Weighing the Week Ahead: Time for a Santa Claus Rally?

The schedule for data releases is lighter than usual. The calendar year is about to end. The market continues to set records. The stage is set for the annual question:

Will there be a Santa Claus rally in stocks?

Prior Theme Recap

In my last WTWA I predicted a three-part week – some post-holiday digestion of the news, a mid-week focus on the Fed, and a shift to the jobs story. That was pretty accurate, although the continuing decline in oil prices was a constant subject.

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

This Week’s Theme

This is the time of year when the calendar seems to command extra attention. Having escaped the seasonal scare of October and with an eye to year-end price targets, the punditry considers the prospects for a year-end rally. The combination of the calendar, record market highs, and relatively light news brings this question to the fore:

Will there be a Santa Claus Rally in Stocks?

Here are the basic viewpoints:

  • Annual seasonal factors are strong. These include the year of the Presidential election cycle, years ending in “5” and similar historical factors. Myles Udland of BI has this story.
  • Monthly seasonals are supportive. (USA Today). This speaks to the information highlighted for average investors.
  • December is not that special. Mark Hulbert runs the numbers and compares to other periods.
  • Any effect will happen in the last few days. (Pension Partners)
  • Oil prices might rebound. Urban Carmel analyzes some correlations. (But see my final thoughts below).
  • A flattening yield curve and high yield spreads signal possible deflation.
  • Economic strength signals potential inflation, sparking faster Fed action.

I have some thoughts about Santa. More about that in today’s conclusion. But first, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

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

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

The Good

The news last week was very good, once again even better than stock prices suggested.

  • ISM surveys were strong. The ISM manufacturing survey came in at 58.7 and services at 59.3 ISM research shows that this level corresponds to economic growth of 5.1%. The comments were also strong. See the official source for a good description and a discussion of the internals, which show continuing growth but a mixed story in the rate of growth.

ISM Manufacturing

  • Declining oil prices – providing benefits to consumers and a long-term boost to stock prices. (NYT) (Also Washington Post). Last but not least, the Fed (via Reuters).
  • Investor sentiment has turned more negative (bullish on a contrarian basis). Bespoke has continuing helpful coverage of this subject. I also appreciate AAII’s official coverage of this topic, which notes that optimism is still above the long-term average.

AAII Bullish Sentiment 120414

  • Chinese stocks get stronger. Josh Brown highlights the move in the ETFs featuring “A Shares” and also notes the implied economic strength for China. This seems counter to current trader expectations. Morgan Stanley agrees.
  • Employment gains are stronger. This is true whether you look at the number of jobs, the hours worked (gain equivalent to a 400K net job change) revisions, wages, or other elements of the survey of establishments. Here are two great sources:

BN-FW769_jobs2_G_20141205085301

 

Data spinners have plenty of opportunity on the employment report. One game is to cite whichever survey is weaker – household or establishment. Each has a wide error band and a different method. The conclusions often deviate in the short run. Eventually they converge. Those citing the household survey this month did not do so last month when it was strong. To keep perspective, here is a chart from Bob Dieli’s excellent monthly employment report analysis:

Dieli Household Survey

 

 

The Bad
There was not very much bad news. There were some very small misses in the data, but nothing really important. Readers are invited to nominate ideas in the comments, but remember that we are focusing on recent developments, not a list of continuing macro concerns.

  • Lower oil prices threaten US fracking. The effects might not occur right away, but there is plenty of attention on how profitable the new producers can be and at what price levels. Matthew Philips (Bloomberg Businessweek) has a good analysis.
  • F-150 Sales. Despite overall strong auto sales, some subgroups deserve extra attention. The Ford F-150 is often cited as an indicator for the strength of construction and small business. Bespoke covers this closely and notes the recent decline. They also observe that it is a time of transition to a new model, which has only recently hit the dealers. It bears watching. Here is the chart.

Ford f150 November

  • Factory orders declined 0.7%, MoM. Steven Hansen at GEI does a complete analysis, looking at unadjusted as well as seasonally adjusted data. He concludes:

    The data has been soft for three months in a row. Consider that this data is noisy – but the rolling averages (which include transport) are decelerating.

     

Noteworthy

Income inequality commands increasing attention. Here is an interesting analysis on which cities have the biggest gaps.

inequality

The Ugly

Congress is back in session, and back in the limelight! Investors basically want to avoid a government shutdown. Meaningful tax reform would be a plus, but seems unlikely. The daily stories feature failed compromises, unlikely proposals, and underhanded deals. It is difficult to forecast accurately, but the results could be very important. I am watching closely.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts.  Think of The Lone Ranger. This week’s award goes to Georg Vrba, for an outstanding response to last week’s challenge. Here was the original chart, which was widely circulated and reposted:

tumblr_nfel6euWDb1smq3o4o1_r1_1280

 

One important problem is that the chart does not take into account the inclusion and compounding of dividends. The dramatic effect of this change is obvious.

Real Price of S&Pcomp 1870-2014

 

It is too bad that Georg’s work, explained further here, does not get as much attention as the original culprit. His method and more analysis is available here. He raised this point more than two years ago. (Honorable mention to several readers who made great comments, including some who cited the dividend issue and others who questioned the long time frame).

Quant Corner

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

Recent Expert Commentary on Recession Odds and Market Trends

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (three years after their recession call), you should be reading this carefully. This week there is (yet another) change in the ECRI story. See also his regular updates to the “Big Four” economic indicators important for official recession dating. We missed Doug’s updates this week, and hope he is back with us soon!

Georg Vrba: has developed an array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal. Georg’s BCI index also shows no recession in sight. Georg continues to develop new tools for market analysis and timing. Some investors will be interested in his recommendations for dynamic asset allocation of Vanguard funds. Georg has a new method for TIAA-CREF asset allocation. I am following his results and methods with great interest.

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

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting market indicators.

Dwaine has a new post on valuation, refuting some of the arguments about “nosebleed levels.” Check it out. Dwaine concludes:

We have a far better stock market valuation model to manage investment risk, one which can forecast forward two-year returns with a correlation coefficient of 0.65 (amazing for this short span of time), and which is surprisingly adept at warning of bear markets and recessions. This we will cover for subscribers in our December research note in the Research main menu.

A replacement for Dr. Copper? Andrew Thrasher nominates semiconductors.

semi-vs-copper

 

The Week Ahead

There is a lot of data packed into three days of a holiday-shortened week.

The “A List” includes the following:

  • Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.
  • Michigan sentiment (F). A new high in prospect? Good concurrent indicator for spending and employment.
  • Retail sales (Th). Some are looking for big gains to match same-store sales.

The “B List” includes the following:

  • JOLTS report (T). When USA Today headlines the quit rate, the world is finally catching on to the importance of this report.
  • PPI (F). Inflation at the wholesale level. It matters little until it shows a real pop for a few months and starts to bleed into CPI and PCE.
  • Business inventories (Th). October data that will influence perceptions (and ultimately reality) of Q4 GDP.
  • Wholesale inventories (T). Early implications for Q4 GDP.

The speech schedule is pretty light on the Fed front.

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

Felix continued the profitable bullish posture for another week. There is reasonable breadth among the strongest sectors. Ratings have continued to drift lower, but are still quite solid in about half of the sectors. Felix does not anticipate tops and bottoms, but responds pretty quickly when there is evidence of a change. The penalty box can be triggered by extremely high volatility and volume. It is similar to a trading stop, but not based only on price. There has been quite a bit of shifting at the top, so we have done some trading.

Felix got interested in China A-Shares this week and still recommends FXI.

You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The recent “actionable investment advice” is summarized here.

Last week brought a rush of scare stories aimed at both the long and short term. I took a closer look at the most recent themes Keeping Investors Scared Witless. If you missed it, please take a look.

Other Advice

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

Stock Ideas

Companies that have the most to lose in the energy space (MarketWatch).

SocGen says it is time to buy Europe. I wonder if they will ever recommend the US.

The most-shorted stocks. (Akin Oyedele at BI).

Investor Psychology

Individual investors remain very worried (via Schwab). They fear market declines and a possible crash. They are much more bearish than institutional investors, as shown by the chart below. This is why so many stocks, especially cyclicals and financials, are currently inexpensive.

file

 

Similar results from Yale – lots of good data in their Stock Market Confidence Indices.

Tactical Considerations

Do stock buybacks work? This interview with Todd Sullivan will help you find the winners.

Behavioral biases limit investment performance in many ways. Josh Brown highlights one for each letter of the alphabet from the Psy-Fi Blog.

Market Outlook

Tim Duy – the top Fed watcher – is optimistic about the projected policy course. He has been very accurate (and contrarian).

Former Value Line market expert Sam Eisenstadt has a model based upon his 63 years of experience. He sees 11% stock gains in six months. (Mark Hulbert)

Bill McBride has an excellent update of a post from two years ago: The Future’s so Bright… See the whole post for the charts you would expect, but here is the key conclusion:

Over two years ago I said that looking forward I was the most optimistic since the ’90s. And things are only getting better. The future’s so bright, I gotta wear shades.

I always try to provide a wide range of interesting links. If you only follow one of them this week, check out the most recent strong entry from Morgan Housel. He has a list of predictions that he feels strongly about – all worth considering. Here is my favorite:

Pessimism will overshadow progress. Twenty years from now,someone will be sitting in his or her self-driving car on the way home from a doctor’s appointment that miraculously cured a disease that’s currently a death sentence, and will be complaining about how awful the world is. It’s always this way. The odds are incredibly high that the average American will have a higher standard of living 20 years from now; yet, we’ll look back at untold numbers of books and articles lamenting that everything sucks. Few will notice how much progress we’ve made because it happens slowly; but they’ll pay attention to the doom forecasts because they are repeated day in, day out.

Second place would be his 16 rules for investors to live by. My favorite here?

Don’t check your brokerage account once a day and your blood pressure only once a year.

Constant updates make investing more emotional than it needs to be. Check your brokerage account as infrequently as necessary to prevent you from becoming emotional about market moves.

Final Thought

I avoid making short-term market forecasts, leaving that to Felix!

I also generally eschew the “seasonal” forecasts. The underlying rationale is often weak and/or not applicable. The end of the Presidential cycle, for example is supposed to reflect efforts to support the party in the next election. The current situation – Obama legacy at stake, GOP Congress, possible compromises – do not really fit that pattern. Years ending in “5” seems like data mining.

I prefer to ignore the calendar and follow a process of constantly upgrading price targets on individual holdings. This is consistent with a key precept:

Do not follow the market. Instead take advantage of what the market is giving you.

To do this you need a method for finding underpriced stocks and confidence to stick to your methods, even when the market disagrees. If you think the markets are efficient, you should just buy index funds.

Most people lack confidence and therefore drift from theme to theme, chasing what worked last month or last year. They have a fixation on what they read in the financial news, forgetting that their business model is selling advertising and yours is making money.

Here are three themes that have my attention:

  1. The correlation between oil price declines and economic weakness. Quite a few observers are doing a simple correlation between lower oil prices and (for example) lower consumer spending. While everyone parrots the “correlation does not imply causation” meme, it is often forgotten in practice. What is happening here is that commodity price declines are usually correlated with weak economic growth, so many other data series seem to be correlated as well. In this case oil prices reflect supply as well as worldwide demand. A true statistical test would have a control for situations where the US economy is strong while oil prices declined, perhaps using a variable like employment growth. Failure to do so leads to a spurious relationship.
  2. Oil prices and oil stocks. There are a wide range of forecasts on oil prices (low and high), but many of the stocks already seem to reflect a very bearish case. I am working on a more detailed analysis, especially parts of the energy complex that benefit from lower oil prices.
  3. Russia and the Ukraine. Part of the drag on worldwide growth is the reciprocal sanctions related to the Ukraine. The benefits of decades of trade deals are being lost. A fundamental concept of the linking of nations in the global economy was to reduce “antisocial” behavior. My sense is that progress on the Ukraine situation would provide an immediate spark to the Russian and European economies, improving markets for China and the US. It is in the interest of everyone, suggesting that eventually it will happen. Joe Weisenthal, operating from his new base at Bloomberg Politics, summarizes the pain of Putin in a series of charts. “It is not a good time to be Vladimir Putin.” Picking just one of his excellent charts, here is the value of the Ruble.

Weisenthal Ruble

 

The economic data provide a good guide for the long-term investor, but the reward might not come from this year’s Santa.

Weighing the Week Ahead: Is the Correction Over?

Was that the bottom? Nearly everyone is trying to time the market, so the financial media will focus on remaining risk versus signals of a bottom.

We have a little economic news next week, but plenty of earnings reports. Despite the news flow, the market reaction itself will be the main theme.

I expect the question of the week to be: Is the stock market correction over?

Prior Theme Recap

In my last WTWA I predicted that we would be asking whether corporate earnings strength could reverse the stock market decline. That was definitely the right question, but the answer is still in doubt. For most of the week it seemed like a resounding “No”, but buy Friday’s close losses had been trimmed. The issue remains in doubt.

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

This Week’s Theme

Financial news is basically reactive – and usually not helpful for investors. For the first part of last week it was all about the reasons for the biggest market decline in three years. I was keeping a collection of links, but they are all very similar. Even some of the finest journalists were tasked with “reporting on the correction.” This produced disappointing stories with a laundry list of well-known problems from around the world. (For an explanation, see Josh Brown below).

There is never a discussion about which of these facts might already be reflected in market prices, nor the suggestion about the need for investors to look forward. Even the best sources cater to losing market timing.

The news flow this week will include plenty of corporate earnings reports. Once again these will be more important than the official economic data. In this context I anticipate more attention to the market rather than to the data. In particular, expect constant repetition of these questions:

Was that the bottom? Is the correction really over?

Here are some key takes on the potential for a market bottom:

Doug Short’s charts are worth more than 1000 words! Here is the story of the week. See the full post for longer term data, context and analysis of past drawdowns over the last few years.

dshort market week

 

Some attribute the Wednesday rebound to comments from St. Louis Fed President Bullard that the last cut in QE3 perhaps should be delayed because of continuing low inflation expectations. Here is a blog from an anonymous twenty-something that explains this viewpoint, which is implied in some mainstream sources as well.

Jim Cramer shifted positions during the week. He began by unveiling a list of ten tests for finding the bottom. By Friday he concluded that there had been enough progress on each to create an “investable bottom.”

cramer bottom signs

The ECRI reports that global growth is weakening and that they made this prediction in July in one of their proprietary reports.

Brian Gilmartin does not typically engage in bottom calling, but he does note the increase in forward earnings estimates, suggesting that “Wednesday’s low could be the end…of this correction.” Brian’s work is always interesting, but especially so during earnings season. He covers many specific companies, and he does it well.

Dana Lyons notes the volume spike in inverse ETFs, but warns that it might be part of a “bottoming process.”

tumblr_ndl7ggaVJN1smq3o4o1_1280

Josh Brown covers all of the bases with his post on “correction Twitter.” I especially like his point #4, with the laundry list of correction causes.

 

Before turning to my own conclusions, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

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

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

The Good

There was not much news. The US economic picture remains solid, while China is a bit weaker and Europe at near-recession levels.

  • Jobless claims remain strong. The 264,000 report was the lowest in 14 years. (Eddy Elfenbein).
  • European car sales up 6.4%. (Geoffrey Smith at Fortune)
  • The early earnings reports have been good. 68% have beaten on earnings and 63% on sales (FactSet’s Earnings Insight).
  • Putin sees problems for the global economy if oil is $80/barrel. (Tomas Hirst at BI). Why is this good news? Unwinding the reciprocal Ukraine sanctions is the single largest current market factor. My guess is at least 10%. The first step is recognition by the participants.
  • Rail traffic remains close to all-time highs. Todd Sullivan has the story. He also provides charts and analysis of other economic indicators. Good stuff.
  • Plunging oil prices create stimulus. We often hear that the cure for high energy prices is high prices. The process works both ways. Citigroup estimates a $1.1 trillion stimulus impact.
  • Housing starts and building permits moved higher. Calculated Risk reports it as an ‘OK’ report. Much of the gain is still coming from multi-family construction. Here is the chart showing that comparison:

StartsSept2014

 

  • Industrial production beat expectations. See Eddy Elfenbein for charts and analysis of the acceleration in this series.

 

The Bad
Most of the bad news was not about the economy. It was about the stock market reaction.

  • Oil geopolitics. The story has many cross-currents, but the path to progress is challenging. Startfor (via GEI) has a great report.
  • Forward earnings guidance has been weaker. FactSet analyzed the conference calls to see what factors have been cited:

    FactSet Forward Guidance Q314

  • Builder confidence decreased to 54, missing expectations of 59. Still positive, but disappointing. Calculated Risk has the complete story.
  • The Beige Book showed little increase in economic growth. I always enjoy the detailed analysis from GEI.
  • Retail sales declined even more than expected, 0.3%, the worst economic news of the week. So far there did not seem to be a pickup from lower fuel prices. Calculated Risk has comparisons including the core and year-over-year data. Here is the long-term chart:

RetailSept2014

 

The Ugly

This week’s ugly news is the continuing Ebola story. The need for treatment in West Africa and international issues are now both commanding attention. It is a sad commentary that the story got traction only when there were cases in the US. I have been writing about this for months, noting that the economic effects are still relatively modest overall, but include concentrated effects in some sectors. Some astute observers (including Jim Cramer) have attributed plenty of selling to Ebola fears. One morning there was a nine-handle decline in the pre-market SPU’s (S&P futures) based on the announcement of one additional US case. I track this story closely, so I am just hitting the highlights here:

  • Cuba is cooperating, sending 460 doctors to West Africa.
  • It has become the biggest story on the campaign trail, with arguments rapidly falling to the lowest common denominator.
  • Inside the beltway politics also looms. Health leaders disagree on how much spending commitments have affected progress toward the best treatments.
  • Cam Hui provides perspective on the market effects. Hint: More modest than most think, including a provocative comparison.
  • Did bureaucracy at the WHO contribute to the crisis? (Jason Gale and John Lauerman at Bloomberg).
  • Ebola is even scarier than you think, according to these five myths. The “airborne” point is especially worrisome.
  • Your risk is greater in driving home from the airport than flying on a plane with one of the Ebola nurses.
  • Airline stocks remain under pressure. Perception is more important than reality.

The Silver Bullet

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

No award this week, although I see plenty of good candidates deserving sharp analysis and refutation.

Quant Corner

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

indicator snapshot 101814

Recent Expert Commentary on Recession Odds and Market Trends

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (three years after their recession call), you should be reading this carefully.

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, he also has a number of interesting market indicators.

Georg Vrba: has developed an array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal. Georg’s BCI index also shows no recession in sight. Georg continues to develop new tools for market analysis and timing. Some investors will be interested in his recommendations for dynamic asset allocation of Vanguard funds. Georg also is working on methods to improve performance from low-volatility stocks. I am following his results and methods with great interest.

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

A continuing strength of Barry Ritholtz’s blog, The Big Picture, is the embrace of a wide variety of viewpoints. This week he highlighted an article from the Cleveland Fed on labor market slack, assuring that many more people would see it. This is wonkish stuff, but very important. Labor market slack is the reason that Chair Yellen gives for relaxing the prior unemployment guideline for the start of tightening rates. If you want to forecast the Fed, you need to understand this argument. The conclusion has the normal couching of the research, but suggests that “the unemployment rate has reached its long-run level.”

The Week Ahead

We have a more normal week for economic data and events.

The “A List” includes the following:

  • Initial jobless claims (Th). The best concurrent news on employment trends.
  • New home sales (F). Better housing growth would be an encouraging economic sign.
  • Leading indicators (Th). Despite some changes in the series, it remains a popular forecasting tool. Hale Stewart illustrates and concludes that the economy is in “decent shape.”

The “B List” includes the following:

  • CPI (W). No sign of inflation so far, so interest is secondary.
  • Existing home sales (T). Less direct economic relevance than new sales and construction, but still a useful indicator.
  • Chinese economic data (T). This includes GDP, industrial production, and retail sales.

The speech calendar is greatly reduced in front of the upcoming FOMC meeting.

The big stories of the week should come from corporate earnings announcements.

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

Felix has continued the bearish call initiated three weeks ago. Most sectors have a negative rating and the broad market ETFs are all negative. The Felix trading accounts were completely invested inverse ETFs and some Latin American ETFs. Since Felix uses a three-week time horizon, the recent move has been timely. Felix does not anticipate tops and bottoms, but waits for evidence of a change.

90% of British retail forex traders lost money. This is in line with most results I see, despite the advertisements that make it all seem so busy. You really need to have a well-tested system if you intend to do short-term trading.

You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The recent “actionable investment advice” is summarized here.

Whenever there is a market decline, we are bombarded with “explanations” and predictions of disaster. To keep perspective I wrote a section last week covering these three points:

  1. What is not happening;
  2. Factors most often linked to major market moves; and
  3. The best strategy for the current market.

If you missed this section last week, I urge you to check out the Investor Section of last week’s WTWA.

I also wrote a section about value investing last week.

If you are a value investor, it is up to you to determine what your investments are worth. If your methods are sound and the market disagrees, then you can use volatility to add more to your most attractive holdings. If you have made a mistake in your choices, you need to re-evaluate and move on. Price is what you pay; value is what you get.

I decided that I could make this point better and with a little humor in Why Investors Must Understand Value (with an apology to Mr. Buffett).

We continue to use market volatility to pick up stocks on our shopping list. We do this because we also sell positions when they reach our (constantly updated) price targets. Being a long-term investor does not require you to “buy and hold.” Taking advantage of what the market is giving you is always a good strategy.

Other Advice

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

Please read and enjoy the piece from Henry Blodget at Business Insider on 16 meaningless phrases that will make you seem smart on CNBC. This is one of the reasons that we use TIVO and mute while watching! If you are a regular viewer of financial TV, you will recognize all of these. The “easy money has been made” is a good example. Henry says that it implies “wise, prudent caution and that you bought or recommended the stock a long time ago.” You can waffle between further upside and the potential for risk. The other fifteen are nearly as good.

Ignoring the commentary noise is also a theme from Carl Richards at the NYT. See the great sketch! He quotes one of our favorites, Art Cashin, who accurately reflects the pulse of the market:

Of course, it’s led to some entertaining headlines and predictions. I think my favorite might be from the veteran trader Art Cashin, who told CNBC last week that “the S&P 500 index needs to stay above the 1,950 level to avoid further declines.”

After hearing that comment, a friend sent me his own explanation. Unless the market doesn’t go down, it will go down. If it stays up, it will not have gone down. Unless it goes down later, which will only happen if it doesn’t stay up.

Such precise predictions are a part of the noisy industry of forecasters and gurus that’s grown up around investing. Sometimes, they get it right, at least temporarily. The S&P 500 did indeed fall below 1,950 and is around 1,900 as of this writing. But it would only need a 3 percent gain to be back above that level again, which could happen in just a couple of days.

 

David Rosenberg (via Business Insider) has earned respect through willingness to change his opinions along with the evidence. His Tuesday note described a problem in market-timing, an excessive focus on the trees rather than the forest.

 

Prof. Robert Shiller’s CAPE ratio is the foundation of many bearish arguments. Jason Zweig eschews the usual media approach of trying to coax him to predict a crash. Instead, he produces a balanced explanation of how Shiller uses his own method. For his own portfolio he is still 50% in stocks, something I have frequently reported before. He does not find current readings to be extreme, and even muses about whether something might have changed. He likes health care and industrials.

 

25iq covers a dozen lessons learned from Guy Spier. It is a great read with good sources. Here is one example:

 

1.”The entire pursuit of value investing requires you to see where the crowd is wrong so that you can profit from their misperceptions.”  A value investor seeks to find a significant gap between the expectations of the market (price) and what is likely to occur (value). To find that gap the value investor must find instances where the crowd is wrong. Michael Mauboussin writes: “the ability to properly read market expectations and anticipate expectations revisions is the springboard for superior returns – long-term returns above an appropriate benchmark. Stock prices express the collective expectations of investors, and changes in these expectations determine your investment success.”

Value investing is buying assets for substantially less than they are worth and, says Seth Klarman “holding them until more of their value is realized.” Klarman describes the value investing process as “buy at a bargain and wait.”  It is critical that the value investor not try to time the market but rather make the market their servant. The market will inevitably give the gift of profit to the value investor, but the specific timing is unknowable in advance. If there is a single reason people do not “get” value investing it is this point. The idea of giving up on trying to time the market is just too hard for some people to conceive. For these people, timing markets is a hammer and everything looks like a nail. That you can determine an asset is mispriced now relative to intrinsic value does not mean you can time when the asset will rise to a price that is at or above its intrinsic value. So value investors wait, rather than try to time markets.

Here are the fifteen most-hated stocks based upon short interest. (Philip Van Doorn at MarketWatch) I am not recommending short selling, but you might want to do some extra research if you own any of these.

 

And here are some stock ideas from Ben Levisohn at Barron’s, who notes that the selling has been indiscriminate.

 

If you are stuck in gold, you might consult us about our gold bug methadone treatment. If you are out of the market completely, you might want to reconsider your approach. The current economic cycle is in the fifth inning. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. You can get our report package with a simple email request to main at newarc dot com. Also check out our recent recommendations in our new investor resource page — a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love and use feedback).

Final Thought

I do not have a short-term market call. For the longer term, the headline risk is well-known and the potential for solutions are not newsworthy. This provides opportunity.

In WTWA I often share conclusions in an effort to be timely. Some of these eventually get a separate article and other spark a useful discussion in the comments. In that spirit, here are a few thoughts from last week:

  • I am amazed by Cramer’s list of problems. When he first produced it (Monday), I suggested to our team that these things were far from solution. By Friday it had all changed. I also dislike the combination of market data and fundamentals. People need to decide whether to trade or to invest.
  • Early week selling did not relate to data, despite the popular stories. No one cares about the Empire Index and a lower PPI is basically good. If you just looked at the retail sales data, the worst news of the week, you would find it disappointing, but not a disaster. It would be amusing to tell a group of “experts” in advance what the data will be for the day or the week and then let them guess the market result.
  • The Schlumberger conference call (transcript helpfully available on Seeking Alpha, a great resource for those watching earnings) provided helpful fresh information on global energy supply and demand providing an upbeat forecast. The selling in energy stocks has been indiscriminate, even though some (refiners?) may benefit from lower prices.
  • GE’s report also showed strength in several relevant sectors. These are not “one-off” companies, so I am paying some attention.
  • And finally, it is a continuing mistake to interpret every market move in terms of the Fed. The remaining QE is small. The exact timing of the end is of little consequence. Do not expect any more QE. The key Fed policy is the pace of interest rate increases and forward guidance. Whether the market likes it or not, that will remain “data dependent.”

Weighing the Week Ahead: Can Corporate Earnings Reports Reverse the Stock Market Decline?

Last week featured a low signal to noise ratio – speech after speech, but little fresh information. This week heralds the start of earnings season. While we have a normal measure of government data, market participants will carefully parse the announcements and conference calls.

This week will be all about earnings.

Prior Theme Recap

In my last WTWA I predicted that the media would focus on the speechifiers, be they central bankers, political leaders, or pundits. This proved to be amazingly accurate. Each of the major speeches was covered extensively and the lesser ones also got significant play. It shows what will happen when there is a vacuum in real news. None of the speeches really broke new ground. We could all have predicted the major theme of each in advance. There was little else to report, and the story had a very negative tone.

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

This Week’s Theme

In sharp contrast to last week’s data vacuum important fresh news about corporate earnings. The stories from around the world will continue, and there is a normal flow of fresh economic data. Despite this I expect the earnings stories to dominate the financial news flow. This is independent, non-government data and it is directly relevant for future market performance. It also provides a fertile source for pundit spinning, always a main driver for financial media.

Can corporate earnings reverse the recent market decline?

Here are some key takes:

European bad news may already be priced in. (Michael Purves of Weeden).

Companies might warn of currency issues.

Disaster impends! You already know how to find ZH— do I need to provide more help?

A balanced viewpoint from Brian Gilmartin, who looks at specific sectors.

The upcoming earnings week is an important story. I want to provide more emphasis than usual on last week in addition to the week ahead. Please read the investor section carefully for these ideas.

Before turning to my own conclusions, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

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

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

The Good

There was not much news. The US economic picture remains solid, while China is a bit weaker and Europe at near-recession levels.

  • Jobless claims remain strong. The four-week average is 287K – not the stuff of economic weakness.
  • Household leverage has further declined. It is “back to the levels of the mid- to late-1990s, a period that saw low inflation and strong economic growth. The “bubble” that was created in the runup to the 2008 financial crisis has completely popped. Households have adjusted to new realities, so perhaps we’ll see more normal, less risk-averse behavior going forward.” Scott Grannis.

Household leverage

  • Gas prices declined again. $3.24 is the lowest in nearly a year. (I am still not seeing this around Chicago). This provides a little extra cash for average consumers. Some will argue that ten bucks a week is not much. Economic analysis is about changes at the margin. Every increase or decrease makes a difference. We noted the negative effects of rising gas prices and now we see the opposite. See Bespoke for analysis and charts. See also NDD for a continuing comprehensive discussion of the effects of energy costs on spending.

Gas Prices Last 12 Months100614

  • Dollar strength is OK. I am having trouble scoring this point in the weekly ratings. The current market action suggestions that a strong dollar is not market friendly. Long-term analysis shows the opposite. With that warning in mind, please read Neil Irwin’s explanation about how to make inferences about the global economy from the increase in dollar strength. Good stuff, good charts. Also please note the Dudley speech (via WSJ’s Hilsenrath) with an unusual mention of dollar strength. This was also part of the Fed minutes. The Fed does not normally comment on currency matters, so it is interesting to note that it might be a factor in future rate policy.
  • US budget deficit declined to $485 B in fiscal 2014 according to the CBO (a good source). This is down almost $200 B from the prior year. Please note the contrast with “fiscal drag” in the bad news. You can’t have it both ways!

The Bad
Most of the bad news was not about the economy. It was about the stock market reaction to last week’s speeches.

  • Germany keeps a hard line on European stimulus. Brian Blackstone of the WSJ has a good article on Jens Weidmann, the German Bundesbank President. He opposes what the ECB has already done, not to mention further moves.
  • German exports declined 5.8%. Matt Phillips has a nice summary article with several good charts, including the one below. Please contrast with “hard line” above and various points on Ukraine sanctions.

monthly-change-in-german-exports-rate_chartbuilder

  • US fiscal policy remains a big drag on GDP Growth. I cannot do a good job by reproducing the interactive chart here, so please look at the Brookings analysis and play with it yourself. (HT reader CS).
  • JOLTs quit rate was unchanged. Many observers try to use the JOLTs report to interpret net job growth. The regular monthly employment report is better for that purpose. JOLTs is better for business dynamics, including length of time to hire and the quit rate. These were both negative.

 

The Ugly

This week’s ugly news is the continuing Ebola story. The need for treatment in West Africa and international issues are now both commanding attention. It is a sad commentary that the story only gets big when there is a single US case. The economic effects are still relatively modest overall, but include concentrated effects in some sectors. Airlines are fighting the battle (via the Hill).

The Silver Bullet

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

No award this week, although I see plenty of good candidates deserving sharp analysis and refutation. How about the “Satan Omen?” Nominations always welcome!

Quant Corner

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

Recent Expert Commentary on Recession Odds and Market Trends

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (three years after their recession call), you should be reading this carefully. Doug includes the most recent ECRI discussion concerning continuing economic weakness in Japan. Doug covers the possible implications for the US. The ECRI has an update criticizing the Fed analysis of labor markets. This deserves discussion, but is beyond our scope in the weekly article.

 

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, he also has a number of interesting market indicators. His most recent update digs deeper into the breadth deterioration that has been a popular topic over the last few weeks. Dwaine notes the possible actionable events from his most recent Great Trough signal. Read the entire post, but be prepared to add context from your other work.

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg’s BCI index also shows no recession in sight. Georg continues to develop new tools for market analysis and timing. Some investors will be interested in his recommendations for dynamic asset allocation of Vanguard funds. Georg also is working on methods to improve performance from low-volatility stocks. I am following his results and methods with great interest.

I added to the recession discussion with some comments on the 2011 ECRI forecast and a possible repeat given current commodity prices.

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured “C Score.” Readers who missed out last week on the WTWA special can still get a free download of Bob’s monthly employment report. Not only does this provide a snapshot of the employment market as of September, there is great historical context. Take advantage while this is still available.

 

The Week Ahead

We have a more normal week for economic data and events.

The “A List” includes the following:

  • Initial jobless claims (Th). The best concurrent news on employment trends.
  • Housing starts and building permits (F). Housing remains important and these provide some leading information.
  • Michigan sentiment (F). An important read on jobs and spending.
  • Retail sales (W). The consumer remains an important read on economic growth.

The “B List” includes the following:

  • Beige book (W). Anecdotal information for the next FOMC meeting. All things Fed remain interesting to most.
  • PPI (W). No sign of inflation so far, so interest is secondary.
  • Industrial production (Th). Rebound in Sept. data for this volatile series?

The speech calendar – loaded up last week – is now at a minimum. Fed Chair Yellen speaks on Friday.

The big stories of the week should come from corporate earnings announcements.

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

Felix has continued the bearish call initiated two weeks ago. Most sectors have a negative rating and the broad market ETFs are all negative. The Felix trading accounts were completely invested in three inverse ETFs at one point last week. Trading accounts are now 1/3 inverse, 1/3 bonds, and 1/3 a non-US ETF.

You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The recent “actionable investment advice” is summarized here.

Whenever there is a market decline, we are bombarded with “explanations” and predictions of disaster. To keep perspective I want to do three things:

  1. Discuss what is not happening;
  2. Re-emphasize the factors linked to major market moves; and
  3. Consider the best strategy for the current market.

What is not happening

Sometimes you need to begin by clearing away misleading information. Here are assorted explanations that I saw last week:

  • QE is ending. Attributing everything to Fed policy is a popular sport, but this is obviously mistaken.
    • QE has been declining throughout 2014 and is now down to $15 B from a start of $85 B per month. It is already 80% over.
    • Some link the market to the Fed balance sheet. That is at an all-time high and is moving higher.
    • Some think the market is anticipating the end of QE. If so, why didn’t it start in December when the tapering was announced?
  • Ebola problems. The Ebola story is very bad on a human front, but the economic effects have been limited. There were some moves in airline and travel stocks this week, but the economic estimates were about $32 B. This assumed that steps to control panic would not occur.
  • Ukraine. This is also bad news, but not fresh news. The reciprocal sanctions are having an effect. Will policies change?
  • ECB inaction. Some expected the ECB to expand bond-buying. Instead Draghi has increased the calls for fiscal policy changes by member nations. This is also not new. While we do not know whether it will eventually be effective, the combination would be better than monetary policy alone.
  • Declining commodity prices signaled another recession. In fact, prices are making a natural response to changes in the dollar, with both at normal historical levels. (See Scott Grannis).
  • Increased volatility shows that the market will decline further.
    • It was only a few weeks ago when the same voices argued that low volatility signaled excessive complacency, a warning of future stock declines.
    • Volatility is actually just back to normal levels.
  • Someone’s valuation model has been proven accurate. There has been a vigorous debate over valuation methods. Nothing happened to resolve it last week.
  • Small caps are lagging, signaling a market decline. When these stocks were strong, it was proof of “froth.” Sheesh! For a nice discussion of this see The Stock Trader’s Almanac.

Factors behind big market declines

The biggest market declines have all involved either a recession (defined as a significant decline from a business cycle peak) or a major increase in financial stress.

  • A reason for our extensive weekly discussion of recession chances is the desire to avoid major declines. In addition to the weekly quant corner, take a little time to review my summary on this topic.
  • Our weekly table also emphasizes the St. Louis Financial Stress Index. My research identified a value of 1.1 as a place where it would make sense to reduce positions. We did so in 2011. Current risk remains low.

Current best strategy

If you have a good investment strategy, it is unwise to overreact to relatively normal fluctuations. Stocks climb a “wall of worry.” This means that the stories you read and see on financial TV are already “in the market.” You need to think about what might be different. This was the key idea behind my controversial call for Dow 20K (good story here). Scott Grannis does a nice job with this topic, including this chart of volatility.

Walls of worry

If you are a value investor, it is up to you to determine what your investments are worth. If your methods are sound and the market disagrees, then you can use volatility to add more to your most attractive holdings. If you have made a mistake in your choices, you need to re-evaluate and move on. Price is what you pay; value is what you get.

If these fluctuations make you uncomfortable, then it may be right to reconsider your asset allocation.

This approach is basically what Warren Buffett and other leading value investors do. To help you, start reading the work of Chuck Carnevale. He relentlessly focuses on the fundamental value of each stock. Everything he writes has great value. We never buy a stock without consulting his screens as part of the process. While we do not always agree with the final verdict, we always appreciate the analysis. Start with this post, directed at retired investors.

We continue to use market volatility to pick up stocks on our shopping list. We do this because we also sell positions when they reach our (constantly updated) price targets. Being a long-term investor does not require you to “buy and hold.” Taking advantage of what the market is giving you is always a good strategy.

Other Advice

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

There are plenty of good ideas in this interview with Eddy Elfenbein, one of our favorite sources. He has especially strong advice for young investors – mostly to focus on personal finance issues and defer investing in individual stocks. He also provides insight into his own stock picking methods.

 

Tom Lee (via Sam Ro at Business Insider) has four reasons why things will get better for markets.

 

Goldman Sachs has a list of expensive stocks to avoid and cheap stocks to buy. Without commenting on the specific names, I have compared the list to our own screens and recommend these articles as a starting point for your own shopping. We own none of the expensive stocks and many of the cheap ones. I also note the concentration of energy, materials, and economically sensitive names in the “cheap” list. This also fits our current sector analysis for long-term investors.

 

If you are stuck in gold, you might consult us about our gold bug methadone treatment. If you are out of the market completely, you might want to reconsider your approach. The current economic cycle is in the fifth inning. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. You can get our report package with a simple email request to main at newarc dot com. Also check out our recent recommendations in our new investor resource page — a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love and use feedback).

Final Thought

I do not have a special insight into earnings season, but I do expect a focus on outlook. A skeptical audience will be watching for companies that are worried about a strong dollar or weakness in Europe or China.

I also do not have a personal forecast for next week’s trading. There are plenty of attractive stocks and plenty of funds that are lagging in performance. At some point the psychology will change. Whether it will happen next week is anyone’s guess. There is a fundamental floor on the market.

Last week I invited people to think about some possible positive events. I got very little in the comments on this topic, partly because it is so challenging to do. Let me illustrate with a few ideas. Since they all seem unlikely, no one is thinking about them.

What if China announced a bid for another oil drilling company?

What if Germany became more active in encouraging fiscal policy changes?

What if OPEC signals a change on production limits? The “instant experts” think that the Saudi’s have a deep conspiracy to crush the US fracking industry. What if the explanation is more mundane? (See this source).

 

What if consumer spending takes a firm upturn in the US?

As he does so often, Joe Weisenthal gets the key point right:

One month ago there were literally no bears left. Everyone had flipped bullish, and nobody could think of a good reason for stocks to go down.

And now, people can’t think of any “upside catalysts,” and everyone thinks the markets are going lower.

What’s interesting is that there’s no obvious change of stories. Sure China is slowing, and the European economy is belly flopping. But so? How is that news? It’s not. It just becomes news and becomes significant after the market sells off.