Weighing the Week Ahead: Time to Search for Bargains?

As the market averages reach new highs, there is a sharp divergence in advice. While we digest last week's economic news and wait for earnings reports, I expect a new theme this week.

How should you react to new market highs and first-quarter trends in various sectors? Should you reduce exposure, expecting a sharp correction? Or should you shop for bargains among sectors and stocks that have lagged in performance?

As he does so often, Eddy Elfenbein provides a savvy summary of recent events and focuses on the key question:

"Let me give you the briefest summation of Wall Street over the last six months: Investors worry about something that's unlikely to happen, the financial media amplifies said worry, calming voices are ignored, the markets trends downward, the financial media then calls for civility and public-spiritedness to address the needless worry they just promoted, incredibly the world doesn't end, the worries fade away, volatility falls and the market quietly rallies.

We've repeated this dance so many times I'm beginning to lose count. There was the Fiscal Cliff, the debt ceiling (remember the $1-trillion coin), the elections in Italy, the fiasco in Cyprus and the Great Rotation out of bonds."

Eddy takes note of the recent market shift into defensive stocks and away from gold and risk. He is expecting more of the same. (His article also includes some great stock ideas).

Michael Santoli writes about the "grandma stocks" and how investors have moved into stocks that look like bonds.

There are at least three choices:

  1. Sell in May (a topic we covered last week, Signs of another Economic Soft Patch?).
  2. Be defensive with grandma stocks and bonds.
  3. Look for bargains in lagging sectors.

There are advocates for each. I have some thoughts which I'll report in the conclusion.  First, let us do our regular update of last week's news and data.

Background on "Weighing the Week Ahead"

There are many good lists of upcoming events.  One source I regularly follow is the weekly calendar from Investing.com. For best results you need to select the date range from the calendar displayed on the site. You will be rewarded with a comprehensive list of data and events from all over the world. It takes a little practice, but it is worth it.

In contrast, I highlight a smaller group of events.  My theme is an expert guess about what we will be watching on TV and reading in the mainstream media.  It is a focus on what I think is important for my trading and client portfolios.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.

Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!


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

This was a generally negative week, but there were a few bright spots.

  • Some movement toward a budget compromise by Obama. Few understand the various inflation measures and therefore do not grasp the significance of changing to a chained-CPI method for Social Security benefit increases. The simple version is that it represents a big future cut without reducing current defined benefits. The change is hated by key Democratic groups and senior citizens. (see The Hill). Presidential second-term behavior sometimes encourages compromise. Many with a political agenda predicted a more partisan Obama after the election. It seems that the jury is still out. Here is a good account of the issue —- from NPR!
  • Auto sales were good and mortgage delinquency down. Daniel Gross suggests looking at these as fundamental factors. (The data on sales were pretty much in line with expectations – "solid start to the year" via Calculated Risk).
  • Construction spending was up 1.2% (February data over January, seasonally adjusted). It is even better if you focus on private construction, since public construction has been a drag for four years – excellent analysis and this chart from Calculated Risk:

ConstructionSpendYoYFeb2013


The Bad

The economic news was mostly negative this week.

  • Initial jobless claims spiked to 385,000. There could be some effects from the Good Friday holiday, since the varying date is challenging for seasonal adjustments (via Scott Grannis).
  • ISM Manufacturing declined to 51.3, a disappointing drop of 2.9 from February. The ISM sees this level as indicative of a 2.8% GDP, but the relationship they use seems to have overstated the GDP level recently. Another good research project for someone. Read the comments for a little more color. Scott Grannis charts the relationship and offers further analysis:

NAPM vs GDP


  • ISM Services dropped to 54.4, down 1.6 from February. Steven Hansen of GEI focuses on two important subcomponents, helping us to navigate this noisy series.
  • Employment is weaker – no matter how you measure it. The official BLS report of a net addition of 88K jobs was far below most estimates (although I suggested some warning signs in my monthly preview). The labor force declined by 500K workers, giving an artificial improvement to the unemployment rate. Prior months were revised higher, but that simply sharpens the monthly decline. Hours worked improved slightly, but the hourly wage did not.

    It is a serious mistake to place too much weight on this report. There are several alternative methods of gauging employment. Truth emerges when you look at all of the evidence. The news reports do not have time to explain the methodology or that there is a sampling error of +/- 100K jobs. The error band in the household survey and the estimates of the labor market is over 400K (since the sample is smaller). This was a weak report that was pretty consistent with other recent employment data. There is a very good discussion of the labor force participation rate at Calculated Risk. It is time to look once again at Bill's popular chart comparing the most recent recession with those of the past. I like the version that aligns at the bottom. It is clear that we have come a long way, but much more is needed.

    EmployRecAlignMar2013


The Sad

We all share the loss of Roger Ebert, who finally lost his battle with cancer this week. Millions know him from his TV show and the "two thumbs up" approach. Those of us from Chicago have enjoyed the Sun Times review of this Illinois alum for many decades. Roger was passionate and outspoken. Even after he lost his speaking voice, he maintained visibility through prolific written reviews and blogging. His work will live on for many years.

Josh Brown captures the non-Chicago sentiment and provides three good links. Start with these 15 passages.

The Ugly

North Korea takes the "ugly" award again this week. Living in a world where unstable leaders have nuclear power presents special challenges. Most leaders operate with a concern for their people. For a special insight into North Korea, readers might take a few minutes to listen to this account from SnapJudgment (the fast-paced NPR storytelling show). Here is their summary:

The only father Kim Yong ever knew was the first leader of North Korea. He grew up an orphan after the Korean War and was raised to be utterly devoted to the state; blindly loyal, even. So blind that he couldn't see what was coming.

More on the policy challenge from CFR—great background!

If negotiation is challenging, the challenge for investors is even worse. I recall an old story from Art Cashin about his training during the Cuban Missile Crisis (1963). Most of the trainees thought that the crisis meant to sell. The instructor explained the error. If the leaders did not resolve the problems, it would not matter anyway….

The Indicator Snapshot

 It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

Anyone who has followed these objective indicators over the last two years has had a significant advantage in trading and investing. Each has contributed to the result. Here is how.

The St. Louis Financial Stress Index

The SLFSI reports with a one-week lag. This means that the reported values do not include last week's market action. The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.

The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events.  It uses data, mostly from credit markets, to reach an objective risk assessment.  The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.

Recession Forecasting

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread."  I have now added a series of videos, where Dr. Dieli explains the rationale for his indicator and how it applied in each recession since the 50's.  I have organized this so that you can pick a particular recession and see the discussion for that case.  Those who are skeptics about the method should start by reviewing the video for that recession.  Anyone who spends some time with this will learn a great deal about the history of recessions from a veteran observer.

I have promised another installment on how I use Bob's information to improve investing.  I hope to have that soon.  Anyone watching the videos will quickly learn that the aggregate spread (and the C Score) provides an early warning.  Bob also has a collection of coincident indicators and is always questioning his own methods.

I feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index.  They offer a free sample report.  Anyone following them over the last year would have had useful and profitable guidance on the economy.  Dwaine Van Vuuren also has an excellent data update, demonstrating how the coincident data have reduced recession prospects. There are seven sample reports available, including Dwaine's latest country-by-country analysis of the global recession status. Good reading!

Georg Vrba is a great "quant guy" with an excellent variety of useful tools, some available via a free subscription. His take on a possible recession? Based upon unemployment data, the ECRI is wrong. His latest article questions the use of M2 as part of the ECRI's WLI.

Doug Short has excellent continuing coverage
of the ECRI recession prediction, now eighteen months old.  Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating — now reflecting the most recent personal income data. Here is Doug's latest opinion on the ECRI forecast:

Ultimately my opinion remains unchanged from my position in recent weeks: The ECRI's current position is best understood as an effort to salvage credibility in hopes that major revisions to the key economic indicators — notably the July annual revisions to GDP — will validate their early recession call.

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.


Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions.  About a month ago we switched to a bullish position.  These are one-month forecasts for the poll, but Felix has a three-week horizon.  Felix's ratings stabilized at a low level. The penalty box percentage measures our confidence in the forecast.  A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings.  That measure remains elevated, so we have less confidence in short-term trading.

[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list.  You can also write personally to me with questions or comments, and I'll do my best to answer.]

The Week Ahead

This week includes a bit of a lull in economic data.

The "A List" includes the following:

  • Initial jobless claims (Th).   Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator. Special interest after last week's spike.
  • Retail Sales (F). The consumer remains central to understanding the economy.
  • Michigan sentiment (F). Important for both consumer behavior and a read on employment.

The "B List" includes the following:

  • FOMC minutes (W). A policy change is far in the future, but it is good background to monitor the Fed.
  • PPI (F). Inflation data will become more important when there is some sign of actual price increases.

Earnings season has the traditional kickoff with Alcoa on Monday. Some big names, including Wells Fargo and JP Morgan Chase report on Friday.

My personal week will include the Kauffman Foundation's 2013 Economic Blogger Conference. I always attend with questions in mind, and I often find answers that will benefit investors. Berkeley Prof Brad DeLong has put together a great program. Anyone can watch the live feed and send questions and comments via twitter. Last year's conference featured panelists responding to tweets from on stage as well as questions from attendees.

Please use the comments to raise the questions that you would most like to see addressed. I'll do my best to get answers.

Trading Time Frame

Felix has continued a bullish posture, but the ratings have weakened. Felix sent one of our holdings to the penalty box on Thursday. The replacement candidates had modest ratings. Since I was concerned about a weak employment report (as I described here) I called an audible and we reduced our Felix exposure to 2/3 long.

This week's Felix forecast remains bullish, but only marginally so. I would not be surprised to see a further reduction in positions this week.

Investor Time Frame

Each week I think about the market from the perspective of different participants.  The right move often depends upon your time frame and risk tolerance.

Buying in times of fear is easy to say, but so difficult to implement.  Almost everyone I talk with wants to out-guess the market.  The problem?  Value is more readily determined than price! Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out."

Sometimes the challenge is buying the unloved stocks and sectors. It is difficult to see the opportunity when everything you read is so negative. Writers and pundits want to look smart, so they "explain" what is happening just as if they had predicted it! I will go a bit farther on this in the conclusion.

Investors who have been underinvested in stocks wonder if it is too late to invest. Those who have enjoyed the current rally are bombarded with warnings about the need to sell.

I do not see this year's current gains as a game changer for the market, and the hoopla about the new record highs is also a distraction. The early move this year mostly reflected an unwinding of fear in front of the fiscal cliff decision. I explained my rationale and emphasized the need to be flexible in adjusting your price targets in this article. The post highlights the reasoning of many analysts who have updated the market prospects rather than remaining locked into a concept created in December.

In case you missed it, please read the assessment from fellow Seeking Alpha contributor Alan Brochstein, Up 10%, Are Stocks Now too Dangerous to Hold? He touches all of the bases in his answer to the key investor question – market valuation, overheated sectors, the profit margin issue, interest rates, and even some technical analysis. There is no good way to summarize this excellent overview article, so I encourage you to read it.

But please beware!  General ideas are not for everyone.  Each person needs unique treatment.  We have several different approaches, including one that emphasizes dividend stocks with enhanced yield from writing near-term call options – a conservative, yield-based approach.

We have collected some of our recent recommendations in a 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 feedback).

Final Thought

One of the best ways to take the pulse of the market is by watching sector trends. I do this daily with the help of a real sector expert — Felix, our trading model. Felix has highlighted the defensive sectors for many weeks. To illustrate I have once again opened to the public my weekly Felix column at Wall Street All Stars, where we have a vibrant community with many good ideas.

The article features iShares S&P Global Healthcare ETF — IXJ. As I do each week I look at the featured ETF both from a trading perspective and also the viewpoint of a long-term investor. The difference is often dramatic.

As further research for today's WTWA post I checked out the top ten stocks for overall valuation using Chuck Carnevale's excellent F.A.S.T. Graphs method.

The result? The sector has a yield of 2.11% and a P/E of 16. Neither is very exciting. The individual stocks are all pretty fairly valued. Most importantly, the risk is greater than you might think. The beta versus the S&P 500 is 1.07, but something much worse could happen if and when interest rates rise.

The answer to the questions I posed in the introduction varies with your investment objective and time frame. I expect a rotation to stocks and sectors that have so far lagged in this year's rally. Traders can play the trend. For investors, it is a good time to look for bargains.

Weighing the Week Ahead: Can the Cyprus Fallout be Contained?

In a holiday-shortened week I expect the Cyprus story to remain on the front burner this week. As I write this post, there is no firm proposal. Whatever is proposed will be bad news for some and therefore great news for pundits and the media. Since we have little earnings or economic news, the field is open for speculative commentary.

The best case in Cyprus will still have negative features. Can the fallout be contained?

I intentionally used the "C word" despite knowing that it invites the smart-aleck comments. Many believe that a major lesson from the subprime debacle was that policymakers (famously Bernanke) thought that the impacts could be contained. This example is raised whenever someone tries to get a handle on the possible impact of some event.

You might be able to guess what I think about this, but I'll elaborate in the conclusion.  First, let us do our regular update of last week's news and data.

Background on "Weighing the Week Ahead"

There are many good lists of upcoming events.  One source I especially like is the weekly post from the WSJ's Market Beat blog.  There is a nice combination of data, speeches, and other events.

In contrast, I highlight a smaller group of events.  My theme is an expert guess about what we will be watching on TV and reading in the mainstream media.  It is a focus on what I think is important for my trading and client portfolios.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.

Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!


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

This was a good week on the economic front, and there was some positive political news as well.

  • The Senate passed a budget. It was the first time in four years and had only a one-vote margin, but you have to start somewhere! (See The Hill for details).
  • Obama's trip to Israel might help. The early reviews applaud the Israel/Turkey effect as well as the general reception.
  • Hotel occupancy is back to pre-recession levels (See Calculated Risk for chart and analysis).
  • Housing starts are higher and that is nicely correlated with employment. Here is the chart from Calculated Risk:

StartsUnemployFeb2013


  • Revenue growth for Q212 was 3.6%, much better than expected. Remember when many were saying that earnings would come without revenue gains? Brian Gilmartin has the data and also a discussion of earnings by sector.
  • Leading Economic Indicators from the Conference Board were strong. Steven Hansen at GEI has the analysis and charts. Here is a sample:

Z conference1


 

The Bad

There is always some negative news, and this week included economic data, earnings, and Europe. The market performed worse than the economic data, suggesting an emphasis on Europe. Feel free to join in the comments with anything else that was market-unfriendly.

  • The Fed downshifted on its economic forecast. Scott Grannis analyzes why everyone is so gloomy, noting that the Fed forecast suggests that the US will never recover the growth path. (Scott deserves respect as a Republican and libertarian who does not allow political viewpoints to sway his economic analysis). See the many key charts showing crucial variables, which support his conclusion, as follows:

    "In short, companies are holding back on their hiring plans, worried about regulatory burdens and big increases in mandated costs. And many individuals have probably decided that the rewards to working harder or returning to work are outweighed by the costs (e.g., higher taxes) to doing so."

  • The Markit "flash" PMI numbers suggest a continuing economic decline in the Eurozone (via GEI).
  • Earnings reports were sparse but negative in tone. ORCL and FDX were two cases in point.

The Ugly

Syria is the latest hot spot, with the civil war spilling over into Israel. (latest via Reuters).

The Indicator Snapshot

 It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The SLFSI reports with a one-week lag. This means that the reported values do not include last week's market action. The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.

The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events.  It uses data, mostly from credit markets, to reach an objective risk assessment.  The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread."  I have now added a series of videos,  where Dr. Dieli explains the rationale for his indicator and how it applied in each recession since the 50's.  I have organized this so that you can pick a particular recession and see the discussion for that case.  Those who are skeptics about the method should start by reviewing the video for that recession.  Anyone who spends some time with this will learn a great deal about the history of recessions from a veteran observer.

I have promised another installment on how I use Bob's information to improve investing.  I hope to have that soon.  Anyone watching the videos will quickly learn that the aggregate spread (and the C Score) provides an early warning.  Bob also has a collection of coincident indicators and is always questioning his own methods.

I also feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index.  They offer a free sample report.  Anyone following them over the last year would have had useful and profitable guidance on the economy.  Dwaine Van Vuuren also has an excellent data update, demonstrating how the coincident data have reduced recession prospects. There are seven sample reports available, including Dwaine's latest country-by-country analysis of the global recession status. Good reading!

Georg Vrba is a great "quant guy" with an excellent variety of useful tools, some available via a free subscription. His take on a possible recession? Based upon unemployment data, the ECRI is wrong.

Doug Short has excellent continuing coverage
of the ECRI recession prediction, now well over a year old.  Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. His latest comment provides a detailed critique of the most recent ECRI media blitz, suggesting that it is "an effort to salvage credibility in hopes that major revisions to the key economic indicators — notably the July annual revisions to GDP — will validate their position." Read the entire post for full details. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating.

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.

Indicator snapshot 032313


Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions.  About a month ago we switched to a bullish position.  These are one-month forecasts for the poll, but Felix has a three-week horizon.  Felix's ratings stabilized at a low level and improved over the last few weeks.  The penalty box percentage measures our confidence in the forecast.  A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings.  That measure is improving, so we have a little more confidence in the bullish forecast.

[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list.  You can also write personally to me with questions or comments, and I'll do my best to answer.]

The Week Ahead

This week brings less data and scheduled news, an artifact of the calendar and the holidays.

The "A List" includes the following:

  • Initial jobless claims (Th).   Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator.
  • Consumer Confidence (T). The Conference Board version has special significance given the weakness in the Michigan survey.
  • Chicago PMI (Th). Upgraded in importance this week since the national ISM index will not come out until Monday – two trading days later due to the holiday. The Chicago PMI is a reasonable directional indicator for the ISM index.
  • Personal Income (F). This is important for recession analysis. It will be reported on Friday even though the market is closed.

The "B List" includes the following:

  • Durable Goods (T).  This is a key element of the economic rebound, so it is important to follow.
  • Case-Shiller home prices (T).  Because of the method and Prof. Shiller's consistently dour interpretation, this seems to be lagging the other home price measures. It gets a lot of attention.
  • New Home sales (T).  Another piece of the housing puzzle.  Will the improvement continue?

I am not very interested in the final Michigan sentiment numbers, unless there is a big change. We also have speeches from Bernanke and some other Fed figures, but the topics do not suggest major market effects.

The bond market stops trading early on Thursday, so this rates to be a very short week for market action.


Trading Time Frame

Felix has continued a bullish posture, now fully reflected in trading accounts. It was a close call for several weeks.  Felix has been long, but in cautious sector choices. At one point we were down to 1/3 long in trading accounts, and it the overall ratings are still not strong.

Investor Time Frame

Each week I think about the market from the perspective of different participants.  The right move often depends upon your time frame and risk tolerance.

Buying in times of fear is easy to say, but so difficult to implement.  Almost everyone I talk with wants to out-guess the market.  The problem?  Value is more readily determined than price! Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out."

This approach would be especially poor right now!

Warren Buffett recently spent a few hours on CNBC's Squawk Box. As regular readers know I use TIVO and mute to find the best stories from this source. CNBC helped with some highlights – only nine well-spent minutes and you can see the best of the Buffett advice.

I particularly enjoyed one observation. Mr. Buffett said that the market offered you a quote on your holdings every day. This should be an advantage, but most people made poor use of it by trading at the wrong times. They would be better off to check on their portfolio every five years or so! It explains why most people make big mistakes in trying to time the market.

So do most "experts." I exposed the false claims of many pundits. You can check out the overall issue and also pundit ranks by reading The Seduction of Market Timing.

While there are no miracles available from market timing, you can definitely improve your risk/reward balance. I explained how in my 2013 preview for Seeking Alpha.  This covers some key investor catalysts, as well as some specific stock and sector ideas.  My recommendations did well last year, and we are off to another good start.  You need to be comfortable in taking the other side of one of the most hated rallies in history.

But please beware!  General ideas are not for everyone.  Each person needs unique treatment.  We have several different approaches, including one that emphasizes dividend stocks with enhanced yield from writing near-term call options.

We have collected some of our recent recommendations in a 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 feedback).

Final Thought

How worried should we be about Cyprus?

For almost two years I have encouraged investors to view the European problem is a multi-party bargaining process, moving slowly toward compromise. The eventual solution will be a compromise – loved by no one. Since most market gurus, including the most prominent, have no experience with this type of situation, they are prone to mistakes. They want to criticize European leaders for being too slow and especially for not making the same decisions they would prefer.

Since the process of creating compromise takes time, it can always be criticized as "can-kicking." Other lame analyses involve dominoes and cockroaches.

Sadly, these conclusions are voiced by some very respected analysts. These are often people who are good at one thing – bonds, corporate finance, marketing to create more assets, telling people what they want to hear – but they have absolutely no credentials in political science or policymaking.

I suggest two specific conclusions:

  1. The initial proposals had the effect of a trial balloon – drawing out criticism and sharpening up the final proposal.
  2. Objective measures like the St. Louis Financial Stress Index are more helpful than scary headlines.

If you followed my suggestions from last week, you were able to profit from scare-induced volatility. If not, you might get another chance this week!

And finally, Scott Grannis offers eighteen charts worth considering. The overall picture can be summarized in this final comment (and one chart offered as a sample):

"It never pays to underestimate the ability of the U.S. economy to overcome adversity and grow. That's why I remain optimistic, especially because I see that markets are still obsessed by the negatives."

Households Balance Sheet

Weighing the Week Ahead: The Importance of Planning and Preparation

How do you react to the unexpected?

Many are paralyzed by surprising information, especially when it seems very negative. Is it time to reduce risk, or is it a time of opportunity?

Housing data dominate this week, but I covered that story quite recently and there is not much to add. (The housing rebound story in the former piece is worth a look).

Since there was no fresh, definitive theme for this week, I had chosen the importance of planning as my topic. As occasionally happens events developed quickly and I decided to include the Cyprus situation as a case in point. The immediate reactions covered a wide spectrum. Some observers saw the proposal to levy a tax on bank deposits as evidence that the European Union was about to unravel. At the other extreme, some accepted that this was a highly unusual situation which had no implications for any other country. The opinions mostly reflected the existing public postures of the various sources.

Confronted with this news of a fresh crisis, what should you do? You are not an expert on Europe or banking systems and certainly not on the internal political dynamics of the proposed bailout. Did your contingency plan help you with this problem?

I have some thoughts which I'll report in the conclusion.  First, let us do our regular update of last week's news and data.

Background on "Weighing the Week Ahead"

There are many good lists of upcoming events.  One source I especially like is the weekly post from the WSJ's Market Beat blog.  There is a nice combination of data, speeches, and other events.

In contrast, I highlight a smaller group of events.  My theme is an expert guess about what we will be watching on TV and reading in the mainstream media.  It is a focus on what I think is important for my trading and client portfolios.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.

Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!


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

This was another good week for economic data. We'll provide an abbreviated look at the most important results.

  • Retail sales were much stronger than expectations, rising 1.1% in February and 4.6% year-over-year. Calculated Risk has a good account including this helpful chart:


RetailFeb2013

  • Initial jobless claims drifted still lower to 332K. This is a promising indicator for net jobs growth.
  • The Federal Budget Deficit has declined by almost one-third in the past three years (via Scott Grannis).

Receipts and Outlays


The Bad

There was a little bad news. Here are the items that I find of greatest concern.

  • Growth in the money supply, as measured by M2, is faltering. The Bonddad Blog notes that M2 has declines 0.7% from the recent peak. Continuing expansion is necessary to maintain conditions for economic growth. Ignore those who keep harping on the "monetary base" and focus instead on the actual money supply – a current concern.
  • Michigan consumer sentiment took a nosedive. The reasons can be a combination of higher fuel prices, the end of the payroll tax relief, Washington shenanigans, and negative headlines. My concern is that this indicator is often related to both consumption and employment. Have the emotional aspects detached from the economic reality? It is too soon to tell, but I am watching closely. Here is my favorite chart from Doug Short, who notes that the indicator is at recession levels:

Michigan Sentiment DShort


The Ugly

European policymakers and the Cyprus situation handily win this week's "ugly" award. Even though the country involved is small, the potential for a larger problem is there. Europe needs to create and maintain confidence in the banking system, with comprehensive and believable insurance. The potential for a bank run is an important destabilizing force. The immediate effects are greater than the tax revenue raised.

The Indicator Snapshot

 It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The SLFSI reports with a one-week lag. This means that the reported values do not include last week's market action. The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.

The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events.  It uses data, mostly from credit markets, to reach an objective risk assessment.  The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread."  I have now added a series of videos, where Dr. Dieli explains the rationale for his indicator and how it applied in each recession since the 50's.  I have organized this so that you can pick a particular recession and see the discussion for that case.  Those who are skeptics about the method should start by reviewing the video for that recession.  Anyone who spends some time with this will learn a great deal about the history of recessions from a veteran observer.

I have promised another installment on how I use Bob's information to improve investing.  I hope to have that soon.  Anyone watching the videos will quickly learn that the aggregate spread (and the C Score) provides an early warning.  Bob also has a collection of coincident indicators and is always questioning his own methods.

I also feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index.  They offer a free sample report.  Anyone following them over the last year would have had useful and profitable guidance on the economy.  Dwaine Van Vuuren also has an excellent data update, demonstrating how the coincident data have reduced recession prospects. There are seven sample reports available, including Dwaine's latest country-by-country analysis of the global recession status. Good reading!

Georg Vrba is a great "quant guy" with an excellent variety of useful tools, some available via a free subscription. His take on a possible recession? Based upon unemployment data, the ECRI is wrong.

Doug Short has excellent continuing coverage
of the ECRI recession prediction, now well over a year old.  Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. His latest comment provides a detailed critique of the most recent ECRI media blitz, suggesting that it is "an effort to salvage credibility in hopes that major revisions to the key economic indicators — notably the July annual revisions to GDP — will validate their position." Read the entire post for full details. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating.

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.


Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions.  About a month ago we switched to a bullish position.  These are one-month forecasts for the poll, but Felix has a three-week horizon.  Felix's ratings stabilized at a low level and improved somewhat over the last few weeks.  The penalty box percentage measures our confidence in the forecast.  A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings.  That measure remains elevated, so we have less confidence in short-term trading.

[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list.  You can also write personally to me with questions or comments, and I'll do my best to answer.]

The Week Ahead

This week brings little data and scheduled news, an artifact of the calendar and the holidays.

The "A List" includes the following:

  • Initial jobless claims (Th).   Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator.
  • Leading economic indicators (Th).  This is still a favorite for some.

The "B List" includes the following:

  • Existing home sales (Th).  This is a key element of the economic rebound, so it is important to follow.
  • Building Permits (T). The best leading indicator for housing.
  • FAFA home prices (Th).  These are the prices from the regular homes in the government market.
  • FOMC decision (W). Not as important as usual since we seem to have the full story already.

The real stories will be about Cyprus and the continuing market move to new highs.


Trading Time Frame

Felix has resumed a bullish posture, now fully reflected in trading accounts. For the last few weeks we have had conservative and partial trading positions.  Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral.  Felix has been cautious, but still has caught most of the rally, and done so with less risk.

Investor Time Frame

Each week I think about the market from the perspective of different participants.  The right move often depends upon your time frame and risk tolerance.

Buying in times of fear is easy to say, but so difficult to implement.  Almost everyone I talk with wants to out-guess the market.  The problem?  Value is more readily determined than price! Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out."

This approach would be especially poor right now!

Warren Buffett recently spent a few hours on CNBC's Squawk Box. As regular readers know I use TIVO and mute to find the best stories from this source. CNBC helped with some highlights – only nine well-spent minutes and you can see the best of the Buffett advice.

I was struck by this comment. Mr. Buffett said that the market offered you a quote on your holdings every day. This should be an advantage, but most people made poor use of it by trading at the wrong times. They would be better off to check on their portfolio every five years or so! It explains why most people make big mistakes in trying to time the market.

So do most "experts." I exposed the false claims of many pundits. You can check out the overall issue and also pundit ranks by reading The Seduction of Market Timing.

While there are no miracles available from market timing, you can definitely improve your risk/reward balance.

I strongly believe that active management can help investors. My concepts emphasize limiting risk and finding the right themes, not trying to time the markets via watching headlines. I really tried to pull this together in my 2013 preview for Seeking Alpha.  This covers some key investor catalysts, as well as some specific stock and sector ideas.  My recommendations did well last year, and we are off to another good start.  You need to be comfortable in taking the other side of one of the most hated rallies in history.

But please beware!  General ideas are not for everyone.  Each person needs unique treatment.  We have several different approaches, including one that emphasizes dividend stocks with enhanced yield from writing near-term call options.

We have collected some of our recent recommendations in a 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 feedback).

Final Thought

The most successful people in any field depend upon planning and preparation. Your favorite sports team has many hours of practice on every situation. If you are a trader, you need to do the same. There is not enough time to react – unless you have a plan!

Suppose you have been waiting for a market correction – a dip to buy. How much of a dip do you need? Here are some possibilities:

  1. Do some buying whenever there is a decline of 1% or more. Just a little, planning to scale into a full position.
  2. Wait for a 5% move before the initial buy.
  3. Expect a significant correction, so wait until there is a decline of at least 10% and a change in sentiment.

Each of these represents a plan, and each might be effective. Many traders and investors start out with a plan to buy a dip, but then get frightened away. The reason?

Those who are underinvested have a basically negative viewpoint on market fundamentals: valuation, economics, earnings – you name it. When news creates a dip, it seems to confirm their fears.

You can get some strong assistance by reading Scott Rothbort's daily "My Gut Feeling" column at Wall Street All Stars.  Scott's commentary is objective and based on both knowledge and experience.

My Plan

My preparation begins with an analysis of risk and fundamentals, something that I write about each week. When there is a "crisis" in a country of one million people, I put it in perspective. In this case, the actual policy had not even been adopted, and it might not be. I might disagree with European officials (and I do) on the merits of this particular plan, but I recognize that it is a baby step, and a tentative one at that. See this analysis by John Dessauer (with special expertise on European banking) via Mark Hulbert.

"(He)…has little doubt that those bankers over the weekend learned their lesson. He's confident that they will very soon come up with some other plan that bails out weak Cyprus banks without imposing a deposit tax or some other haircut on bank deposits. Those central bankers now realize that the alternative to coming up with that solution is simply intolerable.

How soon will the European central bankers come up with their plan to resolve this crisis? By Wednesday or Thursday at the latest, and perhaps even sooner than that, Dessauer suspects. And when it does, the euro will quickly recover."

With that basic concept in mind, my own approach is to adhere to plan #1 for new accounts. Since I see many attractive stocks on a value basis, I start with positions of 35-40% of our target. When there is a dip, I add a little.

For our enhanced yield accounts a day like today provides a great opportunity. Stocks move lower and volatility increases. This is the best time to buy a good dividend stock and sell a near-term call to enhance yield.

Taking any of these actions requires preparation. You have to have a "buy list" of ideas and target prices. You also need to be able to distinguish between scary headlines and something that is really important.

No one really knows whether the market will trade lower for the rest of this week or next. Are you prepared? Do you have a plan?