Weighing the Week Ahead: Fed Chair, Tax Proposal, Data Avalanche, Earnings – A Pundit’s Paradise

There is so much on the calendar next week that it is impossible to choose a single theme. The economic calendar includes all the major reports. It is still the heart of earnings season. Announcements are expected about a new Fed Chair (and perhaps other appointments), the tax reform proposal, and Special Counsel Mueller’s first indictment. The actual Fed rate decision, often the major focus, is almost an afterthought.

It is a paradise for the punditry!

Last Week Recap

In the last edition of WTWA I guessed that there would be plenty of discussion about the lack of fear in markets. That was a reasonable guess as well as an interesting topic to consider. Evidence of the focus on fear came from Wealth Advisor, which teed up a week-old story featured earlier by Business Insider. I had bookmarked this last week for more complete attention, but I was alarmed by an email showing the most popular stories.

The original story was based on an interview with John Hussman who explains every week that the stock market is “overvalued, overbullish, and overbought.” He explains that Mr. Buffett does not really understand the relationship between stock prices and interest rates, and discusses the interest effect on future cash flows. This completely misses the Buffett point, which compares the attractiveness of various assets. A balanced story would have done a better job of explaining the Buffett viewpoint, but it is always popular to predict a 60% market crash.

Trivia question: When is the first time Dr. Hussman used the phrase “overvalued, overbullish, and overbought?” At some point he added “obscene.” Answer at the conclusion of today’s post. Hint: If you read the story on your mobile, you were using the iPhone 4!

The Story in One Chart

I always start my personal review of the week with a chart. This week I am using a chart of the S&P futures from Investing.com. If you visit the page, you can readily change chart style and time frame. The futures show you the overnight action as well as the trading during the day. The “N” indicators will show relevant news if you hover over them.

The change on the week was modest, as it has been in many prior weeks, but it adds up to another new record. Once again, notice that the volatility has been very low. The intra-week range was less than 1.5% and the weekly change only 60 bps. Those who believe that the VIX should be signaling more fear should realize that it has been anchored by the continuing low volatility in the underlying stocks.

Much of the gain was in the technology sector, which now constitutes 24.2% of the S&P 500. (Bespoke)

Eddy Elfenbein reports an amazing research result:

If you take all the days when the S&P 500 moved more than 1.14% in a day, up or down, the combined return comes out to zero. They completely balance each other out.

The entire return, more than 55-fold over 60 years, comes on the low-volatility days (up or down less than 1.14%).

Would you have guessed that?

The News

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

The economic news has been mostly positive. 

The Good

  • Rail traffic is strong. Steven Hansen (GEI) provides the supporting evidence.


  • Durable goods increased 2.2%, handily beating expectations.
  • Earnings beat rate is 76%. The revenue beat rate of 67% is also above historical averages. The blended earnings rate is less encouraging, with a drag from insurance companies. The market is also reacting less to the strong reports and to earnings misses. (FactSet). Brian Gilmartin notes the continuing strength in forward estimates, musing on the possible tax cut effect. He wonders whether 2018’s earnings estimate might rise from $145.69 to $150.
  • New home sales registered 667K on the SAAR, handily beating expectations. Calculated Risk provides analysis about the “Harvey rebound.”
  • Michigan sentiment remains favorable. Jill Mislinski has my favorite chart on this topic, pulling together all the relevant themes.



The Bad


  • Pending home sales hit a three-year low. (Diana Olick). She reports that low supply remains a problem.

Following Up

Last week some readers were skeptical about the poll I cited showing pollution concerns. Statista’s data from The Lancet and NPR shows the overall deaths from pollution.


 

Similarly, Barry Ritholtz cites a powerful study discussing economic and other effects of climate change. He has little patience for climate change deniers. I’ll just suggest doing a lot of reading before making up your mind.

Methods used to estimate the potential economic effects of climate change in the United States—using linked climate science and economics models—are based on developing research. The methods and the studies that use them produce imprecise results because of modeling and other limitations but can convey insight into potential climate damages across sectors in the United States.

The Ugly

A possible pandemic? The IMF is tracking some early indicators and improving preparations, including a simulation at their last meeting.

The Week Ahead

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

The Calendar

We have a massive economic data calendar. As usual, the employment report will claim the featured spot, but wait — there’s more. Both ISM reports, personal income, and auto sales are very important. There are several others that are less significant only by comparison.

It would be easier to say that I am interested in everything on this list, while most should focus on the items I listed above.

Briefing.com has a good U.S. economic calendar for the week (and many other good features which I monitor each day). Here are the main U.S. releases.


Next Week’s Theme

In addition to the big economic calendar, we have expected announcements on appointments, tax proposals, indictments. The Fed will announce a decision on rates. Earnings season is in full swing. I have gone out on a limb before in predicting the likely theme for the week, but this time it is impossible!

After the recent weeks without much solid, fresh news, there is a plethora. We should expect A paradise for pundits!

It is natural to expect a volatility spike from so much news in so little time. Perhaps. But oftentimes the results are expected, or one offsets another. Here is the short list of items to consider, with disparate viewpoints on each

  • Political
    • Fed chair announcement – with Powell in the lead over Yellen and Taylor.
    • Other Fed appointments – might include Taylor to balance Powell.
    • Tax reform proposal.
    • Special Counsel Mueller’s first indictment(s).
  • Economic
    • Most data reports have been stronger. Will this continue? Especially in employment?
    • Some have disparaged what they call “soft” data. Will that continue?
  • Earnings
    • Overall strength has been solid.
    • Sector variation has been important, and will keep the spotlight.
    • Reduced guidance is getting stern market punishment. Many are looking for reasons to sell.
  • Fed decision – No one is expecting a rate change, so the focus will be on the statement.

As usual, I’ll have more in the Final Thought, where I always emphasize my own conclusions. In this case, it includes what I see as most important.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot


 

The Featured Sources:

 

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

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

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

Georg Vrba: Business cycle indicator and market timing tools. It is a good time to show the chart with the business cycle indicator.

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

Guest Sources:

Steven Hansen looks at employment data, wondering whether the tables based upon education are most helpful. He notes that 100 million of the 125 million non-farm jobs are non-supervisory. Many times, the job requirements include credentialism versus actual needs. He makes an interesting argument that many can do better financially without a college education.

 

Insight for Traders

We have not quit our discussion of trading ideas. The weekly Stock Exchange column is bigger and better than ever. We combine links to trading articles, topical themes, and ideas from our trading models. This week’s post compared trading and investing with a focus on Bitcoin. Just for fun, we also added Bitcoin to the ratings list for Felix and Oscar. Blue Harbinger has taken the lead role on this post, using information from me and from the models. He is doing a great job.

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Urban Carmel’s series (Two parts for now) on investor psychology. The first segment looks at how data framing in charts affects perception. Here is a chart of the S&P 500 the way it is often presented.

And how it looks on a log scale (which is necessary to make percentage changes over time equivalent) and also with an adjustment for inflation.

 

Part Two explains why following the stock market is bad for your returns. He writes as follows:

The human mind has a tendency to assess risk based on prominent events that are easily remembered. The 1987 crash, the tech bubble, the financial crisis and the flash crash in 2010 are all events that are easily recalled. The mind automatically assigns a high probability to prominent (but rare) events. It ignores the more important “base rate” probability that better informs decisions. The fact that the stock market rises in 76% of all years, that it gains an average of 7.5% per year and that annual falls greater than 20% occur less than 5% of the time, are ignored in decision making. The mind interprets every 10% correction as the beginning of something much worse, even though a 10% fall is a typical, annual occurrence during bull markets.

The overall analysis is excellent, including plenty of charts for your consideration.

Stock Ideas

I always try to illustrate methods of analysis as well as stock ideas. I do not always hold the positions mentioned, but I regard the idea and analysis worthy of consideration. With eight different investment programs, we have an extensive watch list. That is what I am trying to share.

Value Investing

Chuck Carnevale is the leading resource in this method. His tools are invaluable and inexpensive. His regular (free) articles provide a wealth of ideas as well as a master class in how to evaluate a stock. We never take on a new This week there are two great examples. First, he continues his series on the DJIA with a look at five fairly-valued names. Take time to study the method and check back on the prior entries which you might have missed.

And also, Celgene (CELG) still looks good, even after the reduction in earnings expectations.

Market Maker Hedging

Peter F. Way’s unique approach takes another look at IBM, especially considering the institutional ownership of the stock and market maker hedging. The market maker’s position is temporary, reflecting a professional judgment about how far the stock might move – in either direction.

Finding a Niche

Strong Bio (the work of a multiple PhD analyst) takes a careful look at Cara Therapeutics and analyzes their niche—pain management and pruritic. This may be especially interesting as an approach to dealing with the opioid epidemic.

Focus on Income

Blue Harbinger continues his focus on income with a review of preferred stocks and also some put sales in selected names. This method can work very well with sound stock selection and proper size.

Kirk Spano (endorsed by Mrs. OldProf because he is a Packer fan) combines the covered put approach with an analysis of energy and solar, recommending SunPower (SPWR). I urge readers to follow his advice that you should sell puts only when you are willing to buy the stock at the indicated price.

Assets Versus Currencies

Leading valuation expert Aswath Damodaran begins with an analysis of bitcoin. He uses this as a basis for explaining the differences between assets, commodities, currencies and collectibles. This is a great post, which most people will need to read twice. He also shows why bitcoin is a trading vehicle, not for investors. Here are the key distinctions:


Consistent with this attention to investing versus trading, I was especially interested in John Rhodes’ idea about Bitcoin miners. This would seem to be an asset rather than a currency. He ends by rejecting MGT Capital Investments (MGTI), but the concept is worth watching. I usually prefer buying gold mining stocks rather than the metal.

 

Combining Technical Analysis with Dividends

Bonddad looks carefully at the attractions of Kimberly Clark. While there is an emphasis on dividends, fans of technical analysis will not be disappointed.

Sell-Side Recommendations

Morgan Stanley thinks that Broadcom is undervalued. (Paul Farrell, Barron’s)

And maybe biotech is a bargain (Barron’s).

Personal Finance

 

Seeking Alpha Senior Editor Gil Weinreich has an interesting topic every day. His own commentary adds insight and ties together key current articles. As usual this week he had several good articles, but my favorite this week discusses the timing of negative investment returns. It is a good explanation of the concern, but the answers are more complicated than the sources suggest.

The CBO (via GEI) has some good analysis on retirement needs. One reason I regularly read GEI is John Lounsbury’s widespread search for ideas and articles.

Tadas is back on the job with his regular Wednesday post on personal finance. My favorite this week is some solid advice on what to do if you know that your credit report has been compromised.

Value Investing

The balance between value and growth is once again tilting toward the latter. Does recent history provide evidence for the future?

James Picerno provides analysis and this interesting chart.


This was a week for the high-profile tech stocks, where the earnings and other metrics were celebrated.

David Van Knapp emphasizes that there are many ways to achieve investing success. Developing a process and sticking with it is the key. No method will be the best in each quarter. David’s well-reasoned article is a must-read piece regardless of your approach. Right now, it has special relevance for dividend and value investors.

Watch out for….

Lockheed Martin (LMT). Stone Fox Capital looks carefully at whether current values are justified.

Stone Fox Capital also warns about Sprint (S), especially if the planned merger does not come off.

 

Final Thoughts

I have my own expectations on each of the key question, including which are more important.

  • Political
    • The Fed Chair appointment will not matter much if it is Powell or Yellen. Anyone else will get a reaction.
    • Other appointments are fine if they are mainstream. A single exception will not matter much. The addition of a hard money, non-economist like Judy Shelton would attract a lot of attention. It would also be a good dissertation topic for some student.
    • The tax reform proposal will get plenty of buzz, including analyses of who would benefit. It is irrelevant, a mere step along the path to finding a centrist majority. Current market levels reflect little if any “Trump effect” despite the constant media chorus on this facile theme.
    • The original indictments are this week’s wild card. Will a Trump relative be included? How might the President respond? (Roll Call)
  • Economic – I expect the economic news to be solid, but perhaps affected by weather.
  • Earnings – expectations in most sectors have been beaten by more than the historical average levels.
  • Fed – I expect nothing from a policy change and little from the statement. I expect a rate hike in December and three more next year. This week’s Barron’s cites the Eurodollar market as implying two hikes in this time period. Eurodollars are futures based upon Libor at a specified future date. Many casual observers confuse this with the Euro currency market, which is quite different. Eurodollar trading is a deep and liquid market, where one can construct a trade for any point on the yield curve.

There is plenty to watch this week. As usual, understanding the schedule and expectations will help you navigate the waters.

What worries me…

  • Mueller indictments and President Trump’s response. If a Trump family member is included and the President fires Mueller, the Nixon-era Saturday Night Massacre comparisons will get headlines. N.B., I refer not to the substance of the issue, but to the market reaction.
  • Government computers. We all have a sense of dilapidated infrastructure in roads and bridges. Decades of cuts in government spending have had many under-the-radar effects. As a former government employee, I know how hard it was to get a new computer in a timely fashion. Put his together with recent news on hacking, and you will understand my concern.

…and what doesn’t

  • The Fed. We are still more than a year away from when changes in Fed policy will be important for stocks, despite the popular focus on this topic. It also does not matter (in the short run) whom President Trump selects to be the new Fed Chair, or his other appointments.
  • Low VIX readings. The so-called “fear gauge” is low because actual trading volatility is low.

Trivia question answer

The earliest time I could find was October of 2010. Reader corrections are welcome. That was the year of the BP oil spill and the OldProf’s Dow 20K call. I am still waiting for Dr. Hussman to respond to my post about his ever-changing chart. Many follow the conclusions from this chart; they understand Hussman’s point; but no one seems able to understand or replicate it. It keeps changing when prior forecasts did not work. It would help if, like Dr. Shiller, he shared his data and process with other investigators.

If I had been so wrong about something for so long, I would be taking a hard look at my methods. Instead of quoting ZH, I might be bringing in a few astute critics as consultants. Calling out Warren Buffett would be low on my list, although once you have blamed your own missed forecasts on the Fed, what is left?

Stock Exchange: Do Not Invest In Bitcoin, Trade It!

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

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

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some ideas, please join in!

Review:

Our previous Stock Exchange asked: Are Momentum Trades Better Than Dip Buying? If you missed it, a glance at your news feed will show that the key points remain relevant. One takeaway from last week’s Stock Exchange was that a particular trading style works great, until all of a sudden it doesn’t. Dr. Brett Steenbarger likens this phenomenon to a strong tree that may crack when it gets windy, versus a bamboo or willow that survives by bending with the wind. There is a distinct regime in the current market. And when the momentum trade finally cracks, will you bend like a willow or crack right along with it?

This Week: Do Not Invest In Bitcoin, Trade It!

If you have strong valuation skills, you’re probably a horrible trader. That’s the common knowledge among many successful trading circles. For example, Renaissance Technologies, one of the most successful systematic trading firms of all time, “avoids hiring anyone with even the slightest whiff of Wall Street bona fides” (i.e. they prefer to hire mathematicians, physicists, and statisticians, for example). Similarly, Steve Cohen’s Point72 likes to hire people with non-finance backgrounds such as history and music.

Image source

Professor Aswath Damodaran (from the Stern School of Business at NYU) offers some invaluable insight into why traditional backgrounds in valuation don’t necessarily lend themselves to trading, in this article on Bitcoin: The Bitcoin Boom: Asset, Currency, Commodity or Collectible? Professor Damodaran explains that Bitcoin is not an income-generating asset that can be valued, but rather Bitcoin has characteristics of a currency that can only be priced. And as shown in the following table from Professor Damodaran, pricing means everything to traders, whereas valuation is often irrelevant to them.

Sticking with the Bitcoin trading theme, trader JC Parets points out an amazing pattern to Bitcoin pricing in this article: Fibonacci Analysis On Bitcoin. Specifically, Parets notes Bitcoin pricing has been following the Fibonacci Sequence “so perfectly that it’s hard for some to believe that this is simply normal behavior.” The Fibonacci Sequence is a mathematical phenomenon that has nothing to do with valuation, but has historically demonstrated itself relevant for traders with regard to pricing.

And for those of you with a background in long-term investing, not trading, Blue Harbinger offers five current ideas on how to place trades that fit your style in this article (hint: they’re all income-generating put option sales on attractive stocks that he believes are trading below their long-term value, meaning you keep the premium income generated for selling the puts no matter what, and if the shares happen to get put to you then you’re happy to pick them up at an even lower price).

Expert Picks from the Models:

This week’s Stock Exchange is being edited by Blue Harbinger (aka Mark Hines). And this week, we’ve included Bitcoin in a couple of our momentum model rankings (e.g. Felix and Oscar) to see how the cryptocurrency matches up against other trading opportunities within a particular universe.

Holmes: This week I bought Sally Beauty Holdings (SBH). Are you familiar with this company?

Blue Harbinger: Well, I know Sally Beauty is a specialty retailer and distributor of professional beauty supplies, but I am not a customer. They do hair care and color, nails, skin, accessories.

Holmes: Well the stock’s dip over the last month is the sort of set up I like to see. From the chart below you can see it is below its 50-day and 200-day moving averages. And it has attractive upside over the next six weeks.

BH: Interesting pick Holmes. I have mixed feelings on this one. On one hand, Sally Beauty is a retailer located in shopping malls. People aren’t going to malls so much anymore because service stinks (in my opinion) and it’s easier to just buy stuff online. I believe comps have been mostly flat for Sally Beauty. But on the other hand, Sally Beauty still generates a lot of revenue and it’s consistently profitable. The contrarian in me likes to buy stocks that are out of favor. This stock’s price has essentially been cut in half since early 2016. For some fundamental perspective, here is a look at Chuck Carnevale’s very useful FastGraph.

Holmes: I am happy you’re considering the fundamentals, Blue Harbinger. But I am a trader, and my typical holding period is about 6-weeks, so I’ll be in and out of this one before the long-term valuation story plays out. I am attracted by the current price (i.e. it has upside).

BH: Tell us a little more about your trading style, Holmes.

Holmes: My style is based on dip buying and mean reversion. I’m really into protecting assets too. My process drastically reduces vulnerability to drawdowns while attempting to stay invested for the longest possible period of time. I use a mix of advanced trading techniques (including profit taking, stops, and trailing stops) and technical analysis to help protect if the stock price starts to fall too far.

BH: Like I mentioned, I see positives and negatives to this one. But I’ve been doing this Stock Exchange with you for several months now, and I see the success you’ve been having, even in our current momentum driven market. Let’s check back on this one in about 6-weeks (i.e. your typical holding period).

Holmes: Fine by me. How about you RoadRunner, what have you got this week?

RoadRunner: I like Netflix (NFLX) this week. As you know, I like to buy stocks that are at the bottom of a rising channel, and if you look at the chart below you can see why I like Netfix.

BH: In this momentum-driven market, I can see Netflix going higher, and I like your strategy of buying at the lower end of a rising channel. How long do you plan to hold Netflix?

RR: My typical holding period is about 4-weeks.

BH: Netflix recently posted another strong quarter of subscriber growth and revenues. Plus they plan to increase the price of subscriptions, and that may be a good sign (depending on how it works out) because according to Warren Buffett “the single most important decision in evaluating a business is pricing power.” Also, for your reference, here is a look at Netflix FastGraph.

RR: Thank you for sharing that fundamental information, but I am a trader. I’m most concerned with the current price versus where it will be in four weeks.

BH: I acknowledged I like your dip-buying within a rising channel strategy, but what are you going to do when the momentum trade stops working? Are you going to crack, or are you going to bend like a bamboo or a willow?

RR: I don’t let your touchy-feely fear tactics scare me. I have discipline, and I stick to my strategy. Besides, when combined with the strategies of some of the other traders (Holmes, for example), we deliver strong returns with a lower correlation to the market, so the big market shift you keep warning about is interesting, but we are ready.

BH: If you say so RoadRunner. Your approach has been performing extremely well lately, and I appreciate that. How about you, Felix, what have you got this week?

Felix: I’ve got a real treat for you this week. The following list is my top ranked Nasdaq 100 stocks, and I’ve added the Bitcoin Investment Trust (GBTC) to the universe because I heard you talking about it earlier. And compared to the most attractive Nasdaq 100 stocks, Bitcoin is even more attractive!

BH: Now that is interesting, Felix. I see you have some semiconductor stocks like Nvidia (NVDA), Micron (MU) and even Broadcom (AVGO) on your list of top ranked Nasdaq 100 stocks, but you like Bitcoin even more. Remind us, what is your process?

Felix: I am a momentum trader, as you might have guessed because my top ranked ideas have all been performing very well lately. I hold things longer than the other traders, 66 weeks on average. I exit when my price target is reached, and I control risk by monitoring macro factors and using stops.

BH: Honestly, I don’t know a lot about the cryptocurrency, Felix. Except that the talking heads and media pundits won’t shut up about it. Based on the price performance chart we shared earlier, I can say that Bitcoin is scary. And I have no idea how to value it because it doesn’t pay dividends or even produce any income.

Felix: You don’t “invest” in Bitcoin, you trade it! Didn’t you learn anything from Professor Damodaran’s table earlier in this report?

BH: Great, thanks Felix. How about you Oscar, did you look at Bitcoin this week?

Oscar: I did look at Bitcoin. I added it to my universe of US and emerging market ETFs, and as you can see in the following ranking, Bitcoin ranks at the very top (i.e. it’s very attractive).

BH: And what is your selection process Oscar?

Oscar: I am also a momentum trader, but my average holding period is typically about 6-weeks. I rotate into another sector when it’s time to exit, and I also use stops to conrol risk.

BH: I do find it interesting that Bitcoin ranks so highly in both you and Felix’s models, but I suppose I shouldn’t be surprised considering the current momentum-based market envirnment.

Conclusion:

Momentum trades continue to work very well. One such example is the Bitcoin Investment Trust as discussed in this article. However, it’s important to recognize that Bitcoin is not an income-producing investment asset that can be valued. It’s a cryptocurrency that can be traded based on its price. And Bitcoin’s dramatically climbing price is not inconsistent with the favorable momentum trading envirnoment we are currently in. However, market conditions can persist for a long time, but then suddenly change with the wind. And when the wind blows, will your trading profits crack like a strong tree, or will you be ready to bend with the wind like a bamboo or a willow?

Stock Exchange Character Guide:

Background on the Stock Exchange:

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

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

Getting Updates:

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

Weighing the Week Ahead: Where is the Fear?

With a light economic calendar, there is plenty of air time for pundit pontification. The record-setting market still has many shaking their heads. Many, after noting the many world problems, are asking:

Where is the fear?

Last Week Recap

My last edition of WTWA (two weeks ago) asked whether earnings season could spark a big rally. That was a pretty good topic to consider over the last two weeks. (And it is still quite relevant).

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. She notes the gain of 0.86% on the week, as well as other key comparisons. Once again, it was a week of very low volatility.

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

Personal Note

Mrs. OldProf and I enjoyed our weekend away, and she thanks readers for the birthday good wishes. The only bad news for her was the loss of one of her favorite football players (second only to Jordy). When we got back, my calendar included a webinar featured by Brighttalk, which readers might enjoy.


If you missed my “Monty Hall” post, you might want to check it out. I cite some modern applications of the classic three-door problem.

The News

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

The economic news has been mostly positive. 

The Good

  • Industrial production rebounded from last month’s decline to a gain of 0.3%, beating expectations.
  • Corporate earnings have been solid, with 76% of S&P 500 companies beating expectations. (Factset).
  • Conference calls have been positive. Avondale has detailed notes. Corbin Perception also notes strength in industrial sentiment. More than half regard industrial equities as fairly valued, with “overvalued” declining. Tax reform or infrastructure spending are not priced into the market.

  • Philly Fed
    index of 27.9 rose significantly from last month’s 23.8
  • Existing home sales registered a slight beat of expectations with an annual rate of 5.39 million. Calculated Risk treats anything over 5 million as “solid.”
  • Jobless claims declined to 222K. (Bespoke) New Deal Democrat’s hurricane adjustments for this series have proved accurate.


 

The Bad

  • Housing starts declined to a seasonally adjusted annual rate of 1127K, a decline from August and a miss of the expected 1160K. (Calculated Risk).
  • Leading indicators declined 0.2% after last month’s gain of 0.4%, missing expectations by 0.3%.

 

The Ugly

The 1987 market crash and allegations that 2017 is similar. LPL Research has a nice explanation of the differences, including the charts below. The first is a version of one popular among those who want to make sure you are scared witless. The second uses percentage changes for a valid comparison.



A Chuckle

Charlie Bilello makes creative changes in some classic market slogans. Here are the first few “Aphorisms in the Year of the Bull”:

Buy in May and Stay Leveraged Long

Buy the Rumor, Buy the News

Buy the Dip, Buy the Rip

Be Greedy When Others Are Greedy

 

The Week Ahead

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

The Calendar

We have a fairly light week for economic data, featuring new home sales and the first report on Q3 GDP. Earnings season continues in full swing. And of course, we do not know what Twitter will bring us, but we can be confident that it will be something!

Briefing.com has a good U.S. economic calendar for the week (and many other good features which I monitor each day). Here are the main U.S. releases.


Next Week’s Theme

This week features a pretty light economic calendar. This always provides extra time for pundit pontification. Record-setting markets get daily attention, but it requires little time to take note of the new high. Attention quickly turns to questions about when the rally might end and what could be the spark. Most important of all might be investor attitudes.

Expect the punditry to be asking:

Where is the fear?

Statista cites the biggest current fears.


 

  • Stocks are wildly overpriced – little future and crash potential. There is no fear among complacent investors.
  • Stocks will decline, but….there might be a melt-up first. (I’m seeing this carefully hedged prediction more often).
  • Nobel Prize winners do not understand current stock prices. (see Tim Duy below).
  • Stock prices have increased in line with increased earnings (Brian Gilmartin) and economic confidence (which encourages a higher multiple). Bloomberg.

 

As usual, I’ll have more in the Final Thought, where I always emphasize my own conclusions.

Quant Corner

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

Risk Analysis

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

The Indicator Snapshot


 

The Featured Sources:

 

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

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

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

Georg Vrba: Business cycle indicator and market timing tools. It is a good time to show the chart with the business cycle indicator.

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

Guest Sources:

Seeking Alpha Editor Mike Taylor highlights a strong academic report on recession forecasting. In a phrase, the yield curve does better than the stock market when looking at a lead time of more than two quarters. This is supportive of our methods, and shows why economic indicators do better than the market.

 

Insight for Traders

We have not quit our discussion of trading ideas. The weekly Stock Exchange column is bigger and better than ever. We combine links to trading articles, topical themes, and ideas from our trading models. This week’s post compared momentum and dip-buying methods, with several interesting trading ideas. Blue Harbinger has taken the lead role on this post, using information from me and from the models. He is doing a great job.

Insight for Investors

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

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Tim Duy’s analysis of “newly minted” Nobel laureate Richard Thaler’s take on risk and the stock market. Prof. Thaler, while not “understanding it” believes that we are in the “riskiest moment of our lives” while the stock market is napping. Prof. Duy notes the many past historical risks, including, for example, the Cuban missile crisis. He also cites the record of another Nobel Prize winner and acclaimed expert on bubbles, Prof. Shiller.

 

Ex-Prof. Miller agrees with Tim Duy. The well-deserved Nobel prizes do not imply expertise on everything, apparently including the Wall of Worry concept.

Stock Ideas

 

Stone Fox Capital explains how to analyze IBM. Hint: Drop the focus on the revenue decline.

Gold? A China play? The “mad hedge fund trader” explains.

Blue Harbinger provides some careful analysis in support of his recommendation of Triton International (TRTN). Take a look at his deep dive into the business model as well as the strong (4.7%) dividend.

Chuck Carnevale continues his discussion of Dow stocks with an analysis of several that he regards as “fairly valued.” Those in the “bubble” camp, should be taking a careful look at this series. It illustrates how a sophisticated analyst can discover value in a market at all-time highs.

Total return ideas for 2018 (from Merrill via 24/7).

Lessons from Trading

We frequently feature Dr. Brett Steenbarger when we talk trading. He is the leading expert on psychology, performance, and many other related topics. His conclusions for traders are often quite apt for investors as well. Consider this week’s post on trader mistakes. It describes many investors as well.

The one refrain I’ve heard from those active traders over the past two years is:  this is going to turn around.  Stocks are too expensive.  Rates are too low.  Volatility is too cheap.  Everyone wants to catch the turn and profit from the break.  So stocks dip, VIX bounces, put/call ratios go to the moon, and the trends continue.  Moderate growth with modest inflation and low interest rates that make stocks a desirable carry instrument mean that SPY has ground higher and vol has ground lower.

Traders’ forecasts for reversals in stocks and vol have had more of a psychological grounding than a logical one.  Hope is not a business plan and it’s not an edge in markets.

Dividend stocks

David Fish has a nice update on the dividend increases from the “champion” group. He also has related updates for challengers and contenders. For those seeking a consistent stream of dividend income, this is a great source to follow.

The Next Big Thing

How is value created over time? “Davidson” via Todd Sullivan provides both theory and some examples.

 But, how does one forecast inventions such as the iPhone, the Internet, a cure for Hepatitis C or preventative for HIV which force forecasters to revise all their previous assumptions of earlier forecasts. How does one forecast the future of markets if one never anticipated such evolutionary discoveries? The answer lays in not trying to predict the details of the ‘next great discovery’ but resides in understanding how individuals and society thinks and behaves.

 One begins by identifying how value is created over time. Once one delves into the process of value creation, it forces one to conclude that value occurs when producers successfully meet the needs of society’s relentless desire to improve its standard of living.

Big winners from autonomous driving, and what is blocking the way. (24/7)

Morningstar takes a look at stocks in their Exponential Technologies Index. They cite important themes, rapidly growing technologies, and motes. That said, the resulting names are speculative.

Identifying the “next big thing” before it takes off takes a lot of skill, a little luck, and a leap of faith. After all, if you wait until a new product or technology is flying off the shelves, investors’ optimistic expectations of future growth are likely already reflected in the stock’s price.

Here are some current ideas, which include choices that will surprise many.


Personal Finance

 

Seeking Alpha Senior Editor Gil Weinreich has an interesting topic every day. His own commentary adds insight and ties together key current articles. As usual this week he had several good articles, but my favorite is his post about whether people should work longer before retirement. Gil emphasizes the help this provides for retirement expenses, and that is important to consider. I would add that enjoying your work is crucial. Some would like to continue, but with fewer hours. Others might find things they always wanted to do, and which provide a little extra income. This is really a great topic.

Tadas took a well-deserved vacation. As usual,
Abnormal Returns featured some interesting questions with answers from financial bloggers. They are all well worth reading. This is information that is useful, but difficult to get in any other way. I always enjoy reading the answers from colleagues and reconsidering my own. I am a little disappointed in the answers to “changing minds.” Many of the participants have been wrong about both methods and results. Maybe they should be doing some re-examination. Consider the answers to the Buffett bet question. If you do not think you can improve on an index fund, you must take a hard look at the value of your service. Mr. Buffett himself says that if markets were efficient, he would be on a street corner selling pencils from a tin cup. He would take his own bet! Eddy Elfenbein highlights some key answers.

 

Watch out for….

Nvidia (NVDA). Great company. Brilliant execution of strategy. A great company does not always make a great stock. Price is important. (Dividend Sensei).

 

Final Thoughts

 

There are several errors in the mainstream analysis of fear.

  • Just because the market has low volatility does not mean that investors are complacent. The market does not consist of a single, uninterested investor or trader. It is the result of millions of decisions, reflecting a range of viewpoints and objectives.
  • Asset prices of stocks are reasonable if you look at the premium of expected returns over inflation.
  • There are many frightened investors on the sidelines.
  • So many assume that a long business cycle must mean we are near the end. Wrong! No one knows how much longer it might last.

There is a lot of lightweight analysis and it is all very popular. It caters to popular conceptions of economics, markets, and experts. The challenge for investors is to look at evidence in an open-minded fashion.

What worries me…

  • The number of ETFs and the lack of liquidity in many.
  • Excessive speed. Faster communications and a shortened news cycle seem fine in principle, but too many decisions of all types are made impulsively.

…and what doesn’t

  • The Fed. We are still more than a year away from when changes in Fed policy will be important for stocks, despite the popular focus on this topic. It also does not matter (in the short run) whom President Trump selects to be the new Fed Chair, or his other appointments.
  • Low VIX readings. The so-called “fear gauge” is low because actual trading volatility is low.