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.”

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

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

This week will be all about earnings.

Prior Theme Recap

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

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

This Week’s Theme

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

Can corporate earnings reverse the recent market decline?

Here are some key takes:

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

Companies might warn of currency issues.

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

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

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

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

Last Week’s Data

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

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

The Good

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

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

Household leverage

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

Gas Prices Last 12 Months100614

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

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

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

monthly-change-in-german-exports-rate_chartbuilder

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

 

The Ugly

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

The Silver Bullet

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

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

Quant Corner

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

Recent Expert Commentary on Recession Odds and Market Trends

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

 

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

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

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

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

 

The Week Ahead

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

The “A List” includes the following:

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

The “B List” includes the following:

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

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

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

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

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

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

Insight for Investors

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

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

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

What is not happening

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

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

Factors behind big market declines

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

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

Current best strategy

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

Walls of worry

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

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

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

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

Other Advice

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

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

 

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

 

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

 

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

Final Thought

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

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

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

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

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

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

 

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

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

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

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

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

Weighing the Week Ahead: Investor Lessons From This Week’s Data Deluge

Summary

  • Market divergences were the highlight last week — as expected and in contrast to news.
  • The week ahead features a deluge of data — a test of current market “messages”.
  • The outlook for traders has turned more pessimistic.
  • Investors can enjoy a different time frame, with little risk from recession.
  • Some beaten down sectors offer special opportunities.

Employment week always generates a strong economic focus. Because it falls on an early calendar day this month, we also have an avalanche of other economic reports.

This week will emphasize the message of the economic data.

What can we learn from this news?

Prior Theme Recap

In my last WTWA I predicted that the media would focus on “divergences” and the implications for the broader market. I was out on a limb with that one, since it was certainly one of the more obscure possible choices for a weekly preview. It turned out to be very accurate. Doug Short’s review and summary chart provide one-stop shopping for what happened in equity markets.

dshort market week

The news was actually pretty good, but you would not know it from the markets. The decline on Thursday provided grist for the “divergence theorists.”

Here are some headlines:

From BlackRock: Worlds Apart? Investing in an Era of Divergence 

From Thursday at MarketWatch: This stock selloff has everyone talking about ‘divergence.’

Some of the stories even cited the same sources and charts I used. Apparently I was on target!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.

Calling All (Young) Writers

The Financial Times and McKinsey and Company have joined to offer the Bracken Bower Prize for the best proposal for a book on the challenges and opportunities for growth. A prize of £15,000 will be given for the best book proposal. It is also a good way to attract a publisher for your idea. Entries close on September 30th. More information is available here.

A Note to Readers

Sometimes I try to review my approach to the WTWA series. As a profitable blogging method it is rather dubious. I could get many more page views if I split apart the various concepts, creating several posts per week. My sense is that the article would not be as helpful, but many prefer short takes on specific topics. Here is what I am aiming for:

  • A thoughtful theme that provides an organizing concept for the week ahead.
  • A frank assessment of how well we guessed about last week.
  • A summary of the good, bad and ugly news from the prior week. Ideally, this includes items you do not see anywhere else.
  • Recognition of peers who have done courageous and excellent work via my Silver Bullet.
  • A data-driven summary of the best quant methods.
  • Some ideas for traders.
  • A lot of ideas for investors.
  • Plenty of charts, tables to tease with links to the best of what I read last week.
  • My own take on interpreting the news of the day.

Some readers will not be interested in all of these topics, but I have organized it so that you can find your favorite parts. Can I do better, either in approach or content? Suggestions are welcome.

This Week’s Theme

In sharp contrast to last week (little fresh data, plenty of room for navel gazing) the week ahead includes plenty of new information. Many observers will try to force the data into their pre-conceived themes. Here are the key competitors:

  • Commodity markets show that global economies are weak. (See this discussion of declining commodity prices).
  • Bond yields imply a weak economy. (Gundlach CNBC interview).
  • The bond message does not signal weakness
    • It reflects European yields and arbitrage (Yardeni)
    • Yields are normal for this stage of the business cycle (Grannis)

The Scott Grannis analysis covers a key point that seems to elude most investors – the exaggeration of the effects of Fed policy, especially on ten-year rates. He writes as follows:

10-yr yields, on the other hand, are largely driven by the market’s expectations for economic growth and inflation. The Fed can influence these expectations to some extent, but not by much. The chart shows that even though the Fed purchased trillions worth of notes and bonds in three rounds of Quantitative Easing, 10-yr yields rose during each episode of Quantitative Easing. Yields rose because the market perceived that the Fed’s bond purchases were correctly addressing a problem and thus improving the outlook for growth. Yields fell after QE1 and QE2 because the market realized that the Fed had not done enough to address the world’s demand for safe assets, and this threatened the outlook for growth. We now know that QE3 is virtually finished, but yields have only declined marginally, which in turn suggests that this time the Fed has done enough.

10-yr vs QE

 

As usual, I have a few thoughts about which approach is best. 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 a lot of very good news, supporting the general thesis of economic strength.

  • Gas prices declined another five cents. Doug Short monitors this every week, with the impact on the CPI and great historical charts. Take a look.
  • Q214 GDP was revised higher. This is “old news” of course since we have almost completed Q3. As I noted in last week’s preview, it still explains the foundation for future economic analysis. Bob McTeer likes the source of the revisions in the recent report – exports and business investment.
  • Business investment is improving. (Scott Grannis). Capital goods orders are a good proxy. This supports the GDP news.

 

Capital Goods Orders

 

dshort michigan

  • Durable goods orders increased in the core measurement by 0.7%. The noisy headline number reversed the aircraft news from last month. That was expected, so I am treating the news as a net positive. Steven Hansen at GEI does an excellent job of explaining the apparent contradiction.

 

11734843ztemp

  • New Home Sales beat expectations. Calculated Risk reminds us that this is just one month and it was an easy comparison. I am scoring it as a positive, but we should keep the warnings in mind. (Please compare with the “bad news” on existing home sales).

The Bad
There was also some important negative news.

  • Ukraine story. The effects of this continuing saga appear in the weakness of the European economy and dollar strength. In the short term, these are both negative factors for stocks. My estimate is that the market effect is currently about 8-10%. I do not expect a sudden change in the story, but I monitor it closely. To understand why it has been bad news, here are some current headlines:
    • Russia sees US and EU as backing Ukraine “Coup” (Voice of America)
    • Sanctions hurting Europe more than Russia? (Reuters)
    • Ukraine faces a cold winter without Russian natural gas (Calgary Herald). (See also quotes from Ukraine PM in many sources, including Reuters). Europe, too?
    • US sets reform conditions for Ukraine investment. (Yahoo Finance)
  • Sentiment remains bullish. A bit less so, but still tilted that way. Bespoke has the AAII survey and discusses the expected contrarian interpretation.

 

AAII Bullish 092514

  • Economic growth is decelerating via the Chicago Fed’s activity index. Doug Short has a good analysis. Many of the leading GDP tracking measures are showing growth at 3.5% or so, which does represent deceleration. The headlines can be tricky.
  • Argentina is tanking. It might also reflect broader South American concerns. Scott Grannis has a good account, illustrating what happens when you peg a currency in a weak economy.

 

Official vs Blue Rate

  • Existing home sales disappointed. Calculated Risk reminds us of the importance of inventory, which is not seasonally adjusted. With that in mind, the story is not so bad. The housing numbers are a challenge to follow, which is why we read Bill’s reports on all things housing (as well as other matters). Please compare with new home sales in the “good” category.

The Ugly

This week’s “ugly award” goes to the cozy treatment of Goldman Sachs by the New York Fed. You can read a summary by Michael Lewis and also listen to the NPR story at This American Life (available by podcast). I did both. This is only the beginning of the story, I suspect, but the reporters did well to seek balance and offered chances to respond. Neither Goldman nor the NY Fed provided much. I had a unit in my college classes about “captured” regulators. It is a familiar topic without easy answers. Listening to the podcast provides an interesting insight into the issues.

Our “ugly” list for the last few weeks remains unfortunately accurate. We had headline news from all conflicts with plenty of violence and death competing for our attention. The Ebola crisis, which we started to feature many weeks ago, is deepening. Last week I noted that some were calling it a “Katrina moment” for the World Health Organization.

Sometimes the concerted attention to a problem can change the result. Carl Bialik at FiveThirtyEight suggests that the worst of the CDC forecast might be averted for this reason. My investing audience might remember this effect from the Y2K problem, where advance publicity may have contributed to an advance solution. If only we could have a similar result with Ebola!

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 Michael Batnick, who sought the true story about the “death cross” in the Russell 2000. Please read his entire explanation behind this table:

tumblr_ncd705N9eO1tvtougo1_400

Quant Corner

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

Recent Expert Commentary on Recession Odds and Market Trends

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (three years after their recession call), you should be reading this carefully. Doug includes the most recent ECRI discussion concerning continuing economic weakness in Japan. Doug covers the possible implications for the US. The ECRI has nothing fresh to add, but I expect something soon because of their excessive emphasis on commodity prices.

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

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. Dwaine’s “liquidity crunch” signal played out as projected. This week he highlights his HILO Breadth index which he has designed to pinpoint bottoms and to warn of protracted corrections. Current readings imply an opportunity that usually shows up only once a year. Check out the full post for a description and charts.

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

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

The Week Ahead

We have a big week for economic data and events.

The “A List” includes the following:

  • Employment report (F). Rightly or wrongly, the monthly employment data are the most important economic indicator.
  • ISM manufacturing (W). Good general concurrent economic read with some lead qualities for employment.
  • Consumer confidence (T). The Conference Board version reflects both spending and employment.
  • Auto sales (W). Concurrent economic read from non-government data. Also the F150 indicator for construction.
  • Initial jobless claims (Th). The best concurrent news on employment trends.
  • Personal income and spending (M). Important element of the economy and also includes the Fed’s preferred inflation indicator.

The “B List” includes the following:

  • ADP private employment (W). Valuable and independent read on private employment.
  • ISM services (F). Younger brother to the manufacturing index, but earning a wide following.
  • Pending home sales (M). All housing news is important. Pending sales have implications for new sales as well.
  • Trade balance (F). August data relevant for Q3 GDP calculations.
  • Factory orders (Th). August data in a very volatile series.

Once again, there is plenty of Fedspeak on the calendar. We might think that there is little fresh news on that front, but we still see surprises that add color to the official statements.

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 shifted from neutral to bearish. Most sectors have a negative rating and the broad market ETFs are also tilting negative. Our Felix trading accounts are still partially invested, but not in mainstream equity ETFs. The trading program can sometimes go short via the inverse ETFs. That has not happened in more than a year, but we might see it soon.

I know a few very successful traders — very few! Most of those who try and fail think that they can look at a few charts and see something no one else notices. I embrace some technical methods. It is Felix’s strong suit. The fancier the method, the worse the prospects. Larry Swedroe writes about Problems with Technical Analysis. Here is an entertaining quote:

Martin Fridson, who currently serves on the editorial boards of Financial Analysts Journal, CFA Digest and the Journal of Investment Management,had this to say about technical analysis: “The only thing we know for certain about technical analysis is that it’s possible to make a living publishing a newsletter on the subject.”

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 current “actionable investment advice” is summarized here. In addition, be sure to read this week’s final thought.

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.

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

Investing in Russia? Barron’s features Prosperity Capital, which is challenging the conventional wisdom with Russian investments.

To convince investors that better times are ahead, Westman must stray into the political fray he tries to avoid. Russia hasn’t developed indigenous institutional investors; foreigners own most of the free float in its stock market. That means the best hope for a rebound lies in a global rebranding, peace in Ukraine, and persuading capitalists that Russia will not provoke similar conflicts.

Westman has fought this uphill battle by quitting his London desk for fact-finding missions in Ukraine this year, mingling with Kiev politicians and separatist rebels, and offering investors a view he considers more evenhanded than that from most Western media. “I am convinced there is no plan in the Kremlin to restore the Soviet Union,” he asserts. “We are not trying to defend Russian policy, but to explain their point of view, which is that Russia is the one under attack.”

Looking for beaten down sectors and stocks is part of our value style, so I am interested. It still seems early to me, and the average investor cannot go for the private companies that hedge funds choose, joining them in avoiding the state-owned properties.

 

Need stock ideas? If you want to beat the market like the big hedge fund guys, you cannot buy hundreds of stocks. Bill Ackman’s six-stock portfolio illustrates the principle. We don’t own any of these, but that might relate more to our strategy, focus, and client risk profiles. Maybe some of these should be candidates for our “high-octane” program.

 

You cannot buy stocks just because they have declined. Some of them never come back! Ben Carlson has charts, data, and analysis. Here is his summary of stocks that had a catastrophic loss – a 70% or greater decline with minimal recovery.

dont-com-back
Meanwhile, some stocks are just out of fashion, even if fundamentals are solid. In this post I explored the contradictions in the current commodity trade and mentioned a couple of stocks that qualify as current strong buys, perhaps with calls sold against them.

 

Financial media for investors. In yet another strong post, Josh Brown describes the imbalance in incentives (junk food versus eating your veggies). Financial media are escalating misleading rhetoric to gain a share of a declining population. It is too bad that there are fewer incentives for those providing solid investor education. Josh lists a few favorite sites, so take a look and set your bookmarks.

 

Studying mistakes is important! Morgan Housel explains this very well. The entire post is worth your time, but I especially like this section:

 

Spend more time studying failures than successes. You can learn more about money from the person who went bankrupt with a subprime mortgage than you can from Warren Buffett. That’s because it’s easier and more common to be stupid than it is to be brilliant, so you should spend more effort trying to avoid bad decisions than making good ones. Economist Eric Falkenstein summed this up well: “In expert tennis, 80% of the points are won, while in amateur tennis, 80% are lost. The same is true for wrestling, chess, and investing: Beginners should focus on avoiding mistakes, experts on making great moves.”

His comments are equally true for top-level tournament bridge. I am sure that Mr. Buffett would agree! You can also see the “flip side” from this article at Scientific American. Most of what investors read is completely biased toward the surviving managers.

 

Do not over-emphasize short-term returns. Many investors rush to study their portfolios whenever there is any news. This distracts from your fundamental goals, explains Kris Venne.

 

Most of us would be better off if our 401(k) / IRA had a 30 year lock up feature. Maybe even a 90% surrender charge if cashed in early.

 

If you are stuck in gold or 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

The disparity between the fundamental factors of stock valuation and the noisy price fluctuations provides ample ammunition for those emphasizing worries. Instead, I suggest a successful formula:

  1. Analyze the potential for a big risk by monitoring recession odds (very low) and financial risk (also very low). If these risks become high, then cut back your position size. You get this information free of charge each week by reading WTWA.
  2. Pay attention to the growth in corporate earnings, especially expected earnings. You can monitor this by reading Brian Gilmartin. He provides the data you need without the bombast. Here is his current take, showing both continuing solid growth and which sectors are featured.
  3. In the absence of problems in #1 or #2, take advantage of market volatility with confidence, especially in beaten-down sectors.

And most importantly – Ignore the sources that make their profit by scaring you instead of helping!

Weighing the Week Ahead: Will Job Growth Sustain the Rally?

With the official end to summer, there are many topics for sunburned vacationers to consider as they settle in to their desks and boardrooms on Tuesday. Economic data has been mixed, but with a positive tilt. We learned the latest ideas from central bankers. There are assorted crises around the world. Somehow, in spite of it all, stocks showed a strong gain for August.

I expect the main topic from this will be the economic focus and Fed reaction. I expect financial media to be asking: What does the job picture mean – for the economy, financial markets, and the Fed?

Prior Theme Recap

In my last WTWA I expected that the news would focus on central bankers unwinding. That was indeed the dominant story, in spite of competing world events, but we got precious little new information. There will be some carry over from this theme in the week ahead.

Naturally 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.

San Francisco Appearance

I enjoyed meeting some readers and making new friends during last week’s San Francisco Money Show. As I warned before the trip, there was too much going on for me to write my regular weekly update. My stay ended with a wee-hours wake-up from the earthquake. You can really feel the effects when on the 17th floor of a hotel! Locals were joking the next morning, perhaps because the injuries and damage were mild given the size of the quake (biggest since 1987).

I plan to lay out some of the themes from my presentation in future posts, but it has been hectic catching up after the trip. More on that to come.

This Week’s Theme

In the holiday-shortened week ahead we have an avalanche of economic data and crises from around the world. Many different topics could command attention. Out of these choices, I expect special attention on employment data – more so than ever. Why?

The Jackson Hole Fed Symposium highlighted the continuing importance of the employment situation. Here are the key questions about economic growth:

Are the job gains enough to sustain (or improve?) the rate of economic growth? Looking beyond the gross numbers, is there enough improvement in full-time jobs? Is the quality of employment adequate?

Even if that hurdle is surmounted, there is the question of labor market slack. How much room is there to stimulate job creation without sparking inflation?

Fed Chair Yellen believes that better employment prospects will improve labor force participation, keeping wage pressures low. This is a “cyclical” view of the labor force participation decline. Only after the participation rate improves, will there be a need to consider emphasizing the Fed’s inflation goal rather than employment.

The alternative viewpoint, laid out thoroughly in this week’s Barron’s Cover story, Work’s for Squares, emphasizes structural causes. The argument focuses on those of prime working age, where the high post-WWII rates have been followed both by periods of decline and stability.

ON-BF883_CovLos_G_20140829223008

While there are many possible causes, one intriguing factor is the growth in disability. The causes are not the old-fashioned work injuries; in fact, the workplace is safer. Someone on disability does not get much income, but does (after a wait) receive Medicare. This is a financial disincentive for returning to work.

ON-BF882_CovDis_G_20140829222938

The article provides a good summary of data from various sources.

As usual, I have a few thoughts to help in sorting through these conflicting viewpoints. 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 important good news.

  • Q3 Growth on Track for 3%. The Atlanta Fed’s Macroblog provides evidence for this early and tentative conclusion.
  • Durable goods orders showed record growth. Scott Grannis understands that it was mostly about aircraft. He suggests that it shows strong confidence in travel. See his charts and analysis.
  • Consumer confidence hit a new high. Doug Short has the story on the Conference Board version, the Michigan version, and historical context for both. Ed Yardeni highlights the importance for the economy. Here is a key chart:

dshort consumer confidence

 

us-nonresidential-fixed-investment-quarterly-annualized-rate-us-nonresidential-fixed-investment-quarterly-annualized-rate_chartbuilder-3

The Bad

There was also some negative news.

  • Durable goods orders ex-transportation disappointed. Looking beyond the headline surge, many analysts immediately noted that aircraft orders were the whole story. Doug Short has a more comprehensive analysis, adjusting both for population and inflation in considering the long-term trend.
  • The Russian Economy is in Trouble. The Forbes story from Kenneth Rapoza lays out the problems. I am scoring this as “bad” because of the effects on the European economy. It is, of course, the intended result of the sanctions.
  • Bullish sentiment has spiked again — a contrarian indicator. Bespoke has the full analysis including this chart:

aaiibullbear

  • Personal income and spending missed expectations. This is a blow to hopes for better economic growth. Steven Hansen explores this angle while looking at some history.
  • New home sales declined. Calculated Risk notes that the data were OK if the revisions to prior months are included. (Analysis and charts here).

The Ugly

Our “ugly” list for the last few weeks remains unfortunately accurate. We had headline news from all conflicts with plenty of violence and death competing for our attention. The Ebola crisis, cited a few weeks ago, continues to worsen.

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. Nominations are welcome.

Quant Corner

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


Recent Expert Commentary on Recession Odds and Market Trends

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (almost three years after their recession call), you should be reading this carefully. Doug includes the most recent ECRI discussion, which has been consistently bearish, despite the blown call on the recession.

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. Dwaine’s “liquidity crunch” signal played out as projected. This week he highlights his HILO Breadth index which he has designed to pinpoint bottoms and to warn of protracted corrections. Current readings imply an opportunity that usually shows up only once a year. Check out the full post for a description and charts.

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg’s BCI index also shows no recession in sight. For those interested in hedging their large-cap exposure, Georg has unveiled a new system. Georg now has another new program, with ideas for minimum volatility stocks for tax-efficient returns. He also has new advice for those seeking a safe withdrawal rate, now featuring the use of put options to protect against extreme events.

The Week Ahead

We have a big week for economic data and events.

The “A List” includes the following:

  • Employment situation report (F). The most widely followed, despite the many angles and adjustments.
  • ISM Index (T). Good concurrent gauge of activity and employment in manufacturing.
  • Beige book (W). Anecdotal reports that will provide background color at the next Fed meeting.
  • Initial jobless claims (Th). The best concurrent news on employment trends.

The “B List” includes the following:

  • ISM Services (Th). A shorter series than the manufacturing version, but a bigger slice of the economy.
  • Auto sales (W). Truck sales reflect small business and construction.
  • ADP employment (Th). A good independent read on net job growth.
  • Trade balance (Th). Important element of GDP calculation.
  • Construction spending (T). July data.
  • Factory orders (W). July data, but an important economic sector.

Fed participants are back on the speaking circuit. Did you miss them?

Breaking news from Ukraine is also likely, but nearly impossible to handicap on a short-term basis.

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 switched to bullish last week and remains so. This had little effect on our trading accounts since nearly everything is in the penalty box. Uncertainty remains high – typical for a trading range market. Inverse ETFs were highly rated during this cycle but remained in the penalty box. This mean that Felix went to cash for a bit and also held bonds, but did not go short. The broad market ETFs are once again positive.

I frequently hear from young people looking for a trading job. Brett Steenbarger — PhD psychologist, author, trading coach, hedge fund consultant – is a great source for traders on all topics. His advice for those seeking trading jobs is first-rate: It is more than passion and desire! He provides some specifics on what to do and what to avoid, including how to build your credentials.

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 current “actionable investment advice” is summarized here. In addition, be sure to read this week’s final thought.

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 is not the same as “buy and hold.”

Here is our collection of great advice for this week:

The real “smart money” is looking past the obvious worries. The headlines and financial TV emphasize the scary stuff for the obvious reasons. Blackstone Advisor Byron Wein reports on a series of lunches he hosted, something he does every year. This is a good item to bookmark and review later as an example of how experienced investors use the “wall of worry.”

Many of the participants are well known and a number are billionaires. There are hedge fund managers, corporate leaders, activists, buyout specialists, real estate titans, private equity folk and venture capitalists, providing some diversity in terms of their daily activity. I am adding newcomers to lower the average age. The group was correctly positive during the past two summer sessions, so I was curious to see if their mood had changed with so much unrest around the world.

The answer is that the investors almost universally believed that all of the threatening geopolitical problems would somehow work themselves out favorably without significantly disturbing the United States economy or its financial markets.

“Google never forgets” writes Barry Ritholtz. The subject was CNBC’s feature of David Tice making (yet another) crash prediction. Barry notes his past history of such calls and the performance of his Prudent Bear fund.

I was delighted to get an email from a reader on this same theme. He pointed out the CNBC/Yahoo story citing two “experts” who were predicting a 60% crash. He did his research on both Tice and Abigail Doolittle discovering their past records. This reader is a former scientist who is amazed that the financial world does not provide accountability for cited sources. In the absence of a dramatic change in media behavior, only constant reminders will help people understand “that we are essentially just viewing or reading a more dangerous version of the National Enquirer.”

Google never forgets, but it should not be the responsibility of each reader to check every source.

 

Vitaliy Katsenelson has a good tale on an important subject for investors — confirmation bias. He explains how to make the best use of sources where you disagree with the conclusions.

My own worries. While on the subject of evidence and disconfirmation, I made a list of things that I was watching and what evidence would lead to less optimism about equities. I published it here as the Final Thought, and I keep it in mind.

If you are worried about possible market declines, you have plenty of company. 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

Is the decline in labor force participation structural or cyclical? I certainly cannot answer that question in the context of our weekly focus post, but I can suggest how to think about the problem.

  • Nothing in the Barron’s article would be a surprise to the Fed’s economists. They have looked at the data and reached a different conclusion.
  • There is a little truth in both arguments. Some who lost jobs have simply retired early. Others are restricted by underwater mortgages. Those who have taken temporary jobs or gone to school will react to a better job market.
  • This means that we should see at least some rebound in participation before wages really take off. As is the case with most economic arguments, changes do not come from flipping a light switch.

There is another important implication of this debate – one that we will see repeated for the next two or three years. Many have argued that the lack of any wage growth is a sign of a weak recovery and poor prospects for future consumption. If this finally starts to change, you can expect many of these same sources to warn about looming price increases.

It is more reasonable to expect an intervening period of improved economic growth and better wages. The Fed may eventually be too slow in changing course, but we’ll still be raising that question in a year or two.

Weighing the Week Ahead: Can Earnings Growth Reignite the Stock Rally?

To the surprise of many observers, stocks have survived a series of recent challenges. As Q214 earnings reports starts begin, the questions has changed:

Can strong corporate earnings spark a renewed rally in stocks?

Prior Theme Recap

Two weeks ago I expected that speculation about a market correction would dominate the time before earnings season began. This proved to be accurate, especially when assorted news items were linked to a market decline of more than 50 bps. It does not take much these days to get the financial media excited, e.g. The Dow is down triple digits!! Whoever happens to be on TV at the moment is asked to “explain” the decline.

Naturally 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 stock market has successfully shrugged off a series of recent challenges, including the following:

  • A Portuguese banking “crisis”;
  • A front-page New York Times story explaining that all investments are “expensive”;
  • A streak of weak economic data;
  • A series of geo-political concerns – Ukraine, Iraq, and Gaza.
  • Some advice on stocks from Fed Chair Janet Yellen. (See Steven Russolillo’s WSJ piece and Neil Irwin at The Upshot to get some grounding on this issue!)

Doug Short always captures the week in a single great chart. This one shows the resilience last week.

dshort market week

The chart would be even more dramatic if it included overnight futures trading on Thursday. Those of us sneaking a peek or two in the wee hours noted that futures were down “triple digits” on the Dow. More on that subject in this week’s Final Thought.

After surviving these various tests, it may be time to consider the upside. Will earnings growth be enough to propel stocks higher?

Barron’s cites “earnings based optimism” as the source of strength.

Eddy Elfenbein notes that estimates have come down less than we usually see, and also warns about the deviations in various earnings sources.

Brian Gilmartin confirms Eddy’s observation and also notes that we are seeing some revenue beats as well this quarter.

I am not seeing major sources projecting that earnings will be poor, but feel free to highlight such forecasts in the comments. I have some final thoughts, as usual, but focused more on world events than earnings.

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 important good news last week.

Beat Rate Q214

  • Yellen’s Congressional testimony was market-friendly. Reassuring and no missteps. Whether or not you agree with the plan, investors should take it for what it is. Here are four good takes on the story.
  • Health care spending cost forecasts are improving. The non-partisan CBO shows health care taking a lower share of GDP than projected a few years ago. Health policy remains a hot-button political issue. Everyone on all sides is either assigning blame or taking credit. As investors, we should be interested in facts – especially if worried about the budget deficit. Matthew Yglesias at Vox reviews data from a Brookings study. Here is a key chart:

15_cbo_budget_outlook_fig1-1

The CBO still sees the “risk of a fiscal crisis” without policy changes.

 

The Bad

The important economic news last week was mostly negative.

  • Industrial production missed expectations. Growth of 0.2% is disappointing.
  • Tax inversions will cost the US $20 billion in the next decade unless there is action. (Via WSJ).
  • Housing data missed badly. This included both housing starts and building permits. Calculated Risk is our favorite source on housing. Bill acknowledges the miss, but still sees the single-family data as consistent with his “broad bottom” thesis. To be fair, this has been his viewpoint for many months. He has plenty of good charts, but let’s focus on the bad news from this month:

Starts20132014June

 

ConSentPreJuly2014

The Ugly

The ongoing conflicts and resulting death and injuries. Whether terrorism or war, the issues seem intractable.

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 John Lounsbury at Econintersect for his careful and educational analysis of Japanese machinery orders. Your favorite doomer site (a happy hunting ground for those seeking to win the Silver Bullet) garnered plenty of attention and page views with the “Japocalypse” headline. It is so easy to take a volatile data series and pick a single point out of context. It is especially effective when many see Japan as a good analogy for issues in the US.

John Lounsbury looks at the complete data history, showing both the raw data reports as well as long and short-term trends. His charts tell the whole story, but here is the 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.

For another side of John, read his post on employer discrimination against Republicans. (If you have any questions about this one, please check the end of this article).

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

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis.

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 (2 ½ years after their recession call), you should be reading this carefully. Doug includes the most recent ECRI discussion, which has been consistently bearish, including the blown call on the recession. We included Doug’s chart of the Big Four last week, but data devotees should check it whenever there is a big release. It has now been updated for the employment data.

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg’s BCI index also shows no recession in sight. For those interested in hedging their large-cap exposure, Georg has unveiled a new system. Georg now has another new program, with ideas for minimum volatility stocks for tax-efficient returns. He also has new advice for those seeking a safe withdrawal rate.

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.” One of his conclusions is whether a month is “recession eligible.” His analysis shows that none of the next nine months could qualify. I respect this because Bob (whose career has been with banks and private clients) has been far more accurate than the high-profile TV pundits.

The National Association of Business Economists survey puts the odds of a recession in 2014 or 2015 at less than 10% (looking farther into the future than we find comfortable). They also see the date of the first Fed rate hike coming sooner.

 

The Week Ahead

We have a moderate week for economic data.

The “A List” includes the following:

  • Initial jobless claims (Th). The best concurrent news on employment trends.
  • CPI (T). Real concern about inflation is still not imminent, but the recent increase has attracted more attention and comment. Remember that the Fed is seeking an increase and also uses the PCE, which is still benign. If the measures diverge, it will become controversial, so I am promoting this to the “A list.”
  • New home sales (Th). Important driver of economic growth.

The “B List” includes the following:

  • Existing home sales (T). Less economic significance than new home sales, but still a good concurrent read on housing.
  • Durable goods (F). Bounce back in June data expected.

Earnings stories will dominate.

Events in any of the world hot spots could also command attention.

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 turned neutral with confidence reduced. Uncertainty remains high – typical for a trading range market. This week we were only partially invested in one or two of the top sectors for our trading accounts. That remains our position going into the week ahead, although some of the strength is outside of the US.

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 current “actionable investment advice” is summarized here. In addition, be sure to read this week’s final thought.

The market still did not provide the “dip to buy” sought by so many. The gentle upward action is fine for long-term investors and excellent for those trying out our Enhanced Yield approach. We added positions in stocks that represented good value with solid income from call premiums.

Here are some key themes and the best investment posts we saw last week.

Worried about a market top? Josh Brown provides a short lesson about market tops, comparing key points from the current situation with 2000 and 2007. As he often does, he hits the most important element of the difference, low interest rates and resulting private growth. Barry Ritholtz also has a column showing the huge extremes of investor behavior at market tops and bottoms. (Summary: We are not close yet).

Stock ideas? Some of our holdings have hit their price targets. Unlike some Wall Street analysts we adjust these regularly, not just when they are hit! This means we are always on the lookout for ideas. It is fine to do screening, but sometimes the quantitative rules do not tell the whole story. Here are two sources with some stocks worth considering. Do your own research, as we do.

Morgan Stanley – via Elena Holodny at Business Insider – ideas for the next 12 months.

Larry Robbins of Glenview Capital discussed holdings at ideas at the Delivering Alpha conference.

Portfolio management? Brian Gilmartin explains the role of bonds in adjusting your overall volatility. He illustrates with helpful data from Morningstar. I strongly agree with the idea of understanding and limiting risk. We use both our Bond Ladder and our Enhanced Yield programs to generate some return from the safer parts of the portfolio.

Avoid scams. Read about an FBI Pump-and-Dump scam to learn the signs.

Upside? Richard Bernstein Advisors (HT reader CS) has an interesting explanation for the high equity risk premium: uncertainty on the part of investors and corporations. He has data and charts to prove his point, concluding as follows:

RBA’s corporate motto is Uncertainty = OpportunitySM. Certainty implies risks not anticipated, and potential disappointment. Uncertainty, however, often suggests higher- than-normal risk premiums and investment opportunity.

A broad swath of data, whether focused on investors or corporations, continues to suggest meaningful uncertainty. Accordingly, we continue to believe this may be an elongated cycle that still offers unrecognized investment opportunities.


If you are worried about possible market declines, you have plenty of company. 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 expect next week’s theme to be earnings, but given current events it is also important to consider world events and risk. Josh Brown, after expressing concern for those suffering casualties, takes the role of the professional investment manager, writing as follows:

Suffice it to say that there is never any more or any less risk of geopolitical threat in the world – there are only changes in perception and the attention paid to the various threats, new and old, that have been with us since the dawn of time.

The notion that there is more uncertainty now than there was last month because of a plane being shot down in the Ukraine or an Israeli incursion into Gaza is both childish and ahistorical. Just because we choose not to be concerned with uncertainty at a given moment – like on September 10th, 2001 for example – that doesn’t mean an outbreak of violence or hostility is any less likely to occur.

So what we’re discussing here now is not a rise in uncertainty itself – but a rise in the awareness of that uncertainty and its subsequent effect on stock prices.

This is very good advice for the average investor, but let me add a few thoughts.

  • Many big world changes – end of the cold war, trade expansion, etc. – take longer and provide a longer recognition period. Cam Hui, who has recently been cautious, asks if this is a modern Archduke Ferdinand. Good question! Read his post.
  • Some events do provide new information. You need to know what to watch. In the current crises that meant chances for a direct military conflict between Russia and Europe or the US, sanctions on Russia that would affect the world economy, something in any conflict that would further increase oil prices.
  • If you know what to watch for, you wake up during the night and check news. For most investors, the specific news would not help.
  • Knee-jerk reactions are usually wrong. Investors who sold on Thursday probably did not get back in on Friday.

     

And most importantly —

If you were frightened about your investments last week, your stock positions are too big. You cannot react logically and effectively if you are paralyzed with fear.

[Final notes – The John Lounsbury piece on discrimination against Republicans is satire – a clever way to show the potential confusion between correlation and causation. I trust that most readers of “A Dash” did not need this help, but sometimes the political agenda gets in the way of clear thinking.

I will probably not write WTWA next weekend, but I hope to do some interim posting.]

Seasonality and the Tuesday Lesson

How should traders and investors take advantage of seasonal patterns?

There are so many opportunities for dividing the calendar!  This year, the best has been to go long on Tuesday.  Here is the 2014 summary from the Bespoke Team:

avg daily change day of the week1

 

You could have done even better if you had sold short on the other days of the week.

Issues

You might well be skeptical about this easy system.  When I offered it for comment to the Scutify community they suggested that there were not enough cases and that it did not make sense.   Market veteran Robert Marcin suggested that this pattern would quickly be learned by the market.  Monday buying would anticipate the Tuesday effect, and it would quickly disappear.

In fact, prior years have had different days as the best performers.

So far, so good.  There have been eighteen Tuesdays to establish and test a pattern.

  1. There was no a priori hypothesis
  2. There is no “out of sample” data that could be used for a test
  3. The results are “data mining” covering a specific time period.

Those who are skeptical are fully justified.  The pattern broke down last week.

Implications

Let us take the conclusions and find a new setting.  How about the Presidential Election cycle.  This is getting a lot of buzz as “experts” opine about why the second year of the second term should be bad.  How many cases are there?  If you wanted to get 18  (the same number for this year’s Tuesdays), you would need to go back 144 years.  Would that really be relevant?

We have better data on the “Tuesday effect” than we have on the oft-touted Presidential Election Cycle.

Most of those discussing seasonality violate all three of the points listed above.

Challenge for the Seasonality Crowd

Why hasn’t the market “learned” this behavior and adjusted?

Did any of those parroting “sell in May” advise you to “buy in October” last year?

[Note to readers.  I have had several suggestions about improving the blogging platform, the graphic images, and the ability to deal with comments.  While people have expressed appreciation about the content, they have requested a better platform.  This is a “test post” on my new site.  Comments are very welcome.  Send to main at newarc dot com. Please bear with me as I work out the kinks.  Thanks!]