Fed Balance Sheet Unwind? No Reason to Worry!

In the wake of the Fed decision to begin reducing its balance sheet, speculation abounds. Pundits of all stripes are speculating about what this will do to interest rates, the economy, and the stock market.

The answer is easy. Nothing.

Those commenting often make two types of mistakes – omitting important data and using pop economics instead of real analysis. Let’s consider each in turn.

Data

If we put aside the political debate and merely asked about the impact of reduced demand in a market, what would be our approach? We would take the rate of the change and compare it to the daily volume. If it was very small, we would expect little effect. In a Federal court where I was an expert witness the Fidelity Investments team opined that 1% would be small. While no one really knows, that seems reasonable. Let’s do the math.

The Fed plans to halt replacement of maturing Treasury securities at some point in 2018. We do not know the exact plan, so I’ll make a more aggressive assumption. Suppose that the Fed begins immediately—no replacement of maturing securities. Let’s do the math.

Amount of Treasury holdings expiring in the next five years: $1.4 trillion.

Dividing by five years: $280 billion per year.

Dividing by 250 (or so): $1.12 billion per day.

Total daily volume in the cash Treasury market: $500 billion or so, or about 0.2%.

And this does not count trading in futures markets, where a buyer can hold until delivery if desired.

This is a very deep and liquid market. The error made by many is to compare the size of the Fed balance sheet with net new issuance by the Treasury. Why is this comparison relevant?

Analysis

The net new issuance comparison makes a common, pop econ mistake. It treats a large and complex market as if it consisted of two parties. This may be easier to understand, but so was the concept of “flat earth.” It leads people, like a top TV bond commentator, to ask, “If the Fed and other central banks quit buying new bonds, who will step in?”

In the last few years we have also witnessed assorted experts asking, “who will buy our bonds?” And then shortly thereafter, shamelessly discussing a shortage of long-term bonds. These are great stories to attract viewers and readers, but a simplistic view of the market. It ignores the millions of participants making up the deep market. This cannot be represented as two parties. A beginning economics class is all you really need. Think about supply and demand in terms of distributions of many players. Consider these simple graphs from a helpful source.

If you look at the chart on the right, you might view the Fed absence from the market as an external shift in demand. This does not affect the plans of other participants, but it does mean less demand at each price, so a shift from D2 to D1. We should expect a lower quantity and price (higher yield), but not a hugely dysfunctional market. During the QE period, I sought estimates from many macro economists about the total effect of QE. Some Fed economists also made a similar estimate – about 1% in the ten-year note.

Over a period of several years, we might expect a gradual adjustment in the ten-year note by 1% — or perhaps less, since some of the balance sheet will be maintained. It is small enough that other factors will be the main drivers.

Conclusions

We can now see why past scary predictions did not come to pass. If every TV pundit was required to pass a two-part test:

  1. State the size of the bond market;
  2. Draw and explain one of the charts above…..

…CNBC would have a lot of air time to fill!

Weighing the Week Ahead: Is the Housing Rally Over?

With soft housing data last week and higher interest rates expected, it is a good time to ask:

Is the housing rally over?

Last Week Recap

The big economic news last week was the Fed policy decision and guidance. Friday’s announcement of the Amazon purchase of Whole Foods grabbed the headlines. Attorney General Sessions’ Senate Testimony got the gavel-to-gavel treatment.

Our question from last week – a possible change in market leadership – did attract some discussion. Friday’s grocery news is still being digested, but the sector shifts were pronounced.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. Despite the mid-week Fed announcement, the result for the week was barely changed.


Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read the entire post for several more charts providing long-term perspective, including the size and frequency of drawdowns.

Note to Readers

Thanks to all of those who offered suggestions for changes in WTWA and feedback on my first attempt. I am still working on many of the other suggestions.

I am off next weekend, but I will again try to post an abbreviated version including an indicator update.

The News

Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The economic news last week was mixed.

The Good

  • Jobless claims declined to 237K, maintaining the current record-low levels.
  • Forward earnings estimates are holding up. This may seem like faint praise, but those criticizing the use of analyst estimates point to excessive optimism and repeated cuts in forecasts. Brian Gilmartin tracks these estimates. He notes the comparative strength, but also warns about possible weakness in tech.
  • Chemical activity barometer “suggests continued growth through 2017.” See GEI for the full story.
  • Small business optimism remains high. I have upgraded my attention to this series, since the importance has increased. Sluggish business investment, hiring, and loans to small companies have all been issues. Improved confidence from small business owners is helpful on all fronts. While some have (already?) become pessimistic on the Trump agenda, those relieved of regulations have been more positive. Calculated Risk provides analysis and this chart:


  • CPI remained benign with an increase of only 0.1% in the core rate. Some see this as bad news since it is below the Fed’s target and/or the take inflation as a signal of economic growth. Growth without inflation is good. It gives the Fed a little leeway.
  • FOMC decision got a positive reception. The small increase in the Fed Funds target was expected by markets, demonstrated by the small change in bond yields. Prof. James Hamilton (Econbrowser) explains why the “balance-sheet reduction is not scaring anyone”. He explains, and also provides some interesting data, importantly noting the effects of other news.


The Bad

  • Industrial production was unchanged. The decline from April’s 1.1% gain was expected, but disappointing nonetheless.
  • LA port data is a subject of some controversy. Calculated Risk sees a positive trend, using a 12-month rolling average. Steven Hansen (GEI) prefers rolling unadjusted three-month averages, but notes some anomalies this time. Data nerds should read both pieces in detail to understand how the methods chosen affect what you conclude.
  • Michigan Sentiment declined to 94.5 from a prior of 97.1.
  • Retail sales declined 0.3% compared to the April gain of 0.4% and expectations of unchanged.
  • Housing starts declined and missed expectations. Building permits did the same. On the surface this was bad news, but there is some debate over the data. See below for more discussion.

The Ugly

Collateral damage from the Amazon decision to purchase Whole Foods. While it was obviously bad news for competitors in the grocery business, the reach was much greater. Here is a heat map that I tweeted an hour after Friday’s opening.


There may be some logical extensions of the Amazon strategy, but the effect on only four other stocks exceed the entire size of the deal. In some cases, the declines came because of mutual ETF membership, not any specific analysis. This topic deserves more scrutiny.

Noteworthy

Do you think that chocolate milk comes from brown cows? Does anyone? Mrs. OldProf, who grew up in Green Bay and graduated from Wisconsin, notes that most cows are at least partly brown. That would imply a lot of chocolate milk.

Somehow 16.4 million American adults (7%) hold this belief. These people vote and buy stocks. Check out John Harrington for the story and some other surprising examples.

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

The Calendar

It is a very light calendar. Housing data are most important, especially new home sales.

Fed speakers are out in force. Expect more color on the reduction of the Fed balance sheet.

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.


Next Week’s Theme

We have the combination of a light week for data, last week’s soft data on housing starts, the Fed rate decision, plenty of scheduled Fedspeak, and a calendar featuring home sales. The ingredients suggest a lot of attention to the housing market. People will be asking:

Is the housing rally over?

Here is a range of opinion.

  • The weakening market is a very bad sign. New Deal Democrat analyzes the turn down in permits, starts, and completions. Check out the post for the full story. He promises more to come.
  • Gains in homebuilder stocks and builder sentiment provide a better indication. (Scott Grannis).


  • Housing starts to remain in the expected range of 3 – 7% growth, year-over-year. Multi-family is solid, but the increasing trend is over. Single family starts are taking over. (Calculated Risk).


  • The monthly data present a misleading picture. Steven Hansen (GEI) explains how to interpret the difference between permits and completions.

As usual, I’ll have more in my Final Thought.

Quant Corner

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

Risk Analysis

I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 


The Featured Sources:

 

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

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

Georg Vrba: Business cycle indicator and market timing tools.

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

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

We should expect a raft of forecasts from newly-minted recession experts. This example takes the good record of the inverted yield curve and extrapolates from small recent moves. Part of the extrapolation is from some dubious “technical analysis.”

The yield curve is part of our recession forecasts. The influence of other important variables is considered, along with the likely timing. Articles that feature the ‘R’ word are popular, but usually misleading.

 

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Wade F. Slome’s excellent analysis of the stock market rally – accompanied by “worry, pessimism, and skepticism.” He describes his list as a “small sample.”


He notes as follows:

the endless laundry list of crises and concerns has not broken this significant, multi-year bull market. In fact, stock prices have more than tripled since early 2009. As famed hedge fund manager Leon Cooperman noted:

 

“Bull markets don’t die from old age, they die from excesses.”

 
 

On the contrary to excesses, corporations have been slow to hire and invest due to heightened risk aversion induced by the financial crisis. Consumers have saved more and lowered personal debt levels.

 

Read the full article to see his warning signs – a combination of several trends.

 

Stock Ideas

Simply Safe Dividends does his usual careful analysis of restaurant supplier Sysco (SYS). The dividend is safe, but there are some issues on the horizon. Amazon, which he regards as unlikely to compete in this space, and extra debt taken on for a recent acquisition. That said, he assigns a “dividend Safety Score” of 97. DIY investors interested in dividends should read this post carefully. This is the kind of work required.

A brief digression – which I hope you will enjoy. On trading floors people are watching different things. There is no reason to have everyone covering the same news flow. When there is news, we often shout it out so everyone knows what is happening. This is one reason that managers often choose to work from a desk on the trading floor.

When I see a Sysco truck or news about the stock, I am reminded of a Cramer anecdote about how to avoid confusion:

“Wrong Sysco ( SYY) preannouncing!”

In a market that is so Cisco-dominated ( CSCO) — and believe me, this is Cisco-dominated — just the sheer possibility that someone might take Cisco shares on Sysco saying something positive required that our trader shout out the good news for the food broker.

Chuck Carnevale offers a comprehensive analysis of AbbVie, which he notes has growth, value, and high yield. The analysis uses the stock as an example that helps explain his method. You get both an interesting idea and some information strong stock-selection methods.

Energy stocks? John Butters of FactSet reports that this sector accounts for nearly half of the Q2 growth in earnings for the S&P 500.

And how about wind and solar energy? The EIA reports that monthly generation from these sources has reached 10% of the total.


A lagging railroad? Barron’s Trader Extra recommends a look at the Genesee and Wyoming railroad (GWR). You cannot guess where they operate! It is an interesting idea, although real value depends upon a resumption of earnings growth.

 

Personal Finance

Abnormal Returns always has first-rate, daily links for investors. His Wednesday topic is personal finance – of special interest to the individual investor. I especially liked the discussion about the recent reversal for value stocks, the underlying factors, and the long-term success. The Bloomberg piece includes a range of good sources and provides a balanced perspective. Also excellent is the advice from Todd Wenning on how an investor should avoid distractions. Hint: Why do you think your brokerage makes it easy for you to see online quotes?

Seeking Alpha Senior Editor Gil Weinreich has an interesting topic every day. This week I especially enjoyed the renewed discussion about thrift versus economic growth. Your own viewpoint is probably reflected and discussed.

Value versus Growth

GMO notes that value stocks showed strong gains in 2016, which have been erased in 2017. There are always shifts, but this has been much more dramatic than usual. They provide an exhaustive analysis of the trends and possible causes and highlight this conclusion:

Overall, the lion’s share of the performance gap between value and growth across the globe can be accounted for by an expansion in multiples that has outstripped even the habitually bullish analysts’ expectations for future earnings. This should be no small consolation to valuation-oriented investors: Multiples running ahead of fundamentals is a classic sign of over-extrapolation by investors

Watch out for….

What is in your ETF holdings. Here is a little test. If you own an ETF, try to name the top holdings. If you do not like a particular stock, go the other way. Is this a big holding for some of your ETFs?

 

Final Thoughts

This week’s topic raises interesting questions that have relevance for many other current issues.

Topping markets? The first sign of a rollover in an economic series always gets a reaction. One viewpoint is that it is a clear sign of a top – time to expect the worst. Often it simply puts us on alert, but requires more evidence. If you look at a data series of almost anything, you will see small declines from a top followed by further increases.

Economic relationships do not work like light switches. Changes are not accurately described as two-person transactions – buyer and seller. A change in mortgage interest, for example, affects the point of intersection of supply and demand curves. It shifts the supply at a given price. While we know that this reduces quantity, we do not know by how much.

Even after we improve the analysis by thinking of supply and demand curves, we must consider the micro – the behavior of the individuals making up the curve.

  • Some buyers, who have been on the edge of a decision and fearing higher rates, may step up. (See Diana Olick citing this as the reason behind the jump in mortgage applications). This changes the shape of the demand curve.
  • Some sellers, sensing a tightening market, may absorb some of the implied price increase. This changes the supply curve.

Anyone who begins with a conclusion that “buyers are priced out” is leading with his chin.

Demographic changes? Millennials are starting families and establishing homes. The worries about the overhang of foreclosure homes has decreased. The big wild card now is the level of future immigration. (See this excellent post from Calculated Risk).

One reason that I continue to love the homebuilders is that the factors moving interest rates higher – stronger economic growth and higher wages – are the same as those that will increase housing demand.

What worries me…

  • Continuing contention in Washington. We will need bi-partisan compromise to deal with the big issues like growing government debt and entitlement programs, not to mention infrastructure and tax reform.
  • The unknown effects of ETF trading.

…and what doesn’t

  • Concern about “escape velocity.” Those who do not understand the current economic cycle rely on mistaken metaphors. They are attempting to persuade through language alone, without analysis.
  • The unwinding of the Fed balance sheet. Any reasonable path will barely ripple the market.

 

Stock Exchange: Can Psychology be Applied to Market Behavior?

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

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

Our goal is to be both educational and fun. We welcome comments, links, and ideas to help us make this a great resource for traders.

Review

Our last Stock Exchange we asked whether you should buy the rip or the dip. If you missed last week’s edition, check it out.

This Week— Can Psychology be Applied to Market Behavior?

This great topic has attracted recent attention from the experts we follow.

Trading Tips

Dr. Brett Steenbarger, whose imagination continually creates new ways to view the evidence in front of us, challenges us to consider the psychology of the market. This is sharply different from the normal focus on the psychological challenges to the individual trader. Brett writes:

When we think of trading psychology, we typically think of the psychology of the trader and the factors that either contribute to or distract from a peak performance mindset.  Another facet of trading psychology is reading the intentions of other market players.  This is very similar to psychology in poker.  The mindset of the poker player is important, and it is also important to read the psychology of the other players at the table.  The skilled poker player reads those tells from other players to infer if they are bluffing or if they might be holding the nuts.  When short-term trading/market making occurred on the trading floor, reading the other participants in a market truly was more like reading other poker players.  With most market activity being electronic, we need other ways of inferring the intentions of market participants.

Michael Batnick has an interesting post about experience. One feature is a story about famous hedge fund star Stanley Druckenmiller – why he got a big promotion, leapfrogging eight more senior people:

…the reason he was given that position was because he didn’t yet carry the burden of experience. When he asked why he was promoted above the others around him, his boss said, “For the same reason they send 18-year-olds to war. You’re too dumb, too young, and too inexperienced not to know to charge. We around here have been in a bear market since 1968.’ This was 1978. ‘I think a big secular bull market’s coming. We’ve all got scars. We’re not going to be able to pull the trigger. So I need a young, inexperienced guy to go in there and lead the charge.”

His conclusion is that experience is overrated. I disagree. The real challenge for asset managers is to draw upon experience while avoiding the human frailty.

Let’s turn to this week’s recommendations from our group. They were all eager to put Brett’s poker advice into action, but we did get a few comments.

Expert Picks from the Models

This week’s choices cover a wide range, from energy to financials, to tech. There is something for everyone.

Road Runner: I recommended Netflix (NFLX) in my first appearance on the Stock Exchange. In late March of this year, it had come off of recent highs and reached the bottom of its 6-month channel. I happily held the position as it appreciated through this spring, selling at some point in late May. Now, I think a re-entry may be appropriate. Let’s review the chart:

The collapse of this stock, beginning in June, took it from the very top of its channel to the very bottom. We’re below the 50-day moving average, but not yet close to the 200-day moving average. Further significant declines are unlikely, and there is significant upside.

J: It is always interesting to revisit a trade we have held before. This stock has also attracted attention from one of our trading experts, Adam H. Grimes?

RR: And does he see what I do?

J: Almost. He notes the decline and potential rebound. He is not quite ready to pull the trigger.

RR: If he had spent some time being chased by that crazy coyote, he would move faster! Beep, beep.

Holmes: Range Resources (RRC) declined after a small rally last week. This is typical of stocks providing a good entry opportunity.

The stock showed some life after a patchy decline since mid-April. At its current price of $23.18, it is well below both the 50-day and 200-day averages. I am looking for a rebound to these points. With a PE of 18.6 the stock is also attractive on the fundamentals.

J: It looks like a consistent downtrend, along with the rest of the energy group. The price of oil looks stuck under $47 per barrel.

H: I am not trading oil. Whatever is happening in that market, this stock is showing attractive relative strength.

J: Have you been following the OPEC news?

H: You know well that I do not read news — just charts.

Felix: Micron Technology (MU) is my pick for the week. It’s a good bit sexier than my usual selections, but I have a good reason for it! Look at the chart:

Growth over the past year has been significant, and most importantly, it has been steady. Outside of a jump in mid-May, we’re seeing steady rises in stock price – reflected by the modest curves on the moving averages. I like that the stock has tumbled a bit this month. I’ll gladly take that as a buying opportunity.

J: This morning the pundit-in-chief opined that many people, focused on the stock symbol, thought it was some type of animal rights stock.

F: Who cares? It does not matter. Traders do not care what the company does. We succeed by identifying and exploiting the flow of trades. That is what I have done. What is this company anyway?

J: A chip stock.

F: So! It is in the food group!

J: Not that kind of chip; a semiconductor chip.

F: You should be more precise in your language.

J: Do you have updated ratings?

F: Of course. My fans have made some new requests. My assistant is supposed to respond to all of them.

J: Your assistant? I didn’t see any new additions to the payroll.

F: Oops. Here they are.

 

 

 

 

 

 

 

 

 

Athena: Discover Financial Services (DFS) is an interesting pick after a possible new uptrend. DFS saw a high upward run in the last two months of 2016 trading into 70’s from about 57.50 in early November. The stock had a fall into the higher 60’s territory in January this year. The past prices illustrate the market view of potential value. The recent basing signals a possible bottom.


J: Nice to see you back on the job! You understand that part of your vacation was unpaid.

A: Unlike human traders, I do not force it when nothing is there. That shows up in my long-term results.

J: I really do understand that, and I hope your vacation was refreshing. Turning to DFS, haven’t we discussed this stock before?

A: Not from me, but perhaps one of the others…

Holmes: Yes, I bought the dip in late April.

J: How did that work out?

H: Not well, as you certainly know. Please keep in mind: My batting average is above .500 and the winning trade size is much greater than the losers. My trading discipline helps me to avoid big losses. Small losses are just part of the game.

J: Thanks for explaining. You have indeed done well on limiting losses.

Oscar: I do not have a new sector this week.

 

J: That is a disappointment. Everyone is talking about a possible change in market leadership. The story is that all of the gains come from a few stocks. Why don’t you own those?

O: That general impression is completely wrong. Lawrence Hamtil looks at market leadership over the years. Most people would be surprised.

J: A very interesting article. How did you happen to see it?

O: Someone took my sports section.

J: An honest answer. Did you analyze the sectors requested by your fans?

O: Yes. This week’s list includes everything that has been requested.

J: An astute reader asks about TLT and TBT. You list both in the sell range. Since these are inverse holdings, how can both be a sell?

O: The rankings in the sell range do not imply a recommendation to “short” the group. They simply have very low ratings when other choices are much stronger. I would sell either one for a better opportunity.

J: Thanks for clarifying. You are basically saying that bonds are not a good choice – either long or short.

O: Exactly.

 

 

 

 

 

 

Conclusion

Psychology is a part of trading. Technical analysis, as Dr. Brett explains, is a way of reading the psychology of the market.

This week, a member of our analytical team was having trouble finding the Road Runner trading channel. He opined that the model seemed to be wrong. This is the human psychology question in a different guise. Our answer is very clear.

The model is not wrong! You are. It is based upon thousands of objective cases. If it does not look persuasive to you, grasshopper, you need to change your perspective.

 

After many years of looking at model charts and recommendations, I treat them as wise, but silent, advisors. In the Stock Exchange series, I try to make great advice come to life.

 

Here is a summary of the cast of our characters. Find your own favorite!

Stock Exchange Character Guide

Character

Universe

Style

Average Holding Period

Exit Method

Risk Control

Felix

NewArc Stocks

Momentum

66 weeks

Price target

Macro and stops

Oscar

“Empirical” Sectors

Momentum

Six weeks

Rotation

Stops

Athena

NewArc Stocks

Momentum

One month

Price target

Stops

Holmes

NewArc Stocks

Dip-buying Mean reversion

Six weeks

Price target

Macro and stops

RoadRunner

NewArc Stocks

Stocks at bottom of rising range

Four weeks

Time

Time

Jeff

Everything

Value

One month or long term

Risk signals

Recession risk, financial stress, Macro

 

 

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 usually the only human present, and the only one using any fundamental analysis.

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

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Weighing the Week Ahead: Is it Time for New Leadership?

Friday’s eye-opening decline in the strongest gainers for 2017 has many people wondering:

Is it time for new market leadership?

Last Week Recap

The big news last week was the Comey hearing and speculation about what it meant. Markets have not been reacting to the political news, but it still commands media attention. CNBC provided non-stop coverage.

The punditry did spend time on my question from last week – bonds versus stocks – but seemed happy to turn to the action on Friday instead.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. The loss for the week was only 0.3%, but Friday’s trading added some excitement to a slow, summer Friday afternoon.


Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read the entire post for several more charts providing long-term perspective, including the size and frequency of drawdowns.

Note to Readers

Thanks to all of those who offered suggestions for changes in WTWA and encouragement about my main mission. There are many great ideas that I am trying to implement and many loyal readers who like things as they are. Here are the changes so far:

  • Eliminating much of the material repeated every week and placing it in a static source. I need to find a good way to encourage new readers to check out the background.
  • Reducing the calendar to summarize my own views on what is most important.
  • Moving the Silver Bullet to a standalone series. I am trying to make it more visible, not diminishing the importance. I realize that this is a bit less convenient for current leaders, but I hope they will help me out in establishing this.
  • Moving the trading ideas to the Stock Exchange series. Once again, please read and give this a chance. WTWA readers must be aware of the different time frame.
  • Changing the emphasis of the weekly theme to what I see as more important, with secondary consideration to media attention.

The News

Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The economic news last week was mixed, but the market reaction was positive.

The Good

  • Household balance sheets show new records in wealth in nominal, real, and per capita terms. (Scott Grannis).



  • ISM services registered 56.9. The strong value beat expectations. There was also strength in employment, business activity, and new orders. (ISM).
  • Commercial real estate is looking stronger according to the Dodge Momentum Index. This is claimed to be a leading indicator. See Calculated Risk for analysis and charts.

The Bad

  • Little progress in the debt ceiling debate.
  • Factory orders dropped 0.2%, the first decline in five months. (Reuters).
  • Wholesale sales declined to levels usually associated with recessions. (Steven Hansen at GEI). The lower inventories are also likely to affect Q2GDP.

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

The Calendar

It is a fairly light calendar. The FOMC meeting will be most important for markets – especially the press conference. Watch for hints about future policy and a resulting change in the slope of the yield curve. There will be some FedSpeak in the days after the meeting.

I am also interested in building permits

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.


Next Week’s Theme

The Fed decision will be a popular topic, but the week will begin with a deeper look at Friday’s trading. People will be asking:

Is there a change in market leadership?

Here some of the early explanations:

  • The FANG stocks were dramatically over-valued. A shift was long overdue. Anything might have started it.
  • The Amazon crash captured the attention of the CNBC crew, where they cited the rapid decline in a major name. The focus was mostly on Amazon, but partly on retail strength.
  • The rapid selling is evidence of inherent danger in the current market. Flash Crash redux.
  • Overall, the change in the major indexes was not that great. The differential effects happened too quickly to be called a rotation, but could it be the start of one?

Whatever the reason, it was not just a flash crash in AMZN.


 
 

As usual, I’ll have more in my Final Thought. I have an unprovable, but plausible hypothesis. It fits the evidence and timing from the chart above.

Quant Corner

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

Risk Analysis

I have a rule for my investment programs. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 


The Featured Sources:

 

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

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

Georg Vrba: Business cycle indicator and market timing tools.

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

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

Wisconsin economist Menzie Chinn (Econbrowser) Has his own helpful variant of the Big Four chart we often show here. He sees slowing growth, but no sign of a recession.


 

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be David Van Knapp’s comprehensive and thoughtful response to investors who buy good companies without regard to price.

He does a nice introduction and valuation. He explains that valuation affects probability, not certainty. And he uses some great examples. He explains that markets are not efficient, despite what you learn in school. He illustrates with another good example.

Especially devastating is his refutation of the facile and self-serving argument that has gained recent popularity: large cap stocks are never mispriced because markets are so efficient. He writes:

the idea that large-cap stocks are never mispriced ignores the data. It is clear that even the largest companies go through periods of mispricing. The following table shows the differences between the 52-week highs and lows for the biggest members of the S&P 500 right after the Brexit vote last June.

My summary cannot do justice to this fine work. Read it carefully. Read it twice!

 

Stock Ideas

Brian Gilmartin reviews the pluses and minuses for GE, including both fundamental and technical analysis. He notes the importance of the upcoming earnings report, and the attractions of a dramatic alternative for those with a growth portfolio.

Chuck Carnevale explains that attractive valuation based upon earnings is just a starting point – a way to avoid mistakes. As usual, he provides a helpful specific example.

Blue Harbinger analyzes closed-end funds, with special attention to risk. Mark produces a few ideas worth consideration.

Business Insider highlights an interesting chart from Twitter. It shows the lagging expectations for solar energy growth.

Subscription Sources

I read these sources, sharing a touch of the content so that you can decide whether to buy an issue yourself.

Barron’s has even more stock information than usual. It is the mid-year roundtable issue with ideas from nine participants. There are also interesting articles on energy stocks, tech stocks, and emerging market ETFs.

Personal Finance

Abnormal Returns always has first-rate links for investors. Once a year he takes a well-deserved vacation and substitutes a series of stimulating questions posed to the financial blogging community. I always appreciate being part of this project, and I give special thought to my answers. Looking at this year’s results, I see that my colleagues have done the same. You will find plenty of good advice.

Seeking Alpha Senior Editor Gil Weinreich reads extensively and has a great imagination. Nearly every day the raises an interesting topic for advisors and investors alike. This week I thought his discussion of financially fair divorce and divorce software was especially interesting.

[Mrs. OldProf wandered into my home office as I was doing this research and started scowling. Mystified by this, and eventually figuring out the problem, I explained that my reading was professional research, not personal. Her normal cheerful smile returned. There is a lesson there somewhere.]

Market Outlook

Fear and Greed Trader has another nice market summary. Especially helpful is his analysis of the recent claims of market skeptics. He also identifies some sectors that are benefiting from the rotation that is this week’s theme.

 

Watch out for….

Those turning good news into bad. Charlie Bilello joins in on one of my favorite topics. He lists many things that you might consider as part of the perfect market environment:

The following attributes might come to mind:

1) High returns with low volatility and 2) low drawdowns, with 3) global participation, 4) both stocks and bonds rising, 5) the economy expanding, 6) earnings growing, and 7) an easy Central Bank.

Sound too good to be true? Let’s take at where we are today…

He follows this introduction with a data-filled answer to each question. He then answers the key question: Is this as good as it gets?

I don’t know, but for investors it’s pretty darn close. The challenge, as we know from history, is that just because something is really good doesn’t mean the next stage has to be really bad. If it were, the game would be easy. You would just sell everything today and wait until everything is really bad next month to buy everything back at a lower price.

But that’s not how the market works. Most of the time, really good environments continue to be good for some time and even when they’re less good, they’re still ok. And importantly, investors can still make money in the transition from really good to ok.

Final Thoughts

 

Not every market ripple needs an explanation, but Friday’s trading was pretty interesting. None of the TV pundits had a good explanation. Here is what I observed:

Not much was happening; it was a typical, quiet summer Friday. I noticed a decline in Nvidia (NVDA), a company featured on the Stock Exchange a few weeks ago. It has been a profitable trade, and we still hold it in some programs. Since the decline was 10% or so in a few minutes, there must be some news. Checking out my sources I learned that a negative report had been issued by Citron Research, a noted short-seller. CNBC caught up with this, and invited Citron’s CEO to participate in the discussion. Jim Cramer and Josh Brown, both NVDA fans, were also part of the impromptu debate. One question was why Citron picked this particular moment for the report. The (rather lame) answer was “valuation” and some colorful analogies. There was no fresh news. Within a short time, the entire tech sector was selling off hard.

I remarked to my team that this was a pretty safe way to make money. You get really short, and maybe inform some friends about your plan. You write a report, release it, and your pals give it exposure. A slow Friday afternoon is a perfect time. You go on TV. As the stock craters, you cover your shorts and enjoy the weekend, having made a lot of money in a couple of hours.

This is a completely legal business model, if the reports are factual. By coincidence, Jesse Barron has a feature on The Bounty Hunter of Wall Street in this week’s New York Times Magazine. It features Andrew Left, the Citron CEO. I strongly recommend that you read it and study the examples. Compare them to Friday’s events.

What can you do to protect yourself? As I have often said, do not use stop orders that become market orders when your price is touched.

Does this mean new leadership for the market? We’ll have a better idea soon, but it is something important to watch.

What worries me…

  • Lack of compromise in government. Many believe that gridlock is good. Not so. We will need bi-partisan compromise to deal with the big issues like growing government debt and entitlement programs.
  • Growing tension with Russia, and within Russia.

…and what doesn’t

  • The idea of a “complacent” market. It is a poor description. We have a balance of widely divergent opinions and ideas. A stalemate – at least for now.
  • The Fed decision. We are far from the point when these rate hikes will make a difference. (See analysis by Fed expert Tim Duy).

Stock Exchange: Buy the Dip (VOYA) or Buy the RIP (DPZ)?

The Stock Exchange highlights the results from different technical trading methods. We also provide contrast, and often dissent, from a fundamental analyst. While the methods sometimes agree, our emphasis is on trading.

Review

Our last Stock Exchange took up an important question – how to deal with a losing trade. Any trader who has not planned for this in advance is headed for trouble. If you missed last week’s edition, check it out.

This Week— Buy the Dip or the Rip?

This is not the famous favorite slogan, but it fits today’s choices.

Road Runner: I have another great opportunity to buy a stock at the bottom of an up-trending channel. Domino’s Pizza (DPZ) shows great overall strength with an occasional buying opportunity. Now is the time.

RR: I suppose you will once again invoke Chuck Carnevale and F.A.S.T. graphs.

J: Naturally. Unlike last week, you are once again way out over the cliff.

RR: I am sorry that Mr. Carnevale does not appreciate my chart reading.

J: You do have some support. The research team at Société Financiers likes the explosive growth in revenue. Michael Vinci concludes that the stock is 22% undervalued. Julian Robertson’s Tiger Fund has increased its position.

RR: You see? I am not the only expert! Beep Beep!

 

Oscar: I have a new sector choice: 3D Printing. While I have my own basket of stocks for this sector, we can look at ExOne (XONE) as an illustration for the group.

This chart combines the best of little ball and big ball.

J: I knew you would get around to baseball.

O: It is relevant. When the stock declines a bit, it is as if they are playing in a one-run game. Bunting and sacrificing are OK.

J: Hmm-maybe. I suppose you do not care about earnings. I am not even going to post the F.A.S.T. chart since you would see a string of negative values. This is just a story stock.

O: And it has a good story.

J: Let’s turn to your responses to readers?

O: OK. Here is the current list.

J: Thanks. Let’s see what Holmes has to say.

 

 

 

 

Holmes: I buy dips, not rips. I take profits as stocks rise and always protect my gains. Here is an interesting opportunity – Voya Financial (VOYA).

This is a great setup.

J: Are you expecting higher interest rates? A takeover? Have you been watching those TV commercials with little orange rabbits?

H: I expect the chart to tell a story. I have no knowledge of interest rates or takeovers (whatever those are). I certainly don’t watch TV commercials. I don’t even watch TV.

J: I wouldn’t have noticed the commercials except for Allison Janney, a favorite for both Mrs. Oldprof and me. Turning to the data, you actually have some support from our fundamental analysts. Eric Gregg, a deep value investor, explains why he likes this one. Chuck’s methods also suggest some value here.

 

Felix: I have nothing new this week.

J: Again? I guess I am not surprised. It is still mostly a sideways market. I see that you still hold some big winners.

F: Yes, I have been doing fine. That does not always require a lot of trading.

F: Just so. We continue to follow your directions.

J: We? I suppose you mean that Athena has nothing fresh either?

F: Right. She said to tell you that you will see her again when something is happening.

J: The longest vacation in company history gets even longer. How about your weekly stock rankings? Still buy, hold, or sell, depending on the color?

F: Yes, and I welcome new questions. That is how the list is built.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Conclusion

The natural trader psychology is to buy dips and sell rips. It is fun to lock in profits. You get to score up the little gains that you have booked.

In fact, trend-following methods are among the most successful. If you are a trader who does not know the story of the Turtles, you should spend a few minutes learning about this great experiment. Trend-following can be a psychological challenge, but done correctly it is very profitable.

 

Here is a summary of the cast of our characters. Find your own favorite!

Stock Exchange Character Guide

Character

Universe

Style

Average Holding Period

Exit Method

Risk Control

Felix

NewArc Stocks

Momentum

66 weeks

Price target

Macro and stops

Oscar

“Empirical” Sectors

Momentum

Six weeks

Rotation

Stops

Athena

NewArc Stocks

Momentum

One month

Price target

Stops

Holmes

NewArc Stocks

Dip-buying Mean reversion

Six weeks

Price target

Macro and stops

RoadRunner

NewArc Stocks

Stocks at bottom of rising range

Four weeks

Time

Time

Jeff

Everything

Value

One month or long term

Risk signals

Recession risk, financial stress, Macro

 

 

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 usually the only human present, and the only one using any fundamental analysis.

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

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Weighing the Week Ahead: Is the Bond Market Sending a Message for Stocks?

After the news-heavy calendar last week, there are few market-moving economic reports in the week ahead. It is also the quiet period for the Fed. How will the punditry fill those empty minutes?

Last week’s trading revived a question that many find puzzling. I expect pundits to be asking:

How can bonds and stocks both be so strong?

Last Week

Last week the economic news was mixed, but the market showed strength anyway.

Theme Recap

In my last WTWA I took note of the big economic calendar and short week. My conclusion was that we might finally see some volatility. Wrong! The news was close enough to expectations that the reactions were modest. Since there was little volatility, it never became the theme for the week.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. The gain for the week, achieved entirely on Thursday and Friday, was almost 1% and another new all-time high.


Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read the entire post for several more charts providing long-term perspective, including the size and frequency of drawdowns.

 

Personal Note

I am considering some changes in WTWA. Instead of launching “new Coke” without proper testing, I would like reader suggestions. I have outlined the ideas here, and I welcome comments and suggestions.

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!

The economic news last week was mixed, but the market reaction was positive.

The Good

  • Personal income and spending both increased 0.4%, positive but in line with expectations.
  • Household deleveraging has been “historic.” Since this news is contrary to most of what you hear, it is important to read the excellent global macro update from BlackRock.


To be balanced, we must also note the increasing leverage of corporations. BlackRock notes that this reflects the low cost of loans versus equity. More of the lending locked in for a long period.


Any assessment of debt and leverage must include government. It is a concern, and on my writing agenda.

  • Consumer confidence declined slightly, but remained at a high level – 117.9. Here is the analysis from the Conference Board:

    Consumer confidence decreased slightly in May, following a moderate decline in April,” said Lynn Franco, Director of Economic Indicators at The Conference Board. “However, consumers’ assessment of present-day conditions held steady, suggesting little change in overall economic conditions. Looking ahead, consumers were somewhat less upbeat than in April, but overall remain optimistic that the economy will continue expanding into the summer months.

  • ISM manufacturing beat expectations with a solid 54.9 reading. The Chicago PMI (Calculated Risk) notched its highest reading in 2 ½ years.
  • ADP private employment showed a gain of 253K. Regular readers know that I regard this as an alternative source on the jobs situation, neither better nor worse than the BLS.

The Bad

  • Pending home sales declined for a second straight month. (MarketWatch). Once again, low inventory was blamed. Steven Hansen (GEI) has an interesting take, comparing historical household formation and replacement needs, to new supply.

He writes as follows:

Based on the data in the above graph, since the beginning of the Great Recession there were almost a half million more new homes constructed than households formed. Up until the 21st century, there was good correlation between household formation and homes constructed.

However, historically 300,000 new homes are needed each year to replace those lost to fires, rot, other causes, or simply torn down to make way for new construction. Based on just replacements needs, 3 million new houses were needed since the beginning of the Great Recession instead of the half million above household formation actually constructed. The green line in the above graph is the combined need for new housing (year-over-year gain of households plus the replacement housing).

The bottom line is that the NEED for new construction is outpacing the supply. It seems the price for new and existing housing is above the price many buyers are willing (or can afford) to pay. It seems that there is a shortfall also of buildable land near many metros where people want to live.

 

  • Corporate profits may have peaked. (New Deal Democrat)
  • Legislative chaos from the Trump budget. Stan Collender’s pessimistic viewpoint has five negatives, including a 60% chance of an October government shutdown and reduced chances for tax reform. Stan is an experienced Washington insider, so we should pay attention. I strongly agree with the need for some compromise. That said, it seems overly pessimistic to me.
  • Auto sales declined slightly to a seasonally adjusted annual rate of 16.6 million and may have peaked. This means that companies will be competing for market share. Everyone will be watching to see if this is a peak or a plateau.
  • Initial jobless claims rose by 13K from an upwardly-adjusted prior week. The widely-followed four-week moving average also increased by 2500. Some observers are poised to see any increase in this level as a sign of danger. Doug Short has a key chart, which adjusts the results for the size of the labor force. It is great work, and something to keep in mind.

  • Construction spending dropped 1.4%, the largest decline in a year. (Reuters)
  • Employment situation disappointed in both the non-farm payroll report and the household survey. The headline net job gains of 138K significantly missed expectations. The prior two month reports were revised lower by 66K. The household survey was weak. None of my regular sources showed any enthusiasm about the employment picture. Calculated Risk summarizes the general reaction to this report.

    The headline jobs number was below expectations, and there were combined downward revisions to the previous two months.   Is this slowdown in hiring a short term issue, part of the normal business cycle, or due to a Trump Slump? My view is this slowdown in hiring is mostly part of the normal business cycle (my expectation was job growth would slow further this year).

    There was still some good news – especially with the unemployment rate falling to 4.3% (lowest since 2001), and U-6 falling to 8.4% (lowest since 2007).  But overall this was a disappointing report.

The Ugly

The opioid epidemic. Ohio is suing five drug companies for contributing to that state’s epidemic (Fortune). Some companies cannot find enough workers who can pass drug screening (Washington Post).

And at the low end of those trying to make a buck out of the, “addict brokers” find people whom they can induce to travel to a rehab facility. They qualify them for short-term insurance, and then abandon them after it runs out. (Stat).

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s award goes to David Templeton of HORAN Capital Advisors for his timely refutation of the latest “scary chart.” It is so easy to create these bogus parallels. If you want page views or retweets, this is the ticket. Here is the chart making the rounds:


And here is what you get if you use percentage changes, since the absolute price levels are not similar.


 

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

After the big reports last week, it is a light calendar.

The “A” List

  • ISM services (M). Continued strength expected.
  • JOLTS (T). Little understood report helps identify tight labor markets. A Yellen favorite.
  • Initial jobless claims (Th). Continues at near-record levels.

The “B” List

  • Factory orders (M). Noisy April data, but eyes remain on recent industrial weakness.
  • Wholesale inventories (F). More April data, subject to varying interpretations.
  • Crude inventories (W). Recently showing only modest impact on oil prices, and even less on stock prices.

     

FedSpeak is on hold for the quiet period in front of next week’s FOMC meeting. Those craving a “Fed fix” will have to rely on the pundits – most of whom claim to know more than Fed members anyway!

Next Week’s Theme

In a light week for data with no FedSpeak. That won’t stop punditry speculation about next week’s meeting, of course. And there is the constant possibility of a market-moving tweet. In this absence of this stimulus, what might be the theme for next week? There is already bemused head-shaking about Friday’s trading. If the employment news was weak, causing a rally in bonds, why did stocks move higher?

I expect pundits to be asking:

Is there a bond market message for stocks?

The divergence is simple.

  • Some believe that the bond market is “smarter.” This suggests that stocks do not reflect economic weakness.
  • Others feel that the markets are somewhat disconnected, with many stocks reasonably valued in a low-growth environment.
  • A few believe that bond yields reflect irrational recession fears or a distorted view of future Fed policy.

Most market participants seem to subscribe to the first of these three choices.

As usual, I’ll have more in my Final Thought.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 


 

The Featured Sources:

 

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

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

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.

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. His interpretation suggests the probability creeping higher, but still after nine months. Here is an update of his recession indicator based upon the unemployment rate.


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

Doug Short: The World Markets Weekend Update (and much more). His Big Four chart is the single best method to monitor the key indicators used by the National Bureau of Economic Research in recession dating. The latest update shows the most encouraging picture in over a year.


 

 

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 eight 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?

Most of my readers are not clients. While I write as if I were speaking personally to one of them, my objective is to help everyone. I provide several free resources. Just write to info at newarc dot com for our current report package. We never share your email address with others, and send only what you seek. (Like you, we hate spam!)

 

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, Holmes, and Friends

We continue with a strongly bullish market forecast. Most of our models are fully invested. The exception, Road Runner, is fussy about entry criteria. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our five technical experts, and some rebuttal from a fundamental analyst. This week we took up the important question of how to deal with a losing trade. Many traders do not really have a plan for this crucial issue. RoadRunner plays upward trending channels and likes NetEase (NTES). See the post for charts and a lively discussion.

Top Trading Advice

Pradeep Bonde has two interesting posts this week. He explains the advantage of looking at absolute momentum. This contrasts with most common methods, usually based upon a calculation based upon comparing with other stocks.

He also suggests some swing trading criteria, focusing on 8% moves. Look at his data to see why.

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 Tom Brakke’s big picture take on modern investment analysis. In a helpful technique, he describes a persuasive example about new technology in farming. Readers who understand this are then invited to consider the use of volatility as the key measure of risk.

This is excellent, thoughtful analysis, and it is presented well. We pretend to understand issues with precision. We would do better to make modest improvements on the big risks.

Stock Ideas

 

Brian Gilmartin takes a multi-post look at the financial sector. He asks a question on the minds of many: Is the decline a buying opportunity?

Our Stock Exchange always has some fresh ideas. Holmes takes a look at Credit Suisse (CS).

Blue Harbinger summarizes the data on value stocks and what might be the catalyst for a rebound in this group. Hint: Volatility – which would hit riskier stocks the hardest.

Dividends and Yield

Chuck Carnevale is unhappy with current valuations for the top dividend stocks. I enjoyed his video, where he goes through a history of some past picks. I was happy to note that we currently own only the candidate he identifies as undervalued, while considering one that is close. I strongly recommend studying this to understand a great stock selection method, as well as the current market.

By contrast, Blue Harbinger finds some attractive candidates for a put-writing strategy. (This is similar to our own approach of writing OTM calls. Some of his names are in our universe).

Barron’s finds 6 dividend stocks that “hedge against inflation.”

This is a great topic for analysis.

Graduates

Check out the advice and links from David Snowball at the Mutual Fund Observer. One feature is his citation of Bill Gates who tweeted this year’s advice.

Personal Finance

Abnormal Returns always has first-rate links for investors in the weekly special edition. Investors will find value in several of them, but my favorite is from Bob French (Retirement Researcher). In his argument for investors to look less frequently at their portfolio results, he compares random data to actual performance. Can you tell which is which?


Seeking Alpha Senior Editor Gil Weinreich continues to provide advisors and investors alike with intriguing ideas and links. He frequently highlights articles that I would otherwise miss. I particularly enjoyed this post where he highlights Jim Sloan’s intriguing comparison of Buffett and Einstein. I’m not entire convinced, but it is a great topic for thought.

 

Market Outlook

Bill Kort takes up the ever-changing narrative on bubbles. Is Dr. Shiller really bullish?

 

Final Thoughts

 

Week after week we see focus on a specific issue when the underlying question is one of valuation. Let me take a slightly different approach to this question. Suppose that you anticipated ten percent inflation next year. What rate of return would you expect from your bank, from bonds, or from stocks? When inflation was that high, interest rates were even higher and stock PE’s were low. In a world of low inflation, why is it surprising that people are willing to accept lower anticipated returns.

The anticipated inflation rate of market participants can be determined from the constant maturity ten-year note yield, and TIPS. Here is the result:


 

With this in mind, let us revisit the “mystery?” Many analysts focus on inflows and outflows, risk on and risk off, Trump trade or not. This simple (simplistic?) interpretation presents stocks and bonds as an alternative.

While it is true that each asset class is always part of a relative comparison, the overall valuation in any asset reflects inflation expectations. Moreover, the long-term relationship between stocks and bonds is positive. Viewed in this way, we should not be surprised by Friday’s trading, or by similar reactions.

Those who consider inflation expectations as part of the valuation question will have more accurate results.

Possible Changes in WTWA

I have been considering some changes in my long-running WTWA series. While it is working well for its main function – focusing my own thoughts and communicating with clients and followers – some changes might make it better. It takes a very long time to prepare. I also find that many of my colleagues, who might link to a specific portion, have difficulty categorizing the entire post. While I am not particularly motivated by page views, I am energized by discussion from peers as well as readers. Shorter might be better for that purpose.

Perhaps most importantly, I am very disappointed that others have not joined me in recognizing Silver Bullet winners, or doing something like that themselves. It is vitally important. It is a good idea, but I need help. Even my annual review of winners was not cited by many of those who carry my work. It does not fit the normal boxes. Their boxes should be changed!

Finally, I understand that many do not like to read long posts, even when it is easy to scroll to a favorite section.

I am considering the following possibilities:

  • Shortening the article by removing some sections entirely.
  • Shortening the main article, but publishing some sections separately.
  • Reducing the number of links for investors.
  • Eliminating the “trading section.”
  • Publishing the theme, and my own ideas, as a separate post.
  • Eliminating references to Mrs. OldProf. (This is a test to see if anyone is reading this).

To help in your recommendations, here are the current sections I include.

  • Main theme – Focus for next week, alternative viewpoints, and often a foil for my message.
  • Summary of last week – just keeping things honest.
  • Overview and chart of the prior week. Needed perspective.
  • The good, bad, and ugly. Others have “succinct summaries” but these combine causes and effects. They also include dubious indicators while leaving out important information. I do it better, but it might not be worth the effort.
  • The Silver Bullet. Vital. Maybe should just be a standalone post.
  • The calendar. There are many efforts to do this, but they are all exhaustive. People need to know what is really important, and why. I am considering dropping this and developing a separate guide.
  • Indicator Snapshot – a summary of what I regard as important.
  • Featured updates – either from regular sources or outstanding posts from others.
  • Trading ideas. I try to separate trading and investing, mostly to prevent investors from excess trading.
  • Investment ideas, including “best of the week.” This takes a lot of work to screen and evaluate. I note that most of my blogging colleagues are talking less about stocks. If you are an investor looking for ideas, you will not get much help from the top-rated blogs.
  • My final thought – with a bit of market advice.

 

What do you think? Do you have some favorite items? What can I drop? Anything I should consider adding?

Please feel free to comment (which might stimulate some discussion) or to send me a private email.

Thanks to my readers!

 

Jeff

Stock Exchange: How to Deal with a Losing Trade

Each week the Stock Exchange highlights the results from different technical trading methods. We also provide contrast, and often dissent, from a fundamental analyst. Usually we get to celebrate winners and consider new picks. This week a couple of our participants need to face the music, discussing a losing choice.

Review

Our last Stock Exchange highlighted health care and biotech. The sector was OK after a mid-week dip. Some of the specific names did not fare well. Even worse, two weeks ago Road Runner picked RH. As I write this the stock is down over 20% after hours. Earnings and revenues were fine, but the announced outlook was terrible.

It is time for a frank discussion.

This Week— What About Losing Trades?

The two examples of losses are both interesting, but our team’s approach differs. For the key lesson, we turn trading (and trading coach) expert, Dr. Brett Steenbarger.

Stop losses

Brett has a great discussion in this post from 2014, The Psychology of Stop Loss Levels. He explains the value of a well-chosen stop. He notes that a trade involves both a direction and a path:

Being stopped out means that you were wrong about the anticipated price path.  It doesn’t necessarily mean that your underlying idea was wrong.  The loss can be a prod to help you better manage price paths, and it can also be a prod to take a fresh look at your idea. In both cases, the loss can help make you better.

This is a first-rate article, with both pluses and minuses about stops. Too many traders view stops as some magical method that generates only winners. They set stops too tightly, and instead miss out on winners.

Position Sizing

It is crucial to right-size positions, knowing how much risk to take. Brett writes:

 It’s not uncommon for small traders to have big dreams and take positions that are unusually large for the amounts of capital they’re trading.  Any trader can experience strings of losing trades merely by chance.  When position sizes are too large, those strings of losers incur a risk of ruin.  Once you’re down 50%, it takes a doubling of remaining capital just to return to break even.

There is no answer that fits all situations. Many years ago I offered some help, with discussion of the Kelly Criterion and some practical examples.  

I’ll comment further on this in the conclusion. Meanwhile, let’s see what the team members have to say for themselves.

J: Oscar, what about the weakness in biotech?

O: This kind of fluctuation is completely normal. No one should be surprised.

J: What action did you take?

O: Just like I do at the track. I don’t want my money on a loser, so I move on. Sometimes my pick is OK, but something else is more attractive.

J: How many sectors do you hold at a given time?

O: Three.

J: So the risk control comes from a limited about of sector diversification as well as trading stops. It is like the first of Dr. Brett’s methods.

O: I guess so. That is what I do.

J: Road Runner, what about that pick of RH?

RR: You said there was news after hours? I will evaluate the price tomorrow.

J: It appears that the company guidance was so bad, it will completely break your lower channel. How do you deal with such losses?

RR: It is a percentage game. I right-size each position. I know that most picks will win, and the wins will be larger than the losses. I trade about 5% on each pick.

J: So you are careful about “over betting your bankroll.”

RR: I’m not sure what that means. A single loss – even a big one – hurts my performance, but I do not take excessive risk. There is some expression about “betting the farm” that strikes close to home. Even a loss like RH will not make me jump off a cliff or something.

J: The loss puts you behind Holmes in the yearly standings. You were leading before this. (I can hear some enthusiastic barks in the background).

RR: I’ll get back on top.

J: What do we have for this week?

Road Runner: I have once again discovered my favorite chart pattern NetEase. Here is the rising channel and the current position at the bottom.

 

RR: I suppose you will once again invoke Chuck Carnevale and F.A.S.T. graphs.

J: Naturally. This time you have some support from the master instead of that silly coyote. It could be a good entry point for long-term investors, as well as a potential trade.

RR: I am delighted that Mr. Carnevale finally agrees with one of my excellent picks. Beep Beep!

Oscar: I have a new sector favorite: Utilities. You can readily see that the market has resumed the love affair with this sector.

Just look at the exciting jump above the 50-day moving average. And all of the trends are rising.

J: Aren’t you distracted by any sports streaks? How about the Cubs?

O: A short losing streak is not always meaningful.

J: Exactly. Neither is a winning streak. Let’s take a look at NextEra Energy (NEE). It is the largest component of XLU at 10%.

 

O: We do not actually own NEE. We have our own basket of representative utilities, each weighted equally.

J: Right. We do this because of erratic trading in the ETFs. There are plenty of choices. With a little work, you can find a collection of choices that has a near-perfect correlation. That said, our own choices have a F.A.S.T. graph that is very like that of NEE.

O: I plan to keep a close eye on this one.

J: It might be affected by a Fed rate hike decision later this month.

O: What’s a Fed? Do you mean the Nationals?

J: Get your mind out of the dugout. How about your updates on reader requests?

O: OK. Here is the current list.

J: Why no XLU?

O: I respond to reader requests. Our readers are not on that bandwagon.

 

 

Holmes: I love dips, followed by a period of basing. My most recent purchase, Credit Suisse (CS) is a good example. Let’s review:

For this stock, it is helpful to look at a longer time period – beyond my normal holding period. Here you can see the rebound a few weeks ago from this same level. There are also prior examples.

J: Are you encouraged by the French election? Worried about the British vote?

H: I do not worry about elections or which humans are conducting one. The chart shows the dip and the potential. That is really all that you need to know.

 

Felix: I have nothing new this week.

J: I am not surprised. When we have a sideways market, you have few chances to spot momentum.

F: That is exactly right. You and Vince always tell us not to reach. We are just following orders.

J: We? I suppose you mean that Athena has nothing fresh either?

F: Right. She said to tell you that you will see her again when something is happening.

J: This is the longest vacation in company history. How about your weekly stock rankings? Still buy, hold, or sell, depending on the color?

F: Yes, and I welcome new questions. That is how the list is built.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Conclusion

Whatever trading method you use, you must analyze risk and anticipate losses. A record with no volatility is a sign of faked data.

Many traders err because they choose position sizes based upon what they want to gain rather than what they can afford to lose. Most of the failed traders in my experience — including many good ones – did so by getting too big.

There was a test of this idea where a group of subjects with PhDs were given a bankroll and invited to play blackjack. They were accurately informed that the game was rigged to give them a 5% edge. A few hours later they were all broke. Even smart people underestimate the chance of a losing streak, even when the odds favor them.

 

Here is a summary of the cast of characters. Find your own favorite!

Stock Exchange Character Guide

Character

Universe

Style

Average Holding Period

Exit Method

Risk Control

Felix

NewArc Stocks

Momentum

66 weeks

Price target

Macro and stops

Oscar

“Empirical” Sectors

Momentum

Six weeks

Rotation

Stops

Athena

NewArc Stocks

Momentum

One month

Price target

Stops

Holmes

NewArc Stocks

Dip-buying Mean reversion

Six weeks

Price target

Macro and stops

RoadRunner

NewArc Stocks

Stocks at bottom of rising range

Four weeks

Time

Time

Jeff

Everything

Value

One month or long term

Risk signals

Recession risk, financial stress, Macro

 

 

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 usually the only human present, and the only one using any fundamental analysis.

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

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

 

Stock Exchange: A Fresh Look at Health Care and Biotech

Each week the Stock Exchange highlights the results from different technical trading methods. We also provide contrast, and often dissent, from a fundamental analyst. It is always interesting when we find a pick where multiple methods agree. This week the entire group gives the nod to health care stocks, and there is even some fundamental support.

Review

Our last Stock Exchange suggested that it might be time to buy the dip in IBM. The unusual agreement came because differing methods reached a similar conclusion. We see the same thing this week on health care, although the specific stock choices vary. Combined with the group endorsement of NVDA three weeks ago, we have an unusual streak. Maybe the Stock Exchange discussion should be held around a campfire instead of before the poker game!

Let’s turn to this week’s ideas.

This Week— A Fresh Look at Health Care?

Health care stocks started a decline when drug prices became a campaign issue. The weakness continued after the election. Uncertainty reigned. Would ObamaCare be repealed? Which health care stocks would survive the policy change? Recent political developments have not clarified the uncertainty, but some candidates are showing strength.

Let’s start with RoadRunner, who has an interesting, non-biotech pick.

Road Runner: I have discovered my favorite chart pattern in Align Technology (ALGN). Here is the rising channel and the current position at the bottom.

J: I keep asking you to earn your lizards by drawing the channel.

RR: Even though I cannot draw, I pecked out this chart:

J: Isn’t that a huge break of the channel in April? Shouldn’t we draw the channel to include that break? And this is another of your Wile E. Coyote stocks.

RR: I suppose you will once again invoke Chuck Carnevale and F.A.S.T. graphs.

J: How did you know? The fundamentals might catch up with your purchase in a few years. And here is a nice summary (Timothy Gornall at Seeking Alpha) of what the company does – bringing orthodontics to regular dentists.

RR: Have you made a profit from my channels?

J: Yes.

RR: Then do not complain. I am only holding this for a month. And get someone else to do the drawing! Beep Beep!

Oscar: I have a new sector favorite: Biotech. It’s not uncommon for me to buy the Biotech sector and hold it for a few weeks. This week looks like an especially good time to be in Biotech. The IBB chart has a few tantalizing details:

The first thing that strikes me here is how the 50 and 200 day moving averages are starting to wilt. We’ve been off recent highs for just about two months, but not so far off that the stock price has tanked. Rather, it’s hovering around the $290 mark. Would it be unreasonable to expect another increase up near $305?

J: You do not trade the biotech ETF, right?

O: Right. Ever since you started complaining about intra-day pricing of these sector ETFs, I have traded my own basket of stocks.

J: They are highly correlated with each other, and all very liquid. None of the members are “dragged along” in an ETF trade. Each of the members is equally weighted.

O: Just like the Cubs batting order. Every member counts.

J: Not the analogy that would occur to me. Any specific ideas?

O: Ian Happ is one I am watching, even though he is a rookie.

J: Actually, I was hoping that you would discuss a stock.

O: Oh. I can discuss one of my specific holdings, Incyte (INCY).

O: Here we see some of the dips that have been common in the sector, although it looks like the drops in this stock have been a bit exaggerated. That’s why I felt comfortable picking some positions on the upswing in this past week.

J: Biotech expert John McCamant declared Incyte to be the “King of ASCO.” This is the meeting of the American Society of Clinical Oncologists. The reports showed “compelling evidence of efficacy across multiple tumor types including, lung, bladder, kidney and head & neck cancers, with impressive safety that is leading

to long duration of responses (DoRs)”. The market had been nervous about these findings, but John has been steadfast on the fundamentals. I took his advice, buying the dip for our “aggressive” program. This is a typical example of a stock making the transition from a “story” to actual earnings. I have found this to be an attractive entry point for biotechs. The stock has lost some loyalists, while the sharp-pencil, accounting-style crowd is skeptical.

O: Right. I see that in sports all of the time. Just look at the NBA.

J: Instead, how about your updates on reader requests?

O: OK. Here is the current list.

 

 

 

 

 

Holmes: I always like a bargain, and Biogen (BIIB) is no exception. The month of May has been a rough one here, although there’s been a slight pop up from below $250 just this week. Let’s review:

Previous price declines to the $250 range have happened twice over the past 12 months, and each were followed by a significant spike up above the $290 range. That doesn’t suggest to me that a sharp spike is imminent – only that the market tends to value this stock well beyond the $250 range. I could see myself holding this position for a couple months.

J: Have you been following the news about drug pricing and the health care changes?

H: No. What news? As you know, I study price, volume and trends. We have a nice dip here, and it is worth buying.

J: For once, the fundamental analysis agrees with you.

Felix: I have nothing new this week.

J: I am not surprised. When we have a sideways market, you have few chances to spot momentum.

F: That is exactly right. You and Vince always tell us not to reach. We are just following orders.

J: We? I suppose you mean that Athena has nothing fresh either?

F: Right. She said to tell you that you will see her again when something is happening.

J: How about your weekly stock rankings? Still buy, hold, or sell, depending on the color?

F: Yes, and I welcome new questions. That is how the list is built.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Conclusion

We can always learn from the model ideas. It is a great reminder that different approaches – each all profitable – see the same situation in very different ways. It also is a reminder that there is nothing wrong with waiting for the right moment. That said, when widely disparate methods highlight a sector or stock, it is probably worth a look!

 

 

Here is a summary of the cast of characters. Find your own favorite!

Stock Exchange Character Guide

Character

Universe

Style

Average Holding Period

Exit Method

Risk Control

Felix

NewArc Stocks

Momentum

66 weeks

Price target

Macro and stops

Oscar

“Empirical” Sectors

Momentum

Six weeks

Rotation

Stops

Athena

NewArc Stocks

Momentum

One month

Price target

Stops

Holmes

NewArc Stocks

Dip-buying Mean reversion

Six weeks

Price target

Macro and stops

RoadRunner

NewArc Stocks

Stocks at bottom of rising range

Four weeks

Time

Time

Jeff

Everything

Value

One month or long term

Risk signals

Recession risk, financial stress, Macro

 

 

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 usually the only human present, and the only one using any fundamental analysis.

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

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Weighing the Week Ahead: Will the Fed Change Course?

We have yet another quiet week for economic reports, and it is in front of a holiday. Don’t worry. Pundits will find something to fill the empty time and space!

It is possible that we will have another week of political stories, but I expect a shift. Many will find it time to digest the recent economic data with a focus on the Fed. I expect many to be asking:

Will the Fed alter its policy path?

 

Last Week

Last week the economic news was good, but the Wednesday decline dominated. As expected it was all about the political controversies.

Theme Recap

In my last WTWA I predicted that accusations about President Trump would hijack the financial news coverage, including comparisons to Watergate. In my “final thought” (where I put my own opinions) I concluded that the controversy did not represent a downside risk, but there would be concern about the prospects for tax policy. This was one of my most accurate guesses about the week ahead. Those who read it properly – what a big news story really means for their investments – should have found it helpful during the Wednesday selling.

Those who looked only at the story’s (accurate) headline, or interpreted it as political commentary, or think that everyone should ignore potential threats to their pocketbook — these people will not be successful investors. For many, the comments seemed to offer an emotional outlet rather than an investment discussion. The Fear & Greed Trader’s weekly summary captured the essence of the investor problem – the political side show versus fundamentals.

I cannot help readers who would rather discuss politics than investing. As I explained in last week’s introduction, I do not choose the media focus for the week. I merely try to help in coping with it. Here is one of the best analyses – an expert source, reaching my conclusions, but after learning more information.

Let me ask this: Would you have been helped more by an investing site that did not even consider the biggest story of the week ahead?

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. She notes the news-driven Wednesday decline, the recovery to a modest loss on the week, and the continuing near-record status.


Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read the entire post for several more charts providing long-term perspective, including the size and frequency of drawdowns.

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!

Once again, the economic news last week was good, but the market reaction was negative. Of course, there were other considerations.

The Good

  • Industrial production was up 1%, beating expectations, and up 2.2% year-over-year. Steven Hansen (GEI) reports with a more nuanced viewpoint.
  • Philly Fed’s Index registered a blowout 38.8. Steven Hansen (GEI) notes the trends and reminds us of the best methods for interpreting this volatile series.


  • Revenue growth. Those complaining about the inaccuracy of earnings growth often turn to revenue. Brian Gilmartin has an important post showing information on this topic, by sector. Not only is growth increasing, so are expectations.
  • Home Owner’s Equity is Rising. Marginal Revolution sees balance sheets in “good shape.”
  • Leading indicators rose 0.3%, matching expectations, but reassuring to fans of this method.
  • Homebuilder confidence continues the upward trend. Calculated Risk has the story, including this chart:


The Bad

  • Brazilian stocks and related ETFs (esp EWZ) plunged on new corruption reports. Ian Bezek has an interesting analysis.
  • Building permits declined to 1229K from a prior annualized rate of 1270K. This was also a miss of expectations.
  • The yield curve is flattening a bit notes New Deal Democrat in his analysis of high-frequency indicators.
  • Housing starts decreased to an annual rate of 1.172 million. Calculated Risk notes that the change was mostly in multi-family, with single family starts up 7% YTD. Bill is maintaining his expectation that starts will increase 3-7% for the year.

 

The Ugly

North Korea is threatening to retire my “ugly” award. Complicating the problem is a general lack of knowledge on the part of Americans. A lack of information does not stop people from forming an opinion, of course. The Upshot reports that only 36% of Americans can find North Korea on a map. Those who can are more likely to favor diplomacy over military action. Take a try and then check today’s conclusion to compare your choice with that of others.


The Illinois budget situation and the need for public schools to increase borrowing is also pretty ugly.

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s award goes to David Bailey et.al. via CXO Advisory. One of the most pervasive traps for investors doing their own research is evaluating the record of forecasters and pundits. They often claim selective, cherry-picked credit. CXO Advisory for some years maintained a “guru grades” feature. The Bailey team has re-ranked the market forecasters after adjusting for specificity and time frame. In general, the scores are not very impressive, but your personal favorite might be an exception. Here is the summary:


The Week Ahead

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

The Calendar

We have a very light week for economic data.

The “A” List

  • New homes sales (T). Current strength continuing in April?
  • Michigan sentiment (F). The final figure for May is expected to remain at a peak.
  • Existing home sales (W). Not as important for first-order economic impact as new homes.
  • Initial jobless claims (Th). Continues with record low levels.

The “B” List

  • Durable goods (F). Volatile April data with weakness expected.
  • Q1 GDP second estimate. (F). Not much change expected, and attention has already turned to Q2.
  • Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

     

There is plenty of FedSpeak on the schedule. We also have President Trump’s travels and the continuing news flow about various controversies.

Next Week’s Theme

Once again, we have an economic news vacuum, and it is heading into a holiday. The A Teams will be eager to head for the beach. Almost anything could grab the news cycle, making it a risky guess for next week’s theme. I expect some reflection and digestion of recent economic data, with a focus on the Fed.

Pundits will enjoy a return to a favorite topic, asking:

Will the Fed Change Course?

As always, there are several viewpoints. Most observers seem to expect two more rate increases this year, beginning with next month.

  • The Fed missed its chance to raise rates a few years ago, and now is hopelessly behind the curve.
  • Economic data have been soft. A rate increase now is likely to create another recession.
  • Economic data have improved. The so-called “soft data” is catching up with other reports. A change in Fed policy is a close call.
  • The key for the Fed is whether to reduce the balance sheet or to raise rates.
  • The economy is stronger than most think. Three rate increases are still in play – as is balance sheet reduction.

As usual, I’ll have more in my Final Thought.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot

 


 

The Featured Sources:

 

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

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

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.

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. His interpretation suggests the probability creeping higher, but still after nine months.

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

Doug Short: The World Markets Weekend Update (and much more). His Big Four chart is the single best method to monitor the key indicators used by the National Bureau of Economic Research in recession dating.

 

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 eight 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?

Most of my readers are not clients. While I write as if I were speaking personally to one of them, my objective is to help everyone. I provide several free resources. Just write to info at newarc dot com for our current report package. We never share your email address with others, and send only what you seek. (Like you, we hate spam!)

Barry Ritholtz has a good post on the VIX and why it should not be viewed as a “fear index.”

The Federal Reserve Bank of St. Louis weighs in with its entry in the battling Fed forecasts for Q2 GDP. They are seeing 2.8%.

James Picerno warns against forecasting recessions based upon a single indicator. I hope that our regular readers were already on board with that concept, but the point is always new for some.

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, Holmes, and Friends

We continue with a strongly bullish market forecast. Most of our models are fully invested. RoadRunner is fussy about entry criteria. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our five technical experts, and some rebuttal from a fundamental analyst. This week our dip-buying Holmes model discusses why he is trading IBM. I joined in, describing the buy/write position in our yield program. RoadRunner plays upward trending channels and Restoration Hardware (RH). See the post for charts and more details.

Top Trading Advice

What is lost when trading on a screen instead of in a pit? Many of my friends are veterans of the pit. They describe the signals they got from their surroundings. Here is an interesting comment on the difference in trading from screens.

Volatility traders finally got the long-anticipated spike. Dana Lyons writes that trader fear (measured by the term structure of volatility contracts) also spiked. A 20% jump in this ratio has nearly always led to meaningful, short-term market gains.


Brett Steenbarger, returning from a well-deserved vacation has some extremely important advice about managing your expectations:

Our job is to trade with the odds and accept the probabilities that the odds may not play out on any particular occasion.  Confidence in trading comes from the cultivation of a set of robust processes for identifying opportunity, expressing that opportunity as trades, and managing the risks associated with those trades.  

Check out the full post for some helpful examples.

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 Chuck Carnevale’s important article, The Active Vs. Passive Performance Debate Is Nonsensical. The discussion on this topic has been so one-sided that many might be tempted to conclude, “case closed.” As he always does, Chuck mixes analysis with some excellent examples. He raises questions about what it means to be active, and how it is measured. But that is just the start. Here are a couple of the key points:

And even more to the point is the undeniable reality that there are numerous investing strategies and many of them are not designed to beat the market. Instead, and for example, there are strategies designed to produce income, there are strategies designed to mitigate risk and there are strategies designed to meet specific investor objectives – and many more. Therefore, I consider the raging debate of active versus passive investing nonsensical. Attempting to define the broad universe of investing strategies as either active or passive is simply too restrictive and/or general to be of any real value.

And…

Furthermore, where is it written that as an investor I should have the singular goal of beating the overall stock market on a total return basis? What if I need more income than the S&P 500 index is capable of generating for me? Therefore, if I build a stock portfolio that produces significantly more dividend income than the S&P 500, have I somehow failed as an investor because my capital appreciation component may be lower? Personally, I think not.

Moreover, if I am judging my success or failure based on outperforming a benchmark such as the S&P 500 on a total return basis, this could prove problematic to my goals and objectives. The problem with total return investing is that I become subject to the vagaries of short-term price action. As an income investor, it is possible that I would be forced to harvest shares during a bad market in order to meet my income needs. Therefore, I would be invading my principal and doing it at a time when I might be better served to simply hold. But since I need current income, invading my principal is really not a viable option.

And much more.

 

Stock Ideas

 

Retail? Really? Anyone looking at this sector must never have heard of Amazon (AMZN)! Vito J. Racanelli takes a contrarian stance in this week’s Barron’s. I have listed the nine stocks selected as “survivors” but you should not jump in blindly. Take a careful look at the article and the reasoning.


Those interested in this idea should also read Marc Gerstein’s take on the topic. Providing a good lesson for those wanting to learn screening and backtest techniques, he begins with a hypothesis of what makes for a good retailer, selecting underlying characteristics for return on equity (ROE). Once again, you should read the analysis carefully before rushing to buy his survivors.


I found the contrast interesting, and I hope you will as well.

Peter F. Way’s analysis of Market Maker hedging suggests Goldman Sachs (GS) as “an odds-on buy for a near-term cap gain.”

Our Stock Exchange always has some fresh ideas. There are ideas from five different approaches. To my surprise, Felix (our long-term investor proxy) likes MercadoLibre (MELI).

Lee Jackson highlights JPMorgan’s favorite biotech stocks.

Dividend Investing

David Fish highlights the 18 increases among dividend champions before June 30.

Ploutos analyzes data on dividend vs. non-dividend stocks.


Eddy Elfenbein discusses a dividend champ that is making a 52-week low.

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, this is a must-read. Even the more casual long-term investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. As usual, investors will find value in several of them, but my favorite is about US Household debt, now back at 2008 levels. The overall debt level is a worry for many, but the L.A. Times explains that Americans’ finances are better.

Seeking Alpha Senior Editor Gil Weinreich has returned from his travels. He is back to providing advisors and investors alike with intriguing ideas and links. I particularly enjoyed his discussion of whether the lack of financial literacy meant that more personal finance education is necessary. If you believe the answer is obvious, read and consider his argument.

Watch out for…

Mall REITs. Brad Thomas sees a continuing “elevated risk.” He looks at the group through the lens of a single day’s trading. Then he turns to the exposure to specific retailers. It is an interesting approach that encourages you to look more deeply into how a given name is trading compared to the group.

Final Thoughts

 

The Fed story may well command attention. I classify it as an important story, but not an urgent one. I have some strongly-held viewpoints:

  1. The exact timing of rate hikes is not important for long-term investors. The Fed has been following a policy of rate increases in line with economic data. While many do not believe this, the data are supportive. Tim Duy on recent strength.
  2. That said, the rate increases have second- and third-order effects. The perception of the pace of hikes impacts exchange rates. The weaker dollar affects major corporate earnings – in both directions. This makes the Fed news worth watching.
  3. Current data are stronger than widely thought, but much depends upon how one views the Q1 softness—meaningful or aberrant. Recent Fed speeches suggest a moderation in the rate-hike path. (Merrill via Calculated Risk).
  4. Rates will be increased more slowly, but the balance sheet will be reduced.

As was the case last week, there could be a lot of noise next week – both from politics and from Fed speculation. If you have taken profits or are looking for trades, the week ahead might be one of opportunity.

And here is the map of people’s guesses about the location of North Korea, represented by blue dots.