Some even suggest that higher rates are needed so the Fed can lower them to fight the next recession. They disagree with the Fed mission to avoid or delay the next recession.

The likely outcome from this is the analysis from Merrill Lynch’s Chief Strategist, Michael Hartnett. His conclusions got a lot of attention this week, including Sara Sjolin (MarketWatch) with the chart below, and also the FT. The latter discusses the Keynesian Put, a concept you will soon be hearing more about.

The bear steepening occurs when a stronger economy raises rates on the long end of the curve. It is bearish for bonds and bond proxies, but very bullish for economically sensitive stocks and banks. We saw some hints of this shift on Friday. Strong economic data, especially tighter labor markets, may (finally) move interest rates higher.

Weighing the Week Ahead: How Should Investors React to the Oil Price Rally?

This week’s economic calendar is pretty light. Market participants will be looking to an early getaway for the long weekend. While there will be plenty of entertaining FedSpeak, I expect a different topic to be at the fore. Pundits will be asking:

Should investors react to the oil price rally?

Last Week

The news was pretty good, but the stock market was not.

Theme Recap

In my last WTWA, I predicted that the punditry would be asking whether it was “springtime for housing”. That was the recurring topic as housing news was reported on several different days and garnered plenty of discussion. Competition came from the Fed Minutes, some dramatic earnings reports, and the election race.

The Story in One Chart

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

SPX-five-day

The News

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

The economic and market news, on balance, was pretty good.

The Good

  • Housing starts increased to a 1.172 annual rate, beating expectations. Calculated Risk has a complete analysis. I am especially interested in single-family building permits, a good leading indicator. Bob Dieli’s monthly economic report always updates this chart:

Dieli Building Permits

 

  • Existing home sales were up 5.45 million (SAAR), the top of the Calculated Risk range for a solid report. Bill writes:

    Note that January and February are usually the slowest months of the year and March and April are the beginning of the “selling season”.  This is a solid start to the year.

    EHSNSAApr2016

  • Jobless claims down ticked to 278K, in line with estimates and below the 300K level that some have been citing. (The four-week moving average was up slightly).
  • Industrial production rose by 0.7%. Eddy Elfenbein has a good report, noting that this interrupts the downtrend since November, 2014. He also points out the effect on the Atlanta Fed’s GDP forecast for Q2, now up to 2.8%
  • Sentiment remains very negative. Urban Carmel summarizes asset allocations and economic skepticism. Ben Eisen of the WSJ cites four stats, including the fund flows in the chart below. Schwab’s Liz Ann Sonders agrees. She notes only negative questions from both investors and advisors, “all almost bordering on Armageddon.”

w1056

The Bad

  • The Philly Fed indexremained negative and essentially unchanged, -1.8 on the diffusion index. Employment improved dramatically, but remained marginally negative. The outlook fell a bit but remained strongly positive. There was little market reaction.
  • Fed minutes showed more chance for a June rate increase. Our go-to Fed expert, Tim Duy, sees a June hike as a bit less than 50-50 but July as quite possible. The Fed remains more confident about the economy than most market participants.
  • LA port traffic declined. Calculated Risk uses a rolling twelve-month average to control for seasonality. The decline was 0.7% for inbound traffic and 0.8% for outbound. Steven Hansen opines that this raises recession concerns.
  • Rail traffic “moves deeper into contraction”. Steven Hansen looks at a variety of rolling averages, including some analysis that adjusts for the declining coal shipments.

The Ugly

State and local pension funds. Chicago provides an example. A decision of the Illinois Supreme Court struck down an “overhaul” of the system, adding $11.5 billion to the deficit, now $18.6 billion. The fund covers 70,000 workers and in the absence of any changes, will run out of money in ten years. (Crain’s Chicago Business)

Noteworthy

Try this financial literacy quiz designed by economists from Wharton and George Washington. (via Shawn Langlois) I am confident that WTWA readers will do well. Keep in mind that less than 1/3 of the population could get all three questions right!

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. Think of The Lone Ranger. This week’s award goes jointly to Gene Epstein of Barron’s and New Deal Democrat of the Bonddad Blog and xe.com. Both take on the frequent current scary articles about the “flattening” yield curve, citing the yield difference between the ten-year and two year notes. That spread is currently 0.94 percentage points. Those on a mission often cherry-pick the part of the curve to analyze, and cry alarm whenever it gets a little smaller.

Epstein points out that until the curve actually inverts (a spread of less than zero) there is not a reliable recession indicator.

2016_05_23_cmyk_NL_

NDD has a great article with plenty of charts. He calls out the “doomers” with this commentary and chart:

In the last week or so there have been a spate of articles – from the usual Doomer sources but also from some semi-respectable sites like Business Insider vans an investment adviser or two ,see here ( https://lplresearch.com/2016/05/19/is-the-yield-curve-signaling-trouble-… ) – to the effect that the yield curve is flattening and OMG RECESSION!!! Here’s a typical Doomer graph – that draws a trend line that ignores the 1970s and neglects to mention that 2 of the 4 inversions even within the time specified don’t fit:

image_686

I wish that more publications would recognize the Silver Bullet winners and writers like them. It is difficult to call out weak and biased posts. There is little reward for good and courageous analysis.

The Week Ahead

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

The Calendar

We have a modest week for economic data. I highlight the most important items, helping us all to focus.

The “A” List

  • New home sales (T). Continuing strength in housing?
  • Durable goods (Th). Important April data. Continuing recent strength?
  • Initial claims (Th). The best concurrent indicator for employment trends.
  • Michigan sentiment (F). Best for job growth and prospective spending. Strength continuing?

The “B” List

  • Pending home sales (Th). Unlikely to match last month. Not as important as new sales, but a read on the market.
  • GDP second estimate for Q1 (F). This will get attention, but it is old news by now with Q2 more than half over.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

There is plenty of FedSpeak, including a Friday appearance by Chair Yellen. Things will be slowing down by Friday as some slip away early for a long weekend marking the unofficial start of summer.

Next Week’s Theme

 

It is a pretty light economic calendar. In addition to the daily dose of analysis by pseudo-experts on the Fed, I expect to see some serious discussion about energy prices. Will the oil rally continue? What does that imply for investors and traders?

Voting a tentative “No” is Dana Lyons, who cites technical resistance and concludes as follows:

Will the oil rally stop here? We have no idea – but we wouldn’t be surprised to see the rally get clogged up, at least temporarily.

tumblr_inline_o750onwm8P1sq14jh_500

Oil & Energy Insider is also cautious but more bullish, mostly citing fundamentals. Their free edition includes this analysis:

Oil prices bounced around this week, flirting with $50 per barrel but stopping short of that key threshold. The major supply outages in Nigeria (now at 900,000 barrels per day) and Canada (more than 1 million barrels per day) continue to put upward pressure on oil prices as they are erasing the supply overhang. Still, much of that will be temporary. The EIA poured a bit of cold water on the rally this week, reporting a surprise uptick in oil stocks. At the same time, U.S. production continues to slowly erode. The markets are more confident than at any point in recent weeks that prices won’t crash back into the $30s, but more movement to the upside is not a given.

Their premium edition (which requires a subscription) is headlined Fundamentals Starting to Underpin Oil Price Rally. They cover a wide range of considerations, but include key questions: When might we expect Nigerian supply to rebound? Most investors would find their analysis quite helpful:

–    The Niger Delta Avengers have attacked pipelines and platforms in Nigeria, knocking 800,000 barrels per day offline.
–    Between 2006 and 2009 Nigeria suffered a similar level of attacks and outages, and a sweeping amnesty policy helped bring an end to the violence. The new President Muhammadu Buhari has taken a tougher line, ending patronage that existed in security contracts for many militia members, a move that has contributed to the resurgence in pipeline attacks.
–    Nigeria’s cash reserves are running low as its economy slows. Reserves have plunged from $49 billion in 2013 to $27 billion recently.
–    Eni (NYSE: E) suffered the latest attack this week. Fellow oil majors Royal Dutch Shell (NYSE: RDS.A) and Chevron (NYSE: CVX) have also seen their infrastructure taken out from explosions.
–    Nigeria’s oil production is at its lowest level since the 1980s. The attacks show no sign of letting up, and as of now the Nigerian government is unwilling to back down.

 

 

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

Indicator Snapshot 052016

The Featured Sources:

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

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

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

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting approaches to asset allocation. This week Dwaine opened to the public one of his subscriber-only research reports. He notes that one of his recession indicators has moved up to 60%. He goes on to explain that he uses a group of six different methods as his preferred approach. He writes as follows:

Another way to look at the RFE is to average the current recession probability showing on each of its six model components, which is currently showing a 14.6% probability of recession. This model appears to have served well in the past, with zero false positives above readings of 0.20.

2016-04-26_1743

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

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

Noteworthy this week:

Hedge funds are using artificial intelligence to analyze the Fed minutes. Guess who can do it faster – you or them?

Peter F. Way reports on the hedging techniques of “big money” traders, identifying candidates with the best risk/reward balance. Apple?

501110-14632831049172328

 

How to Use WTWA

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

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

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

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

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (Suggestions and questions welcome!)

 

Best Advice for the Week Ahead

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

Insight for Traders

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

Felix and Holmes

We continue our neutral market forecast. Felix is about 75% invested, and with less aggressive sectors. REITs and utilities have moved near the top of the list. The (usually) more cautious Holmes remains almost fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates.

Top Trading Advice

Dr. Brett Steenbarger has important advice about Seeing Beneath the Market Surface. He writes:

Markets move higher, markets move lower.  The question worth continually posing is, “Is the market getting stronger or weaker?”  This is a meaningful question because a market that moves higher can be getting weaker and a market that moves lower can be getting stronger.

Read the entire post as he explains how to apply this approach.

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read, it would be this Forbes article by Brett Steenbarger (and not just because he has some kind words about WTWA, but thanks!) As a psychologist and trading coach he sees things missed by others and explains them very well. I share many of his themes, but often cannot communicate them as well. People need to be open to new ideas and unemotional in executing the plan.

Few can meet these tests.

Stock Ideas

Chuck Carnevale has a timely post on cyclical stocks. He shows how to use his tools to analyze valuation in this difficult sector. When can these stocks be right for dividend-oriented, conservative investors? Emerson Electric (EMR) is his illustration. If you agree with our experts that a recession is not imminent, cyclical stocks are a good place to shop.

How about Kroger? Hale Stewart makes this a good example of how to search for a good stock – find an interesting sector, a cheap stock, and a catalyst.

Retailers that might profit from the “Amazon effect.” (Philip Van Doorn) Hint: they need to change their business model.

Marc Gerstein has some interesting contrarian retail plays. Marc always uses some science in his method. Here he identifies desired characteristics, develops a screen, and looks for a catalyst. It is another article that goes beyond simply delivering stock ideas (although it does that). Stock screening meets Peter Lynch.

How about solar? If energy prices improve, solar stocks do as well. Travis Hoium has an interesting argument favoring First Solar (FSLR) over some alternatives.

Outlook

Why is it so attractive to be negative on your investments? One good answer lies in Morgan Housel’s explanation of volatility and how it can take investors off course. It is so easy to think about an account in terms of how far we are from the past high. In fact, that is the condition over 87% of the time. Each year includes a lot of big moves that seem small when you later look at the long-term stock chart. He uses 1998 as a year of major gains, but only if you were able to ride out the major swings. I like this chart showing time spend below the prior high:

sp6_large

 

 

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. There are always several great choices worth reading, but my favorite this week is from Carl Richards at Investment News. He suggests that a good financial advisor helps clients by turning off the news spigot. (If you do not use a financial advisor, I recommend that you turn it off anyway! You might make an exception for WTWA).

There’s a valuable role for us to play as real financial advisers, that of the human curator. Do our clients really need to spend hours sorting through their feeds and trying to decode the headlines or could we be doing that for them? What should they be paying attention to?

For instance, one friend shared with me that when he turned off the financial news spigot, he calculated that he saved two to three hours every night. Do the math and it ends up being a savings of 40 or so days each year.

Value Stocks

Time to buy again? They are cheaper than the broad market and that seemed to be the story last week.

Watch out for….

Boeing (BA). Barron’s warns that demand for fuel-efficient aircraft has declined.

Bonds and fund redemptions. If the ten-year note increases one percentage point, to something like 2.8%, you will immediately lose 9% on your investment. It would take a few years to make that up, even if rates moved no higher.

Investment big-shots using a platform to talk their book. Are they really there to help you? This is an interesting summary of recommendations at the recent SALT conference, which was breathlessly covered in the media. Most of the topics would require a lot of research, but the Sherwin-Williams (SHW) recommendation (You can’t buy paint online) caught my attention. It took about five seconds to discover the error of this assertion.

13F filings. Here is one example that highlights stocks from David Einhorn. This, and nearly everything written about 13F reports is misleading. This WSJ article headlining George Soros is especially misleading. I explained this carefully (for the second time) but no one cares. We can think of it as our secret!

Final Thoughts

Knowing economics helps to understand energy pricing, but the payoff for that knowledge has been delayed. In my most popular article ever on Seeking Alpha, I noted a few basic facts about energy including the relatively small gap between supply and demand. We are now observing the closing of that gap. It could (and will) continue in one of three ways:

  1. Reductions in supply through economic forces. U.S. producers responded, but most others have not – so far at least.
  2. Increases in demand through a growing economy. This is happening with record miles driven in the U.S. and many new consumers worldwide.
  3. External shocks, through weather, disasters, or war.

The same economic effects may well push against a price increase. The reduction in rig counts, for example, seems to have paused for the first time in eight weeks. Bespoke has one of their great charts using data from the primary source on drilling activity, the Baker-Hughes weekly report.

052016-Baker-Hughes

 

Even if $50/barrel represents an intermediate high for oil prices there are important favorable consequences:

  1. The savings to the consumer, compared to recent years, remains large;
  2. The fears about failing companies and job losses, exaggerated and localized, will be less of a story.;
  3. The concern about banks failing due to oil company bankruptcies will be reduced.

Current oil prices may represent a sweet spot both for the energy sector and the overall stock market.

Government Reports from Big-Money Investors: Three Things You Need to Know (but don’t)

Four times a year big-time money managers are required to file form 13F with the SEC.  This always sparks news stories naming the most important investors, people like George Soros and Warren Buffett, and drawing conclusions about what they are doing.  The implication is that you might benefit from looking over their shoulders.

You won’t!  The information is worse than worthless — it is misleading.  Here is why, the three things you should know:

  1. The reports are old news.  The law provides 45 days to file after the end of the quarter and there is no incentive to be early.  The process for filing has been streamlined for the modern age, but the requirements have not.  This delay is an eternity in the modern investing world.  The consumer of the information has no idea whether the positions are still valid.  Has recent news been important?  Could the firm reporting be selling into the strength generated by the report?  They have no obligation beyond the legal reporting.  They are free (and should be) to trade in the best interest of their investors as they get new information and opportunities.
  2. The reports cover only long positions.  There is no requirement to report “shorts.”  The implications of this gap invalidate the reports.  Bill Ackman, for example, is widely known for his short position in Herbalife (HLF) and his very public attacks on the company and its business model.

If you relied upon the government to inform you about Mr. Ackman’s short positions, the 13F would tell you absolutely nothing!

Ackman Longs

Here is another example.  George Soros reported long positions in Barrick Gold and a call (a bullish position) in a gold ETF.  What do we know from this?  Nothing at all.  He might actually have a neutral gold position like a pairs trade, long Barrick and short another gold stock that he believes to be weaker.  We don’t know, because shorts are not reported.

His long call position in the gold ETF might be paired with a short call.  Whether the overall position is long or short depends on which strike and expiration date was bought and sold.  Once again, we know nothing about the overall position.  I do not know from the filing whether Mr. Soros is really bullish on gold, and neither do you.

3. The report on options positions is  — can’t think of a kind word — clueless.  Since the government will not approve a method of analyzing an options position, they require something that is really stupid.  The filer reports long options only.  This means that there are no spreads, including both long and short options, even though that is the most common method of trading for big-time investors.  Worse yet, the long options are not described in terms of their actual value.  The value of each option is assigned the nominal value of the underlying stock!!  Professional traders, and the Nobel-Prize winning options modelers, know that an option has a value based upon a variety of factors, including the stock price, the strike price, the time to expiration, interest rates, expected volatility, and expected dividends.  The option has a theoretical value based upon these factors and a “delta” (the expected change in option value for each dollar move in the underlying).

I understand the government problem in assigning a “theoretical value” and assuming some level of expected volatility.  That does not excuse these blunders:

  • Ignoring short positions in the spread
  • Assigning the underlying stock value to options, even those that are far out-of-the money

Here is a great example from Mike Saltzman, my top researcher, associate portfolio manager, and a veteran options trader.

The reported SPY put position (a bearish bet) is 2.1 million.  The government filings multiply that times the value of the underlying spy, reaching a total value of $430 million or so.  Since the total number of puts is greater than last quarter, this is seized upon in the popular media.

In reality, we have no idea of the strike or the time to expiration for these puts.  The implication is that we have no idea of the value or the deltas for each put.  If far out of the money, they might be cheap protection.  More likely they represent a spread, the sort that a professional trader might buy as cheap downside protection.

Suppose, for example, that you did this spread.

Buy 1.05 million Jun’16 180P for .21

Sell 2.1 million Jun’16 175P for  .12

Buy 1.05 million Jun’16 170P for .09

This is a put butterfly, an extremely common  limited risk position. We own the same number of long and short option positions, so risk is limited. This particular butterfly would cost about $.06 in option, and $6 in commissions. It has a lot of potential. If the SPY goes down to 175 it would make  $9.94 per spread or almost  This spread has a very small short delta component.  It will only make money if the SPY were to fall  more than 10% in just a few weeks. It costs eighteen cents (or about 180K) and might make almost $10 million.

This is not really a short bet on the market.  It is downside protection purchased on a risk/reward basis.

Meanwhile, on the 13F this would show up as being long 2.1 million puts, with a value of (think short value) of $430 million — completely unrelated to the actual position value or properties.  There are many other examples of spreads that would fit the 13F filing,  including some that actually are bullish plays on SPY.

From the filing itself we cannot even conclude that Mr. Soros has a short position in SPY.  It is extremely unlikely that he simply bought 2 million puts without any offsetting short puts.  Professional traders usually work with spreads.

Conclusion

The 13F report is an unhelpful and costly exercise.  Those who take it seriously may well do the wrong thing.

I wrote about this two years ago but the media coverage has not improved.  The best investment advice is to ignore these stories.

 

Is the Market Cheap? Three things you need to know about valuation, but don’t

There is a general consensus that valuation indicators are not very useful for market timing. Despite this, the financial media and the blogosphere feature an avalanche of articles warning that the market is seriously overvalued. Your retirement account might drop 50% at any moment. There are countless worries in the world.

Many investors have been “scared witless” (TM OldProf) by this, missing out on a great opportunity. Is it now too late? What is the current potential for market gains?

Here are three things you do not know about valuation:

  1. The oft quoted indicators are not currently endorsed by their developers, only by those of the bearish persuasion.
    1. Warren Buffett described his “favorite valuation indicator,” the stock market cap to GDP ratio, in 2001. The current high readings are gleefully cited by many. Warren Buffett himself, while not specifically repudiating the indicator, has often noted that it does not work when interest rates are so low. He has repeatedly said that investors should prefer stocks to bonds in the current market climate. Charlie Munger has said the same thing. There have been many stories about this, but they are mostly ignored.
    2. Prof. Shiller’s CAPE ratio shows an overvalued market and is frequently cited. No one ever mentions that Prof. Shiller himself is more than fully invested in stocks for someone of his age. He cut exposure a bit last fall, but does not recommend the “all-in, all-out” approach of many who quote him. Whenever he is asked in an interview he explains that young people should certainly own and hold stocks. He never advocates using CAPE for market timing. He has endorsed CAPE for sector selection. Barclay’s seems to have pulled the page with the Shiller endorsement, although the CAPE Fund is still trading. My article explains the methodology.
    3. Tobin’s Q was invented in the 50’s by a great economist. It emphasized the replacement cost of major companies. If he were alive today, this brilliant man would be revising his methods to explain modern technology companies, as well as stocks like Amazon, Google, and Facebook. It is not fair to apply methods designed for a world with more manufacturing to one so different. No one uses this method for individual stock analysis. Only a few people profit from writing about this aged and obsolete indicator.
  2. There are many experts whose methods show that stocks are attractive. Whenever these people – Laszlo Birinyi, Brian Wesbury, Jeremy Siegel, Jim Cramer, and me, to mention a few – suggest that stocks are undervalued, someone plays the “perma-bull” card. I don’t know for sure about the others, but I am perfectly willing to shift positions as the evidence changes. No one should be embarrassed about being right. I find the name-calling unhelpful for both bullish and bearish viewpoints.
  3. There is a bias in valuation coverage. Because the bearish concept has such a grip, and predicts huge declines like 50% or so in stocks, it grabs headlines and page views. If you do not believe me, do a little personal poll or else a Google search on stock market valuation. Look at the headlines. Those who are comfortable with current stock values expect 10% gains or so. For the average investor, the risk-reward seems dangerous. The key is that the big declines are low probability, while the expected gains are pretty normal.

Conclusion

The bearish valuation theme has persisted for many years. It is usually invoked to claim that all indicators show an over-valued market. No other choices or ideas allowed! This is not a balanced analysis.

The consensus that valuation methods are not good for timing came years too late. It was only after the various bearish valuation indicators did not signal a buy in 2009. How many years will it take before investors catch up? Forget about changes in pundit opinion. They are all “locked in.”

The single greatest reason for the valuation error is the level of inflation and interest rates. And not the Fed-controlled rates, but the longer end that reflects market forces. Mr. Buffett, as usual, nailed it in his commentary, but few paid any attention. In an interview last August, he stated:

Buffett reiterated that he was a long-term investor, saying he expected prices to be “a lot higher” 10 years or 20 years from now.

He likened owning stocks to owning a home, saying that if homeowners expected prices to fall 5%, they wouldn’t sell their homes in hopes to buy it back for 5% less. They are locked in for the long haul.

He also stated, as he has on many other occasions:

What you can say now — [it’s] not very helpful – but the market against normal interest rates is on the high side of valuation. Not dangerously high, but on the high side of valuation. On the other hand, if these interest rates were to continue for 10 years, stocks would be extremely cheap now. The one thing you can say is that stocks are cheaper than bonds, very definitely. We’ve seen low interest rates now for six years or so, rates that we really wouldn’t have thought possible, particularly in Europe where they’ve gone negative. And that’s continued a long time, and of course we saw them continue for decades in Japan.

Do you think you should pay attention to What Mr. Buffett said fifteen years ago, or what he says now? Can’t he interpret his own indicator? Can you or I do better?

The same argument applies to Prof. Shiller, who is poorly served by the uber-bearish applications of his work.

My conclusion? Earnings prospects are important and remain my own principal focus for stock valuation. Stocks remain moderately attractive, despite the scary stories. Specific names are quite cheap, with low PEG ratios and great prospects. Develop a good shopping list!

Weighing the Week Ahead: Will there be a January effect?

After two weeks of slow, holiday-shortened trading, the A-Teams will (gradually) get back to work. Despite the importance of the data on this week’s schedule, I expect a different sort of fixation on the calendar. We can expect widespread discussion of the question:

Will we see a January effect?

 

Prior Theme Recap

In my last WTWA I predicted that the slow news and trading environment would lead to a pundit parade, with plenty of forecasts for the new year. This was pretty accurate, including some carry over from our prior week’s question about Santa. Things were looking up until the last two days of the year disappointed. You can see this clearly from Doug Short’s weekly chart. His full post also includes analysis for the full year. (With the ever-increasing effects from foreign markets, you should also add Doug’s World Markets Weekend Update to your reading list).

SPX-five-day

 

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

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

This Week’s Theme

There are plenty of important data releases this week, including the most important. At most other times this would stimulate spirited discussion about the economy. At the start of the year there is a very different dynamic. Perhaps because it is simpler to think about, everyone loves the focus on the start of the new year. I expect most observers to be asking –

Will we see a January effect?

I did not say “the” January effect, since the calendar-based prognoses have broadened to include the following:

  1. The original January effect saw losers sold near the end of the year to harvest the tax losses. After 30 days, many repurchase, causing a January rebound.
  2. Some investors wait until January to sell winners, delaying the tax effect. Reportedly (Art Cashin) others sell winning names short during the last two days of the trading year, anticipating the tax trade.
  3. Many believe that as goes January, so goes the year.
  4. Some believe that as goes the first trading day, so goes January and the year.
  5. Some will focus on the Presidential election year.
  6. And a few will stick to the data.

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

Last Week’s Data

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

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

The Good

Despite the negative result for stocks, there was some good news last week.

blogger-image--1496232610

  • Consumer confidence from the Conference Board registered 96.5, beating expectations by a few points. Doug Short has the story, including data showing the historical significance of the indicator.

DShort Conference Board

The Bad

Some of the economic data was disappointing.

  • Initial jobless claims increased to 287K. See Calculated Risk for analysis and a helpful chart.
  • Rail traffic weakness continues. Steven Hansen of GEI says it is “sliding into recession.”
  • The Chicago PMI was only 42.9, missing expectations by seven points and signaling continuing contraction in Midwest manufacturing. Detailed analysis from Steven Hansen of GEI (who was definitely working last week!)
  • Pending home sales declined by 0.9%. Too little inventory once again gets the blame. Hmm.

The Ugly

My intention was to skip this topic over the holidays, despite the many candidates. Then I saw a famous bear’s list of “possible” predictions for 2016. The list was heavy on terrorism ideas and even included a possible injury to Warren Buffett. To me, this went beyond the bounds of good fun. It also serves to keep investors scared witless (TM OldProf Euphemism). The question of how terrorism affects investing is difficult, and not a subject for light-hearted speculation – especially when it includes specific ideas of what attacks might be the worst.

Mrs. OldProf advises me that I should not name and link to this source – who is notoriously thin-skinned. You can find it easily if you really want, but I am not recommending it. The post just hit me the wrong way. I suppose that others might like it.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts.  Think of The Lone Ranger. This week’s award goes to Matt Busigin, who explains that US Recession Callers Are Embarrassing Themselves. Here is his lead paragraph, worth keeping in mind on Monday when the ISM data come out:

 

Through a combination of quackery, charlatanism, and inadequate utilisation of mathematics, callers for US recession in 2016 are embarrassing themselves. Again.

The most prominent reason for recession calling may well be the Institute of Supply Management’s Manufacturing Purchasing Manager Index. The problem with this recession forecasting methodology is that it doesn’t work.

 

Please also see our review of last year’s winners. You will find the summary fun to read, featuring advice which remains timely.

A Well-Deserved Remembrance

If we had been doing the Silver Bullet in those days, we certainly would have recognized “Tanta” who wrote anonymously for Calculated Risk before her death in 2008. Joe Weisenthal and Tracy Alloway have a nice interview on the subject with Bill McBride.

Noteworthy

How would you do as Fed Chair? Could you get reappointed after four years? Give it a try with this enjoyable game.

Quant Corner

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

Our economic risk indicators have not changed.

In our monitoring of market technical risk, I am using our “new” Oscar model. I put “new” in quotes because Oscar is in the same tradition as Felix and the product of extensive testing. We have found that the overall market indication is more helpful for those investing or trading individual stocks. The score ranges from 1 to 5, with 5 representing a high warning level. The 2-4 range is acceptable for stock trading, with various levels of caution.

Oscar improves trading results by taking some profits during good times and getting out of the market when technical risk is high. This is not market timing as we normally think of it, since it is not an effort to pick tops and bottoms and it does not go short. Instead, Oscar identifies and limits risk. (More to come about Oscar).

I considered continuing to report the Felix updates, but I already have a distinction between long and short-term methods. I want to minimize confusion. Those who want this information can subscribe to our weekly Felix updates.

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

For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

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

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

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

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

Check out Georg’s new mutual fund analysis tool. You can easily see how your fund has done on this fee-adjusted ratings scale.

Monitoring earnings trends is a crucial step in making sound investment decisions. Brian Gilmartin has an excellent review of the last several years, as well as a look at the year ahead.

The Week Ahead

This is a big week for economic data, including several of the most important reports, as well as some catching up from the holidays. While I highlight the most important items, you can get an excellent comprehensive listing at Investing.com. You can filter for country, type of report, and other factors.

The “A List” includes the following:

  • Employment report (F). Still viewed as the single most important data point.
  • ADP private employment (W). A strong alternative to the official report, using a different method.
  • ISM Index (M). Of special interest given the recent softness in manufacturing and the Chicago PMI.
  • Auto sales (T). Continuing strength in this important non-government read?
  • Initial claims (Th). Fastest and most accurate update on job losses.
  • FOMC minutes (W). Even with a unanimous vote and a press conference, we can expect careful scrutiny in the search for added information.

The “B List” includes the following:

  • ISM services index (W). Less widely followed than manufacturing because it is newer – actually covers more of the economy.
  • Construction spending (M). November data, but still interesting.
  • Factory orders (W). Also November data, with weaker results expected.
  • Trade balance (W). November data with significance for Q4 GDP.
  • Wholesale inventories (F). Also November data with implications for GDP.
  • Crude oil inventories (W). Continued focus on oil prices keeps this report in the spotlight.

It will be a light week for speechifying, but there will be some action at the American Economic Association’s annual meeting, held in SF this year. Regional Fed President John Williams will be on a panel.

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

Oscar continues both the neutral market forecast, and the bearish lean. We are about 35% invested in this program. There are often plenty of good investments, even in an expected flat market. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix and Oscar’s weekly ratings updates via email to etf at newarc dot com. They appear almost every day at Scutify (follow here).

Dr. Brett Steenbarger has two great pieces this week.

 

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

Other Advice

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

If I had to pick a single most important source, it would be it would be the annual economic summary from Calculated Risk. Most investors find it challenging to link news about the economy to their own portfolios. Chuck Carnevale has provided great evidence that “earnings determine market price.” I have repeatedly shown that economic growth is strongly linked to earnings, with recessions the biggest risk. Bill McBride tells you what to watch for in 2016 – a very helpful list. A recent interview with Peter Lynch underscores this point. His advice has been widely summarized as investing in what you know. He notes that this is not enough.

 

What’s wrong with the popular-wisdom version of his ideology, which is usually cited as “invest in what you know”? It leaves out the role of serious fundamental stock research. “People buy a stock and they know nothing about it,” he says. “That’s gambling and it’s not good.”

 

Stock and Fund Ideas

Chuck Carnevale has ten undervalued dividend champions, with complete analysis and explanations. Here is one that we like, enhancing the nice yield with the sale of short-term calls.

426415-14508078108688552-Chuck-Carnevale

Value investors should note that even Mr. Buffett had a tough year, the worst since 2009. Great methods do not always work within a twelve-month period.

A guide to contrarian investing in 2016. (Luke Kawa/Bloomberg)

 

Lessons from 2015

 

You can get in short form – pithy and witty entries — with Josh Brown’s annual list. He asks many contributors to comment on what they learned. I always give some thought to this question, but it is difficult. I thought I had a good entry, but it didn’t beat this response:

 

Scott Redler (T3 Live): Uber, the world’s largest taxi company, owns no vehicles. Facebook, the world’s most popular media owner, creates no content. Alibaba, the most valuable retailer, has no inventory. And Airbnb, the world’s largest accommodation provider, owns no real estate

Michael Johnston has a categorized list of 50 favorite posts from a variety of authors. You can use the descriptions to find the most interesting for your own needs.

 

Watch out for….

 

Market Forecasts. It is pretty easy to find a long list of failures in the forecasting business, especially if there is no attention to error bands or the general volatility of the series in question. But what should you do? Even a buy-and-hold investor is making an implicit assumption about the general market trend. Cullen Roche has, as we would expect, a very pragmatic viewpoint on the subject. You will find it helpful in navigating the noise.

 

And also …. Market history in headlines for the last decade. This is a great illustration of the difficulty in calling the twists and turns of events. (Morgan Housel)

 

Hotel stocks. Does Airbnb represent a real threat?

 

Oil price forecasts. A history to consider. Check out some of the big-time calls versus this chart:

 

fp1228_oil_c_jr

 

 

 

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. There are several great links, but I especially liked Monevator’s advice on How to Lose Money in 2016. There are seven great points, but the first will give you the idea:

1. Sign up to some bearish investing websites

Good investing starts with a long-term businesslike mindset, so to really invest badly, it’s vital you start rotting your thinking without delay.

Where better to begin than by overdosing on some of the doom and gloom newsletters that have been predicting Financial Armageddon since, well, the start of the last bull market?

They’ll have you swapping your carefully chosen funds and shares for baked beans and survival kits in no time.

Ideally find one that offers occasional tips on Russian gold miners, Panamanian oil explorers and the like.

That way you’ll get twice the bang for your buck.

Final Thoughts

If we are to believe in a calendar effect, we need to see two things:

  1. Some logical reason behind the action. Deadlines for tax effects qualify, so it is something to think about.
  2. A reason that the effect has not been fully anticipated – already “discounted” by the market. In general, this sort of regular opportunity lasts only until it is widely known.

Count me in with the final group, de-emphasizing January and following the data. The calendar data are weak, and do not cover enough history.

This illustrates our most persistent theme from last year:

If you want to be a trader, you need to outguess what everyone else is thinking about. We do some of that.

If you are an investor you can rely upon your own assessment, taking what the market is giving you.

Eventually stock prices depend upon earnings which depend upon economic growth. Leading economist Brad DeLong illustrates why growth continues, but has been sluggish.

6a00e551f08003883401b7c7fe0e6a970b

[long EMR versus short calls]

Weighing the Week Ahead: Time to Revise Year-End Market Estimates?

Sometimes the calendar dictates the agenda. The Labor Day weekend marks the official end of a summer that was eventful for markets. The punditry will be asking:

What is your (revised) EOY target for stocks?

 

Prior Theme Recap

In my last WTWA I predicted that everyone would be focused on the lessons from the prior market turmoil. That was mostly wrong, since there was too much new turmoil! As he does each week, Doug Short’s recap explains this dramatic story and his great weekly snapshot lets you see it at a glance. With the ever-increasing effects from foreign markets, you should also add Doug’s World Markets Weekend Update to your reading list.

The chart shows the changing “lesson” that we might draw, starting with sharp selling on Tuesday (CNBC Markets in Turmoil back on the air), a comforting rally on Thursday morning, and the decline through the end of the week. It was an ever-changing lesson.

 

SPX-five-day

Doug provides several great charts, including all of the drawdowns from the most recent peak since 2009. The current weakness is the third largest.

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

Last week some advance planning was especially important. There was little time to react intelligently.

This Week’s Theme

The market correction is causing some firms to revise their year-end targets for stocks. Because the decline occurred while many were on vacation, reconsidering targets will be job one for those getting back to the office.

The question is whether the key fundamentals remain intact, or whether something has changed? Whether the bull market trends continue, or recent selling changes the trend. Simply put,

What is your year-end target for stocks?

The question encompasses an array of issues.

The Viewpoints

Last week’s presentation, which showed alternative positions as separate bullet points, seemed to confuse some readers. I was trying to illustrate opposing takes, while (as always) confining my own opinion to the conclusion. Let me try again with a different approach.

To provide a clear contrast, I am over-simplifying the bull and bear cases. Your target for the market depends heavily on the topics listed in the table below (which include some links).

 

Topic Optimist Skeptic
U.S. Economy Solid and growing Sputtering
China Slowing gradually Hard landing
Recession Little chance in next year Potential drag from global effects
Fed Rate hike coming – gradual and irrelevant End of Fed accommodation ends the only market support
Market strength A reaction to the economy and earnings Artificial gains supported only by Fed “pumping”
Valuation Attractive considering interest rates Dangerously high
Earnings Rebound expected as energy scrolls off More downward revisions needed
Inflation Subdued, permitting continued low rates No one believes official inflation measures
Target? Fundamentals intact: 10-20% Downside retest needed. Look out below

 

While the correspondence is not perfect, the optimists include many of the chief global strategists from major firms, professional economists, and investment managers who take a value perspective. The pessimists include most of the trading community, bond managers, “independent” economic thinkers, and conspiracy buffs. If you are inclined to disagree, I invite you to make your own list and share results in the comments. You might start by reading this week’s cover story in Barron’s, U.S. Stocks Could Rally More Than 10% by Year End.

 

This contrasts sharply with nearly any site with a short-term, trading focus. The difference is simply a statement of fact. The question is, “Why?”

Scott Grannis suggests (including an interesting series of charts) that the only change has been in volatility.

What’s the source of the volatility? It could be the disconnect between investors’ fears of the future and the lack of evidence that the fundamentals of the U.S. economy are deteriorating. Fears can’t get traction if they don’t impact the economy in some fashion, but they can make for choppy markets.

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 economic news.

  • Auto sales were strong at a seasonally adjusted annual rate of 17.7 million. This is the best level in ten years. This is an important economic indicator.
  • ISM nonmanufacturing registered 59, beating expectations and signaling continued solid expansion. Bespoke has the story and this chart combining both ISM reports:

    090315-ISM-SVCS-Charta

     

  • Loans for new homes are no longer so scarce. (WSJ).
  • The Fed Beige Book was positive. (Calculated Risk).
  • State economies look solid. The Liscio report (via Barry Ritholtz) has a comprehensive summary.
  • Employment improved by most measures. The ADP private employment report showed a gain of 190K. Unemployment was lower. Wage gains were 2.2% on a year-over-year basis. See below for discussion of the miss on the headline payroll employment number. The WSJ has a nice nine-chart package with the key results, including unemployment.

BN-KD868_UNEMPL_G_20150904091150

The Bad

There was only a little negative data last week, despite the weak stock performance.

  • Payroll employment gains were only 173K, missing consensus expectations of 200K or so. I am listing this as a negative, although the CNBC panel called the overall report “solid.” Here are some of the reasons:
    • Prior month revisions added over 40K jobs.
    • August is typically revised higher.

And a generally upbeat view from fivethirtyeight, including data on what the formerly unemployed are doing:

casselman-datalab-sepjobs-2

  • Factory orders missed expectations with a gain of only 0.4%.
  • ISM manufacturing was weak at 51.1, below expectations. It is basically consistent with modest economic growth overall. Steven Hansen notes that the businesses surveyed now constitute only about 10% of the economy. See his post for a complete analysis.

1596022ztemp

 

The Ugly

Illinois finances. Even lottery winners are not getting paid. The State does not seem to realize that this is not good for business!

 

The Silver Bullet

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

This week’s award goes to David Templeton, writing at Horan Capital Advisors. He takes on the apparently scary topic of the “death cross” finding it to be more of a buy signal. Check out his charts and analysis, leading to this conclusion:

Moving averages are lagging indicators by the nature of their construction. In other words, the patterns traced out in the moving averages follow the price of an index or stock. When the death cross is triggered then, it is likely most of the price decline in the index or stock has already occurred. Again, the exception is around recessionary economic periods and our current view at HORAN Capital Advisors is the U.S. economy continues its slow growth pace and does not tip into recession.

 

Noteworthy

Regardless of your opinion about current clean power initiatives, it is interesting to know the sources of power for the 100 largest cities. This Brookings story, using EIA data, is informative and provides an enjoyable interactive chart. The representation below does not do it justice, so visit the site and sort on your own criteria.

9-5-2015 10-39-52 PM

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.”

Doug Short: Provides an array of important economic updates including the best charts around. One of these is monitoring the ECRI’s business cycle analysis. Jill Mislinski has joined Doug’s team and provides this week’s update.

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

Georg Vrba: 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 new market climate indicator to reflect risk levels. The market risk is edging higher.

Scott Sumner explains the “pseudo recession” effect in foreign markets. This is a thoughtful and clever post which will help investors keep the right perspective.

The SLFSI has reacted to the market with a bounce from the extremely low levels of recent years. This change caught some recognition from Paul Vigna (WSJ). He accurately notes that it is not signaling danger. The article accurately concludes:

This means the market is still in an environment of remarkably little stress, despite the screaming headlines to the contrary. To us that means sentiment, despite some reports elsewhere, is still historically, even remarkably, sublime. The market hasn’t even begun to panic.

I have been featuring this report for years, after making it one of our summer research projects. More complete findings are available upon request, but here were two key conclusions:

  1. This is not a market-timing tool, but a measure of risk.
  2. The important risk threshold is somewhere around 1.1.

We are not even close to a high risk level.

Yet another good source – BlackRock – weighs in the low probability of a recession, analyzing all of the negative arguments.

The Week Ahead

It is a rather light week for economic data. I highlight what I see as important. For a comprehensive listing I use Investing.com. You can filter for country, type of report, and other factors.

The “A List” includes the following:

  • Michigan sentiment (F). Good read on employment and spending.
  • Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.
  • JOLTs report (W). Labor turnover report is still widely misunderstood. Fed uses it as an indicator of structural changes in the labor market.

The “B List” includes the following:

  • PPI (F). Continues at an uninteresting level for now.
  • Crude oil inventories (W). Current interest in energy keeps this on the list of items to watch.

Non-US markets trade on Monday while the US is closed. Various reports on the Chinese economy will be released before Tuesday’s opening. These have typically had a negative effect, even when meeting (modest) expectations. It is a quiet week for Fed officials with the FOMC meeting looming.

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 has switched to “bullish,” one of our fastest changes in history. Felix remains only partly invested because of the extremely high level of uncertainty. Felix does not explain these changes, but I observe the sector charts. Felix likes sectors that pull back from the highs and show some evidence of basing. From that perspective we are near the bottom of a possible trading range with plenty of upside. The confidence in this three-week forecast remains extremely low with nearly all sectors in the penalty box. Felix withdraws from the market when volatility gets very high. It is simply not a good environment for the model. Many system-oriented trading firms have temporarily suspended trading. There is nothing wrong with waiting for better conditions. 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).

Morgan Stanley issues a “full house” buy recommendation on global stocks based upon their timing indicators. It is an interesting agreement with Felix.

I like trading analogies because they force us to drop our predispositions. Those from sports often work well, so check out this post from Tradeciety. My favorite is from baseball (because of the value of hitting singles and doubles). The chess example is not as strong. I won my University Chess Championship many years ago, and I assure you that thinking one move ahead will get you nowhereJ

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.

If I had to pick a single most important article, it would be this interview will Bill Nygren of Oakmark. I like to track what other value managers are thinking, so I have seen several Nygren interviews. He has not been a big recent buyer, because he had found plenty of bargains before the correction! Read the entire interview for some stock ideas. Here is the key takeaway on the market:

Some people interpret the market as fairly valued and think it must be time to sell. We would think that a fairly valued market means you should expect returns going forward that are about average. And average has been a [few percentage points] a year more than you can get in intermediate term bonds. So it’s not a super exciting number, compared to it tripling over the last six years. But I think an equity investor today who is invested for the long-term can expect a mid- to upper-single digit minimum return in the market. I think there are certain areas where investors are still skeptical because performance was so poor six years ago, like financials, where if you tilt your portfolio in that direction you’re likely to do better than the market.

 

 

Stock Ideas

Asset Managers – especially Franklin Resources. Barron’s takes up the prospects for this sector, beaten down from recent market action.

Put selling? The volatility spike has presented opportunities in blue-chip stocks. (Steven M. Sears at Barron’s) JM — Be careful about size! Only sell the number of puts corresponding to shares you would actually be willing to buy at that price.

Put buying? Beware of purchases when fear is high. Alpha Architect explains how costs soar. Check out some great charts.

Value stocks — and how to find them – from Chuck Carnevale. See both his excellent charts and the instructive analysis.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. As always, there are several great links, but I especially liked this post from Bankers anonymous on the importance of getting started with your investments and a plan.

My question back to my reader: How do we get people to start at the very beginning, that very good place to start?

I really don’t know how to fulfill my reader’s wish of inducing people to call up a brokerage firm, open up an account, and buy their first stock or mutual fund. I wish I had the words to express the importance of beginning, like, right now.

Market Outlook

BlackRock’s Russ Koesterich explains why the current economic and market climate is “not like 2008.”

Sean Broderick at the Oxford Club sees three reasons to buy stocks aggressively. Hint: He sees an end to several recent headwinds.

 

China Outlook

I have given this a lot of emphasis in recent weeks, and it is all still quite relevant. Here is a good WSJ summary illustrating that the Chinese effect cannot account for a 10% change in the value of US stocks. Of course, many believe that it was a market looking for a reason to decline. Perhaps so, but it does not hurt to keep fundamentals in mind.

 

Final Thought

My response to the questions of the week – once again – depends upon your time frame and objectives.

Most importantly, I do not like the concept of the year-end market target. For our individual stock positions we regularly update targets based upon the economy, earnings, and risks. You should do the same. Why is a target time frame good when it is looking a year ahead, and now only for four months? It is a silly media exercise.

The only benefit is that it stimulates a general market assessment as people return from summer vacation. More specifically, here are some thoughts for traders and investors:

  • When breaking news has anything to do with the Fed, the market trades down on a hint of a rate increase. Whether or not that makes sense to you, it is a fact.
  • When key technical levels are broken, the market trades lower.
  • When a meme like “support may be tested” appears, it will happen. Even fundamental traders wait for the expected entry point.

The principal short-term trading ideas have played out during the summer. Algorithmic traders note these trends and swiftly adjust. Those with a longer-term perspective are aware, so they also respect the trading targets.

For those with a long-term time horizon the story is different. It has been a summer of frustration if you focus too much on monthly returns. If you understand the norms of market fluctuation it should be business as usual – taking what Mr. Market is giving you.