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

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

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

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

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

Ackman Longs

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

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

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

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

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

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

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

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

Suppose, for example, that you did this spread.

Buy 1.05 million Jun’16 180P for .21

Sell 2.1 million Jun’16 175P for  .12

Buy 1.05 million Jun’16 170P for .09

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

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

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

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

Conclusion

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

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

 

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

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

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

Here are three things you do not know about valuation:

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

Conclusion

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

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

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

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

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

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

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

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

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

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

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

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

Will we see a January effect?

 

Prior Theme Recap

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

SPX-five-day

 

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

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

This Week’s Theme

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

Will we see a January effect?

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

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

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

Last Week’s Data

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

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

The Good

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

blogger-image--1496232610

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

DShort Conference Board

The Bad

Some of the economic data was disappointing.

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

The Ugly

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

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

The Silver Bullet

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

 

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

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

 

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

A Well-Deserved Remembrance

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

Noteworthy

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

Quant Corner

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

Our economic risk indicators have not changed.

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

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

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

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

For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

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

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

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

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

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

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

The Week Ahead

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

The “A List” includes the following:

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

The “B List” includes the following:

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

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

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

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

Dr. Brett Steenbarger has two great pieces this week.

 

Insight for Investors

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

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

Other Advice

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

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

 

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

 

Stock and Fund Ideas

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

426415-14508078108688552-Chuck-Carnevale

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

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

 

Lessons from 2015

 

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

 

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

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

 

Watch out for….

 

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

 

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

 

Hotel stocks. Does Airbnb represent a real threat?

 

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

 

fp1228_oil_c_jr

 

 

 

Personal Finance

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

1. Sign up to some bearish investing websites

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

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

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

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

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

Final Thoughts

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

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

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

This illustrates our most persistent theme from last year:

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

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

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

6a00e551f08003883401b7c7fe0e6a970b

[long EMR versus short calls]

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

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

What is your (revised) EOY target for stocks?

 

Prior Theme Recap

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

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

 

SPX-five-day

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

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

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

This Week’s Theme

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

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

What is your year-end target for stocks?

The question encompasses an array of issues.

The Viewpoints

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

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

 

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

 

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

 

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

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

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

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

 

Last Week’s Data

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

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

The Good

There was some very good economic news.

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

    090315-ISM-SVCS-Charta

     

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

BN-KD868_UNEMPL_G_20150904091150

The Bad

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

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

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

casselman-datalab-sepjobs-2

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

1596022ztemp

 

The Ugly

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

 

The Silver Bullet

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

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

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

 

Noteworthy

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

9-5-2015 10-39-52 PM

Quant Corner

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

Recent Expert Commentary on Recession Odds and Market Trends

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

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

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

Georg Vrba: An array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal. He gets a similar result from the Business Cycle Indicator. Georg continues to develop new tools for market analysis and timing, including a new market climate indicator to reflect risk levels. The market risk is edging higher.

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

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

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

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

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

We are not even close to a high risk level.

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

The Week Ahead

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

The “A List” includes the following:

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

The “B List” includes the following:

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

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

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

Felix has switched to “bullish,” one of our fastest changes in history. Felix remains only partly invested because of the extremely high level of uncertainty. Felix does not explain these changes, but I observe the sector charts. Felix likes sectors that pull back from the highs and show some evidence of basing. From that perspective we are near the bottom of a possible trading range with plenty of upside. The confidence in this three-week forecast remains extremely low with nearly all sectors in the penalty box. Felix withdraws from the market when volatility gets very high. It is simply not a good environment for the model. Many system-oriented trading firms have temporarily suspended trading. There is nothing wrong with waiting for better conditions. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com. Felix appears almost every day at Scutify (follow him here).

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

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

Insight for Investors

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

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

Other Advice

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

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

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

 

 

Stock Ideas

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

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

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

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

Personal Finance

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

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

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

Market Outlook

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

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

 

China Outlook

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

 

Final Thought

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

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

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

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

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

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

Weighing the Week Ahead: Time for “Risk On?”

With a modest schedule of data releases, we can expect more analysis of last week’s news. Trading in several markets changed course rather abruptly. With traders poised to spot any change in trend, the question will be whether this shift is for real.

Is it finally time for “Risk On”?

 

Prior Theme Recap

In last week’s WTWA I predicted that the deluge of economic data would be closely examined for signs of weakness. Put another way, would the economic releases confirm the story of the markets in commodities and bonds? The question was a good one, and the answer was “no.” Friday’s employment report was the final element, changing the terms of the debate from deflation concerns to that old standby, worrying about the Fed.

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

The quirks of the calendar sometimes result in a quiet week following one crammed with data releases. Such is the case in the week ahead, but there is plenty of food for thought. Strength in oil, commodities, and stocks combined with weakness in bonds, utilities and even the dollar. It was the first 2015 sign of a change in market tone. Traders were asking: Is it time for “Risk On?”

Background

Over the last two months I have carefully raised and explored the “message” from various markets.

These themes all gave due respect to the approach of seeking a “message from the market.” This is a favorite for most traders and pundits, but it often serves to explain the past. Few seem to find predictive edge from this approach, although it sounds good on TV.

The alternative is to use economic data and corporate earnings to discover where markets may not be efficient. This helps to identify sectors and stocks that are mispriced. Last week I suggested that it might be time to start with the economic data rather than market prices. This advice echoed my 2015 Annual Preview.

The Viewpoints

Here are the main contenders:

  • Trader perspective – markets lead. Brett Steenbarger started the week with his explanation of weakness in five macro themes. In the old days when he lived in Naperville, we would have a cup of coffee to argue it out. I miss those conversations. By week’s end he acknowledged that a “savvy trader” had to be alive to changes in market themes.
  • Trader perspective – agility. Charles Kirk’s indispensable weekly chart show (small subscription price required, and well worth it) notes that markets held support, “safety” trades could be quickly abandoned, and there was still a search for reasons to sell. Well put!
  • Improving economy. Check out the weekly analysis below. Also “Oil Near a Bottom?” And New Deal Democrat. NDD also has his valuable comprehensive summary of factors.
  • There is no hope. Some pundits cannot even discuss good news for a few minutes before turning to what this means for the Fed. You know it is politically charged commentary when it says the Fed is “running out of excuses.” A small change in the timing for the very first increase in short-term rates is heralded as a market disaster. This theme finds its way into the mainstream media, even including non-financial sources like the PBS Newshour.

The tone change was apparent in oil, bonds, utilities, and other markets. The trading in TNX is typical. This is a CBOE product that tracks the ten-year yield. Just divide by ten. Pick your own upside target for the first move.

TNX

 

And here is the same story told in utility trading – last year’s big winner and last week’s big loser.

xlu

 

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

Last Week’s Data

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

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

The Good

Despite the market reaction, there was plenty of good news last week.

  • Rail traffic was strong. See Steven Hansen at GEI. Also note Bob Dieli in the quant corner on truck traffic. Skeptics of government data should be paying attention to verification from private sources.
  • Weekly jobless claims remained low. The 278K reading confirmed last week’s holiday data. Bespoke has the story and this chart:

020515 Initial Claims SA

 

  • Earnings reports have been positive. It may not seem like it, but 78% of reporting S&P companies have beaten on earnings and 58% on sales. (FactSet). Some readers objected last week that these results reflected success against lowered expectations. Of course. I have frequently written about this phenomenon. The question right now is whether estimates have fallen enough, and apparently they have. Brian Gilmartin has a more upbeat take, emphasizing the results outside of energy. If energy were to stabilize, potential would be even stronger. This is why it is right to take note of results, especially in the energy sector, where the news was pretty good this week.
  • Auto sales were strong versus easy comparisons from last winter. A feature was the rebound in the Ford F150 indicator. This has some correlation with small business and construction activity, but has recently been distorted by the model changeover. See Bespoke for the story and charts.
  • ISM services registered a slight beat of expectations at 56.7, maintaining former strong levels. (Doug Short).
  • Oil prices firmed. The long-term economic effects remain a subject for debate. Meanwhile, the short-term “risk on” correlation remains. James Stafford at Oilprice.com summarizes the economic and geopolitical factors behind this week’s trading.
  • Employment strengthened. Net payroll jobs increased as did wages and hours. Labor force participation was stronger. Prior months were revised higher. You had to look hard to find something wrong with this report, mostly factors that were improving less than the headline numbers. The WSJ has a full chart pack. Jon Hilsenrath goes quickly to the possible implications for Fed policy.

BN-GV541_annual_G_20150206085332

 

The Bad

The bad news included some significant economic reports.

  • Ukraine. There were European meetings without apparent progress, addressing the question of whether Ukraine supporters should provide more deadly weapons (as requested). A peaceful resolution and the winding down of sanctions would be a major plus for the world economy and also for equity markets. Since the negative impact has built up gradually, it is much greater than most realize. To be fully informed, you could start with the interesting Brookings debate.
  • The ISM index declined to 53.5 from 55.1, missing expectations. Some key internal factors also looked weak. Steven Hansen at GEI has a full account. I like his analysis since it includes detail on the component breakdown. As he notes, this is still expansion territory. The official ISM commentary has several references to the West Coast port issues and also notes that the data imply a GDP increase of 3.3%.

16142985ztemp

 

The Ugly

Measles? Libya again? Medical records hacking? Discussion welcome!

The Silver Bullet

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

Recent Expert Commentary on Recession Odds and Market Trends

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured “C Score.” This week’s report covers a range of important issues beyond the headlines, including interesting sections on part-time employment as well as important sectors. An example of important information you do not see elsewhere is the analysis of job growth in trucking, “…if there is nothing to put in the trailer, you don’t put anyone in the tractor.”

Dieli Truck Hiring

 

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.

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 has the latest interviews as well as discussion. Also see Doug’s Big Four summary of key 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 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 and TIAA-CREF asset allocation. He has added a method for Vanguard Dividend Growth Funds. I am following his results and methods with great interest. You should, too. Georg’s update this week is a relative value bond indicator. Georg asks, “When Will the Panic Buying End“? Read the entire piece for the full interpretation behind this interesting chart:

bvr2-5-15

 

The Week Ahead

It is a modest week for economic data.

The “A List” includes the following:

  • Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.
  • Retail sales (Th). What will happen to the gasoline savings?
  • Michigan sentiment (F). Remains important for jobs and spending.

The “B List” includes the following:

  • JOLTs report (T). Most still do not understand the significance of this series – labor market slack. This is the factor watched by the Fed, not a backdoor method for estimating overall job creation.
  • Wholesale inventories (T). December data, but relevant for Q4 GDP.
  • Business inventories (Th). Same as wholesale data.
  • Crude oil inventories (W). Maintains recent interest and importance.

There is a little FedSpeak as well as appearances and meetings featuring world leaders. Important corporate earnings continue.

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 continues a “neutral” posture for the three-week market forecast, but it continues to be a close call. The data have improved a bit, but are still marginally neutral. There is still plenty of uncertainty reflected by the high percentage of sectors in the penalty box. Our current position is still fully invested in three leading sectors, and we have gotten more aggressive. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

Brett Steenbarger has typically wise advice for traders – thinking about trading as an entrepreneur would a new business. Great stuff.

A sadder note for many of us is the end of floor trading in many contracts at the Merc. The several Chicago floors at one time had over 10,000 traders. To be successful required a unique blend of spirit, fast thinking, intelligence, athleticism, integrity, and courage. You also had to be impervious to distractions like people spitting on you, poking you with a pencil, or getting in your face. Trades were cleared at the end of the day. If you did not honor a trade, you were soon gone.

Craig Pirrong has a great account of this change, historic but inevitable. Follow his links to some online video documentaries that provide realistic portrayals.

As I have noted for five weeks, Felix continues to feature selected energy holdings. Felix is not just a momentum trader!

Insight for Investors

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

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

My bold and contrarian prediction for 2015 – that the leading sectors would lose and the laggards would win – looked a lot better this week. If I am correct, there is a very, very long way to run for the cheapest market sectors – energy, technology, cyclicals, and financials.

Other Advice

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

 

Being Contrarian

If you were going to pick one link to read this week, I recommend this Michael Mauboussin piece. It will take a few minutes, but be worth your time. He explains, using some great examples, why it is not enough to be contrarian. You also must have edge! Sometimes (often?) the crowd is right. Markets may be accurately priced. Can you spot the difference? Will you be patient enough to let your system work? (I confess that part of my love for this work is that it is exactly what I and other value managers try to do).

The Quest for Yield

David Merkel does a great takedown of the new eBonds. We see another version of financial alchemy, turning risky assets into something with an AAA rating. Even if you cannot see a flaw, it might simply mean you need to look farther. Risk must be reflected somewhere, and you need to know whether counter parties can pay.

On the positive side in the quest for yield, Charles Sizemore makes the case for REITs. He explains why this should be a diversification for many and an alternative to bond funds.

Or maybe not! Oliver Renick and Brian Louis explain that REITs are over-valued and poised to fall. Expect bond-like, rate-sensitive performance.

Stock and Sector Ideas

Jeffrey Kleintop warns against being “fooled by currency.” Citing Europe and US multinationals, he notes that a “weaker currency is no substitute for a stronger economy.”

Someone is making a big bearish play in the XLU, the Utilities SPDR. The increase in put buying on Friday was 852%.

Consider using Liquid Alts both for hedging and diversification. Rob Martorana is our go-to expert on this topic. I am less worried than he is about the “aging bull” but I consider his recommendations with great interest and respect.

“Secret” hedge fund picks, leaked from a big-name conference. Including short ideas. (CNBC).

 

Market Outlook

Nouriel Roubini calls out the doom-and-gloomers. Here is a key quote:

One result of this global monetary-policy activism has been a rebellion among pseudo-economists and market hacks in recent years. This assortment of “Austrian” economists, radical monetarists, gold bugs, and bitcoin fanatics has repeatedly warned that such a massive increase in global liquidity would lead to hyperinflation, the U.S. dollar’s collapse, sky-high gold prices, and the eventual demise of fiat currencies at the hands of digital cryptocurrency counterparts.

None of these dire predictions has been borne out by events.

Mark Hulbert says that Dow Theory is now flashing a “sell signal.”

 

Final Thought

Risk. Many investors wisely begin by thinking about risk. That is how I start each interview with a potential client. Everyone has the need to protect a portion of the investment portfolio, with the assurance that any losses will be modest.

It is not always easy to identify safety. Last year’s most successful investments were bonds and bond proxies. The quest for safe yield has become a crowded trade. Those celebrating the success of bond mutual funds and their utility payouts should look at this week’s results. It is a very small taste of what will happen when interest rates return to more normal levels.

Reward. And we all need some investment reward, either to keep pace with inflation or to increase the retirement nest egg. There is excessive focus on arguments about the overall market valuation. There are plenty of cheap stocks and sectors.

Take only one example. The energy names that I mentioned in the annual preview – refiners and integrated oil companies that actually can benefit from lower oil prices – are all up about 10% in less than a month. (VLO, MPC, CVX).

Regional banks that allegedly have exposure to energy company loans are another happy hunting ground.

Positions For 2015: Still Plenty Of Life In The ‘Aging Bull’

[This post originally appeared on Seeking Alpha as part of their acclaimed yearly positioning series. It is republished in full below for the convenience of our readers.]

Over the past two weeks, Jeff has engaged in an email interview with Seeking Alpha’s George Moriarty, and we are pleased to share his thoughts below. Enjoy!

George Moriarty (GBM): First, thank you for once again participating in our series. We really appreciate you taking the time, especially since you already spend so much time working on your WTWA series.

Jeff Miller (JM): I appreciate the opportunity to join in. I always read the entire series for the rich variety of viewpoints and great ideas. The high standard encourages all of us to sharpen our thinking before responding, so it is a valuable start to the year. I always spend a lot of time on this, but it is well worth it for my own thinking. I always learn something from the discussion and comments as well.

GBM: You use economics as part of your investment positioning. What does that imply for 2015?

JM: If I had to pick one theme, it would be the toughest challenge for investors: Staying in the market with a normal asset allocation. So many articles and commentaries refer to the “aging bull” and “lofty” stock prices. It is yet another play on using a simple heuristic to guide investments. It sounds good, but it is mistaken.

GBM: In your weekly series, you focus keenly on important economic themes and put them in context for your readers. What do you see for this year?

JM: It is not a dramatic forecast, but it is very constructive. The main economic theme is that there is no expiration date on the business cycle. Major stock downdrafts come after a cycle peak. The best indicators show to be at least a year away. The current economic expansion could go on for years, especially if there is plenty of worldwide weakness. We could easily be having this same conversation a year from now, with the economy growing and the market 15% higher.
Why is the business (and stock) cycle longer? The sharpness and depth of the decline and the slow and gradual recovery. This should not really be a surprise.

GBM: Does your analysis imply a stock price target for 2015?

JM: Heh, heh. Every stock price forecast should come with an error band of +/- 15%! That is just normal volatility. Unlike the featured Street strategists, I do not wait for a target to be hit before adjusting. I always have a base case and adjust as I get new information. One factor is the falling estimates for energy stocks. We’ll know more in another month.
The base case is S&P earnings of $126.80. If earnings grow by 8% and you apply a forward multiple of 18 (often achieved in bull markets) you get a 23% increase. Let’s call that the high part of the range.

Jeremy Siegel’s call for Dow 20K next year could easily be right. It is approximately the historically normal increase. When I made my Dow 20Kforecast in 2010 it was based upon the odds of the market doubling versus being cut in half. I do not know if it will happen this year, but it will happen.

GBM: Would you predict Dow 35K before Dow 8500, essentially the same thing you called in 2010?

JM: Another trap question! In general, that is always a safe call. We will see another recession along that path, so it is a little premature. Following the quant corner in my weekly WTWA should be helpful in dodging the next recession-linked decline. We’ll take another look then.

GBM: As we head into 2015, where do you think the U.S. economy is, relative to the rest of the world.

JM: Normal growth is about 3% and there is a long-term mean-reverting trend. That is the base case for most economic forecasts. The underlying factors are population growth and productivity, so there is room for debate about possible trend changes. The US is not like Japan on these factors. Immigration is a consideration.

A common mistake is to think that the natural state is recession, saved only when there is massive government intervention. This comes from talking pop economics instead of analyzing data. Plenty of the top-rated financial sites embrace this theory. Fear sells.

GBM: What is the greatest risk facing the economy right now?

JM: For starters, it is not what most people are citing. There is a general perception that Europe and China will drag down the U.S. This is a popular theme, especially among non-economists with an agenda, but it is virtually without precedent.

The biggest risk is something we do not already know about. In recent years, these have included extremely unusual weather effects like the polar vortex or the Japanese Tsunami, an international crisis, or a terrorist attack. These “black swan” events can (and will) always occur.

Critics of economic forecasting often observe that the standard macro models do not allow for recessions. True enough. The best-performing models predict that the long-term trend of economic growth will resume. Recessions are a shock to that system, and therefore worth special attention. None of the best recession forecasting methods are flashing a warning for 2015.

But let me flip this. Nearly everyone talks about downside economic risks. There are also some significant “upside risks.” I have written about this concept in the past, but it is neglected by most. The impression for the average investor is the potential upside is limited, while we might have a crash at any moment. Here are some examples of good surprises:

  1. Housing is still dragging. What if it finally shows significant improvement?
  2. Government spending has been a drag, especially at the state and local level. What if it gets a little stronger through higher revenues?
  3. World events could get dramatically better, especially Ukraine. What if a solution were to be reached? Reciprocal sanctions ended? European growth fostered? A better market for China? My ballpark estimate for this alone is about 10% for U.S. stocks.

And these are only examples. Investors should engage their critical thinking skills, noting articles that do not even consider upside surprises.

GBM: What do you see as the major catalysts, and major risks, that investors ought to monitor in 2015?

JM: The biggest surprise last year – and it affected everything else – was the persistence of low long-term interest rates. Almost everyone was wrong about this, including me. I expected a stronger economy with the traditional shifting from bonds to stocks. I was right about the economy, but not about rates. There is always a danger in sticking with a failed forecast, but it is time for a reality check: Would you lend money to the US government for ten years at 2%?

Neither would I. The most important thing to understand about the markets in 2015 is the dynamic relationship between interest rates and stocks. Why are rates so low?
Let us start with what happened:

  1. Continued low inflation
  2. Continuing fear of stocks with a preference for the perceived safety of yield
  3. European arbitrage

The last factor is the most important. If you have the ability to borrow in Europe (selling high-priced bonds with low yield) and lend in the U.S. at a higher yield, your only worry is currency risk. Dollar strength lets carry traders “go commando” and even use leverage. Individual investors in Europe may also show a preference for U.S. investments. [Important note: Nearly everything the average investor sees about the “carry trade” is wrong – mostly because they cite examples of the US as the “funding country.” ReadMark Dow for a great explanation.]

Result: Asset classes emphasizing yield (e.g. utilities) showed strength. Assets responding to economic growth and/or without dividends showed less strength. This helpful interactive tool from Morningstar shows how the overvalued sectors became more so as well as where things stand now.

While valuation methods vary, some time spent with this tool will be profitable for investors.

GBM: About two weeks ago, you penned a mid-week column on “Crucial Facts About Energy Stocks.” In that, you laid out where you see opportunities in the sector. While I’d encourage everyone to go read that, can you tell us how you’re looking at energy now? And if any of the political or currency strife in certain countries has changed your view on the sector?

JM: There are three different levels for our consideration.

  1. Oil prices. The normal supply/demand equation has lost relevance. The leading expert on this topic, Dr. James Hamilton, originally estimated that economic weakness contributed about $20 to the decline in oil prices. Another top source, The Schork Report, says that the market has been “broken” for three months. Stephen Schork notes that there are bets on prices falling to $20/barrel.
  2. Exploration stocks. These are the most leveraged to prices, with the biggest reward if prices reverse. ESV is the best of the breed.
  3. Other energy stocks. Some of these actually benefit from lower oil prices, but get dragged down as part of an ETF. Valero Energy Corporation (NYSE:VLO), Marathon Petroleum Corp. (NYSE:MPC), Chevron Corporation (NYSE:CVX) are all good examples. Maybe Exxon Mobil Corporation (NYSE:XOM).
  4. Related stocks perceived as having economic sensitivity. This includes a long list of deep cyclicals and material stocks. Freeport-McMoRan Inc. (NYSE:FCX), Cummins Inc. (NYSE:CMI), Caterpillar Inc. (NYSE:CAT) are all good examples.

I started with no position in energy stocks, but bought a little after the initial decline. It was a gentle initial position. Wrong! Anything was too much.

Since then I have not added, but I am watching closely.

GBM: What signals are you watching?

JM: Anything that might affect the carry trade, including the following:

  1. European stimulus
  2. Ukraine
  3. China stimulus and growth
  4. OPEC policy
  5. The dollar

And other things that I see in daily trading. How ETFs move versus individual stocks. There is an opportunity for those watching carefully. You really need to distinguish between three approaches:

  1. Traders
  2. Algorithms
  3. Pension funds

While we have been discussing this article, my viewpoints have not changed but the market has gyrated wildly. The start of the week was dominated by the trading guys. The latter part by the value guys.

GBM: What other themes are you monitoring as we enter 2015? Are there areas of opportunity that investors are missing?

JM: Here are some things that will probably happen

  1. The Fed starts to raise short-term rates, a process that will be gradual and will take a couple of years. There will be a knee-jerk negative reaction describing the reduction of stimulus as “tightening” and warning that you should not “fight the Fed.” This will create yet another dip to buy, since markets usually rally for many months after the start of a tightening cycle. If utility stocks have the same dividend but interest rates go back to 3% on the ten-year (where we started last year) that implies a 21% stock decline – and it is not coming back. An increase to 4% would mean a 35% decline. I am not worried about interest rate effects until the 10-year gets to the 4-5% range.
  2. Wages move higher. This healthy sign of an improving economy will be heralded as the first indication of incipient inflation.
  3. The Fed may start a reduction of the balance sheet, probably by not reinvesting maturing holdings. Another opportunity for the Fed pundits who have been wrong all along to continue their streak.
  4. More normal stock market volatility. The modest dips of 2014 are depicted as scary corrections. Investors should be prepared for a historically normal correction in the context of a bull market. This means 15-20%. And don’t expect to guess when it will happen.

Implications for 2015

Markets hate uncertainty, but that is the story on the interest rate effect. Expecting rates to rise has become a prediction without a time frame – not a good forecast, but no one really knows. Here is what to watch for:

  • Stronger European growth
  • Hint of weakness in the dollar
  • Ukraine resolution

Things could shift quickly if the “hot money” is pulled out of U.S. bonds.

As to what investors might be missing, most of them remain under-invested in stocks and scared witless. This may seem strange to say with the market hitting new highs, but the participation has been narrow. There is (yet another) bogus chart making the rounds showing a record high in stock investments.

Consider how the 2015 forecasts we have seen so far are treated. Barron’s had a cover story with a panel of experts predicting quite modest increases in stocks, but the response was, “Why no bears.” I just watched a CNBC interview where an institutional market strategist said he expected a gain of about 10% next year. “So you are really bullish,” was the response. Everyone has been trained to expect something negative.

A popular blogger published a list of the five most popular charts from last year. They are all misleadingly negative and the highest rated one was completely wrong. I gave one of my Silver Bullet awards for the correction. People love to be scared, so the media delivers.

GBM: All that said, and since we’re looking at broad portfolio construction here, how are you positioning portfolios heading into this year? And what has changed since last year, if anything?

JM: First off, thanks for the opportunity to describe a bit more about what we do. We manage six different programs (not funds). Each investor has his/her own account with a blend of risk reward. For those who have already made it and are protecting wealth, we have a bond ladder. For clients who have stock portfolios, we have three levels of risk/reward:

  1. Enhanced yield – conservative stocks, reasonable yield, good balance sheets. We sell near-term calls to enhance the yield. The idea is to break even on the stocks and generate retirement income from dividends and call premiums.
  2. Thematic value stocks. This is an aggressive portfolio of things we expect to work in the near term. Under-valued by key measures. Reasonably safe for the long-term investor.
  3. Aggressive stocks. Companies that have great prospects, but there is a blemish. Maybe it is a drug trial. Or management. Or a review of earnings. We like the company, but there is more volatility. Current holdings includePCYC and ISIS, just to give the flavor.

We expect good risk-adjusted returns on all programs, but we will remain agile of the recession or financial risk odds change.

GBM: Finally, as the “Old Professor” you have always had an eye on politics. Some argue that politics is as much a threat as it’s ever been today. Where do you see the interplay of politics and investing today?

JM: There is a positive aspect that few are considering – a bit of bipartisan cooperation. We are already seeing this with more GOP confidence leading to less brinksmanship – which the market hates. Increased GOP control also has increased a sense of responsibility and accountability going into the next election.

A possible outcome is that we will actually see some legislative compromises. There is a long-standing theory about the “minimal winning coalition.” It means that legislation needs enough compromise to get the votes on board. A good recent example was ObamaCare, which included several compromises to get a filibuster-proof majority in the Senate, across party lines. There is some early evidence on the tax reform front.

A secondary political issue will be the start of the 2016 Presidential campaign. (Already??) The market reacts and over-reacts to these stories, so expect anything negative for Clinton or positive for Warren to weigh on big banks.

On the international front, the biggest example is Europe. Most people simplify the analysis of other countries by imagining a policy formed by a single leader – like a chess player. Since this is their mindset, they find it persuasive when TV experts explain things in those terms.

Those who are willing to reflect a bit will readily see the error. Suppose a foreign citizen were trying to draw conclusions about the U.S.? They might think that policy was strictly that of the Obama Administration, when there are many internal debates as well as disagreements, with the GOP, the liberal wing, the Tea Party types, etc. Other countries have similar diversities. European policy, for example, is the result of bargaining and negotiation…

Those studying political science or organization theory learn this in an early class. Business leaders and traders never took those classes. Investors would do well to ignore the popular press and do some independent thinking. Countries that have a lot at stake will negotiate to reach a solution. The leaders are not stupid.

GBM: Each week’s WTWA has a final thought. Do you have one for 2015?

JM: There is plenty to worry about, but that is not unusual. Let me suggest an idea about stocks that I have not seen elsewhere:

Take the major market sectors. Go short those that were the leading picks last year and go long the laggards.

Most investors will be doing the exact opposite!

2014 in Review: Hot or Not?

We introduced the “Hot or Not” segment last year as a lighthearted way to break down important themes for individual investors. Rather than looking at page views or ratings, we want to review economic, market, and public policy themes that could help you most in the new year.

In this illustrated review of the year, the “Hot” (or profitable) items will appear on the left, while the “Not” (or disappointing) corollary appears on the right. We hope you have as much fun reading as we did putting the list together.

siegel v hussman

Jeremy Siegel used a relatively simple method to predict (accurately) that we’d end the year right around DOW 18k. On the other hand, John Hussman’s complex modeling may have had a little too much elbow grease.

consumers v producers

OPEC’s price war has been successful in straining American producers – but the average consumer isn’t the least bit concerned.

krushcheva v putin

Putin ends 2014 with his nation more isolated on the world scale, and a currency facing rapid devaluation. The granddaughter of the former shoe-pounding premier continues to enjoy considerable success as a writer and analyst.

shark tank v kudlow

The record high ratings for CNBC’s “Shark Tank” – particularly among young people – suggest a sense of optimism and faith in American innovators. Meanwhile, Larry Kudlow’s slant had a narrowing audience.

gundlach v gross

Bill Gross’s dramatic exit from Pimco at the end of September came as a huge shock. Jeffrey Gundlach is set to begin a new year as the “King of Bonds.”

journalistic entrepreneurs v enrollments

While enrollment in journalism schools has fallen for the past two years, wonks like Ezra Klein and Nate Silver appear to be thriving after striking out on their own.

washington v washington

Approval ratings for Washington institutions remain stuck near all-time record lows. On the upside, the capital city’s baseball team enjoyed their best season ever – winning the NL East Division by 17 games.

yellen v critics

Last year we wondered if Janet Yellen would be batting cleanup in 2014. To the dismay of her many critics, QE3 is over and the sky has not fallen. As for Ben Bernanke – it turns out it pays well to be the the former Fed chair.

Have some ideas of your own? Great! We welcome all nominations and suggestions in the comments section below. Thank you for reading, and have a happy new year!

2014 in Review: Best of the Silver Bullet Awards

Lone Ranger 2014Here on A Dash, we do our best to steer individual investors away from politically motivated agendas and misleading analysis. An important part of this is being able to recognize colleagues and friends who do outstanding work to expose myths and rumors in the financial media of all kinds. We congratulate these writers with the Silver Bullet Award – named in honor of the Lone Ranger, who lived his life knowing “…that all things change but truth, and that truth alone, lives on forever.”

At the end of 2013, we published our first column reviewing the year’s Silver Bullet awards. Readers old and new would enjoy reviewing it – much of the information is still relevant today. We’ve summarized all of this year’s winners in this column. We encourage you to keep a close eye on these topics as we move forward into 2015.

January 19, 2014

The Bespoke Investment Group won this year’s first Silver Bullet award by taking aim at the idea that big Wall Street movies signal market tops. Observe the following chart on the left, with the corrected BIG chart on the left. As you can see, the original plays it “fast and loose” with causality.

BIG

More detailed analysis from Bespoke here.

February 15, 2014

Near the beginning of this year, a misleading chart comparing the DOW’s current period with its movement during the 1920’s was receiving undue attention in the blogosphere. The implication of course, was that the market was headed for imminent disaster on par with the Great Depression. Ryan Detrick of Schaeffer’s and Bespoke Investment Group stepped up to put things in perspective. The original is on the left, with the corrected version on the right.

1929 chart

Again, this was merely an issue of a chart being taken out of its proper context and presented in an intentionally misleading fashion. More analysis here.

March 1, 2014

Scott Grannis was quick to respond to fears in mainstream financial news regarding the collapse of the Yuan. His chart (below) places the currency in its proper context, clearly showing more recent moves in their proper context. His analysis is serves as an important reminder for individual investors – changes in valuation generally don’t amount to imminent collapse.

grannis yuan

May 11, 2014

Anyone with an introductory level knowledge of data analysis knows better than to confuse correlation with causation. Unfortunately, many bloggers are capable of cooking up a story plausible enough to create a relationship where none actually exists. Tyler Vigen at Spurious Correlations earned himself a Silver Bullet award for illustrating an important statistical principle with a good sense of humor.

crude oil and chicken

June 1, 2014

The unemployment rate is a popular source of fodder for doom and gloomers. We awarded Paul Kasriel the Silver Bullet for discouraging “knee-jerk analyses” of the newest numbers. He writes:

“…(A) decline in the labor force does not always reflect an increase in so-called discouraged workers. And, in fact – well, fact may be too strong a word, but according to data contained in the April Household Employment Survey – the number of people not in the labor force in April but who did want a job changed by a big fat ZERO.”

Individual investors would be wise to keep his words in mind ahead of the newest updates.

June 29, 2014

Barry Ritholtz moved from the Lone Ranger’s six shooter to a Gatling Gun to confront a general failure in causal reasoning partway through the summer.

What are a few examples of the single factors that have been making the rounds these days?

GDP: “We have never had a negative 2.96 percent GDP report and not gone into recession…”

Rising Rates: “The U.S. stock market doesn’t do well when interest rates are rising.”

Earnings Surprises: “Earnings are good this quarter, better than expected, and therefore, the market’s going higher.”

New Financial Products: “These new products are being adopted, therefore it means the bull market is coming to its peak.”

Death Cross/Golden Cross: “When the 50 and 200 day moving average cross to the upside (downside), it bodes well (poorly) for any trading vehicle.”

These sorts of fallacious statements should set off alarm bells in the minds of critical thinkers.

July 20, 2014

We awarded John Lounsbury of Econintersect for taking on a new rumor from one of the biggest doom and gloom sources in the blogosphere. In response to a sensationalized “Japocalypse” headline, he delved into Japanese machinery orders. His key summary:

Whether the May readings have any special significance or not will not be known at least until the June data is reported, and probably not known with any certainty until at least three more months are on the books.

In the meantime, terms like “Japocalypse” can be put back on the shelf (under a dust cover) in case they are actually needed later when the long-term wild up and down swings in new machinery orders are ended with an extended move to the downside.

We encourage you to read through his full analysis here.

November 9, 2014

Those with little understanding of bureaucratic practices are quick to suspect that government officials are cooking the books. We awarded Floyd Norris of the NYT with the Silver Bullet for attempting to disabuse the public of this notion.

This is so credible to the general public, where the perception of government is strongly linked to B-movies, that few even challenge the notion of misleading government data. If I had to pick a single mistake of the individual investor, this would be a strong contender. They are likely to believe that the President can call up the BLS and tell them what to report, or that the Fed buries certain results, silencing hundreds of employees, and misleads us all. Here is a key quote from Norris, possibly persuasive to those with an open mind:

“The idea that politicians could force government bureaucrats to fake the statistics, and do so without any leaks, is hard to believe. Such a conspiracy, if it managed to exist for long, would be a marvel of organization. But those who believe in the conspiracy theory also tend to subscribe to the theory that governments are generally incompetent and unable to do anything right. Those two beliefs do not correspond.”

November 16, 2014

Merrill Lynch economist Ethan Harris earned the Silver Bullet award for taking on one of the most frequently cited misleading charts: QE and stock prices. Part of his explanation follows the chart.

harris pe

“Every time the end of a QE program looms, pundits warn of a big shock to markets and the economy. In the business press, the story of exactly how this happens keeps shifting to fit the facts.”

The main target of Harris’ critique is the above chart, which has been a favorite among the “QE-truthers,” or folks who believe the Fed’s policies are directly responsible for the rise in the stock market.

But the big problem Harris has with this chart is, well, basic statistics.

Implicitly, this chart assumes that the markets are not forward looking and it is the implementation of Q that drives the stock market: when the Fed buys, the market booms and when it stops, the market swoons,” Harris wrote.

“As our readers know, we think this relationship is a classic case of spurious correlation: anything that trended higher over the last 5 years has a 90%-plus correlation with the Fed’s balance sheet.”

December 7, 2014

Georg Vrba responded to a challenge we issued near the end of this year regarding a misleading chart claiming the US Stock Market is over 90% above trend for the second time ever. The original chart appears below, with his detailed correction following.

misleading 90

georg correction

As we noted at the time, Georg has been dutifully making this assertion for years. It is unfortunate that the myth has persisted for so long. More information on his methods and analysis is available here.

December 21, 2014

Our last Silver Bullet award for the year goes to Jeffry Bartash of MarketWatch, who explained why Wall Street should pay less attention to Philly Fed & Empire State.

“Regular readers know that I downplay these results. It is nice (finally) to have some support. I mistakenly took my CNBC feed off of mute to hear their “experts” calling describing the most recent report as “crashing” from the prior high. The prior high was described as an anomaly when it occurred. There is no report that will satisfy those on a mission. No one seems to understand that a diffusion index compares one month to another. There are several other problems with this regional survey.”

Conclusion

As always, you can feel free to contact us with recommendations for future Silver Bullet prize winners at any time. Whenever someone takes interest in defending a thankless but essential cause, we hope you’ll find them here.  Have a Happy New Year and a profitable 2015.

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.”