Weighing the Week Ahead: How Strong is the Labor Market?

A holiday-interrupted week is loaded with important economic data. Since many market participants will skip Monday to stretch their weekend, the action will focus on Friday’s employment situation report. People will be asking:

Just how strong is the labor market?

Last Week Recap

The big economic news last week was the (slight) increase in volatility. Tuesday’s decline was attributed to the ACA repeal/replace delay and what it implied for the Trump agenda. That was forgotten by Wednesday. Thursday saw technology selling right at the opening. Art Cashin attributed the rotational decline to dueling programs. That had little carry over to Friday.

Our question from two weeks ago – a possible change in market leadership – got some real attention. Financial stocks did well in the wake of the bank stress test results.

Continue reading “Weighing the Week Ahead: How Strong is the Labor Market?”

Stock Exchange: Should You Embrace Evidence-Based Trading?

Our 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.

Review

Our last Stock Exchange asked whether traders were joining the yield chase. If so, we might be seeing another rotation as energy and financials have taken the lead. Congratulations to traders who made bets on the bank stress tests.

This Week— Should You be Trying “Evidence-Based” Trading?

This important topic has already attracted expert attention, as we see in today’s Trading Tips.

Trading Tips

  • Dr. Brett Steenbarger, as usual, provides leadership on this subject. Traders should carefully read his entire post as well as the prior article in Forbes. There is no good way to summarize all the excellent points, but let me highlight two of them:

    If you read old texts on technical analysis, you’ll encounter generalizations such as “this is a bullish pattern”.  No actual evidence is produced to document this.  It is the “clinical judgment” of the practitioner.  Similarly, a fundamental analyst might assert that the price of a stock or index will rise because of increasing consumer spending or a growing GDP.  Once again, no evidence is provided for those links.

    The alternative to technical analysis is not fundamental analysis.  The alternative to technical and fundamental analysis is evidence-based decision-making.

And also, this….

It starts with what Victor Niederhoffer calls “counting”.  When we see a pattern that we believe has some implications for non-random forward returns, we look back in time and see if that pattern indeed has led to those anticipated results.  Cherry-picked examples supporting our inference does not constitute an evidence-basis.  Rather, we look back over a meaningful sample and count the times when the pattern has and has not led to expected returns.

  • Steve Burns cites Colibri Trader on the four levels of trading. What is your level? Will you be one of the 5% who makes it. If you think this is not related to Dr. Brett’s post, read it again.
  • Ian Huntsley warns about the temptations of excessive trading, providing a helpful catalog of reasons. Like the Burns post, you can consider whether you see yourself. It is both useful and fun.

I’ll share my own observations in the conclusion.

Expert Picks from the Models

This week’s choices cover a wide range – different sectors, market caps and risk-reward.

Felix: It’s been a long year for Hertz (HTZ). This stock has been on a steep decline for nine months, but there’s a good reason to like it in the long run. The chart shows why:

Apart from a small bump in early November, this is pretty ugly. Now that the price has declined from $50 to $11, this is a buying opportunity. The segment from mid-May to late June could be something Jeff calls a “reverse head and shoulders.”

J: It requires a lot of imagination to see an upside-down-head and shoulders in that chart! I suggest you read my post from earlier this week – The Limits of Technical Analysis. The Seeking Alpha version had a spirited debate in the comments. There are some examples of chart-reading like yours.

F: I suppose that you will next show a chart from a fundamental analyst, like Chuck Carnevale.

J: Of course. His tools are the best! Anyone serious about buying a stock should begin with a look at Chuck’s analysis.

J: You can see the huge decline in earnings both last year and this year. The soft market for used cars, which they depend upon to turn over their fleet, is a problem. The rise of Uber is another. Many are choosing the inexpensive ride service rather than a car rental.

F: That may be the reason for the decline, which I do not care about. I am focused on the rebound.

J: Are you paying any attention to the SEC?

F: Why would I do that?

J: Your purchase of the stock at nine and change was within hours of the company’s announcement of an agreement with Apple. The SEC monitors “insider trading.” The stock spiked $2.

F: You mean the story about Apple leasing six (count ’em, six) cars for testing?

J: That might not impress you, but rightly or wrongly, the stock soared after that news.

F: Sometimes the prior chart action provides a clue. That was the case here. I had no inside information, but some other buyers might have. That is often the reason behind technical buy signals.

J: Would you still buy the stock now — after the instant gain? Most traders would be selling, and moving on to the next trade.

F: At the moment, the stock still meets my buying criteria.

J: How did you do today?

F: My portfolio was unchanged – not bad on a tough day.

J: How did you do so well?

F: I hold some energy names, which did well, and little in technology.

J: That is not completely reflected in your rankings.

F: I wish that readers would submit more diverse questions. You and Vince will not let me just post a list of the top stocks.

J: That would be OK, if we were charging for a newsletter or something. We invested a lot in developing your method, and we execute it in a timely fashion for our clients – just as you would expect. What we publish here is a sample. No one should expect it to work as well as our own trades.

 

Athena: My pick this week is the biotech company, Incyte Corporation (INCY). I know Holmes and RoadRunner have held this earlier. I also see this stock has been through quite a lot of ups and downs over the last six months. I made my pick when the stock showed some strength in the face of the short-term downtrend. In my mind, that is a strong reason to buy. I expect upward price slopes for the stock in the coming weeks.

Jeff: I will not even bother with the earnings chart. This is strictly a “story stock.” The pipeline will come through, or it will not.

A: My holding time will me much shorter than the resolution of the pipeline question.

J: How did you do today?

A: In line with the market. It is normal trading.

 

Holmes: This week, my pick is Oceaneering International, Inc. (OII). Early this week, the stock touched new lows trading at just above the 20-mark. I found this a good point to buy-in at its lowest point. The stock has since picked up and is now hovering around its previous-week levels. I certainly look forward to more upside gains from here.

J: Here is the F.A.S.T. Graphs chart. Enough said.

H: I have no concern for the earnings picture in that time frame. As usual, I just look for a rebound.

J: How did you do today? Almost no change. My stocks have already sold off, so I had little tech exposure.

 

Roadrunner: My most recent pick is NetEase (NTES). Others might not think this is the world’s most attractive chart, but I like it. Let’s have a look:

As you can see, this stock nearly hit the very top of its channel twice in the last month. It also scraped along the bottom of its channel twice. This suggests to me that this could be an attractive target for a 2-week holding. We’ve already moved from the June 27 low up to the current price. For me, this is just a question of how high this can move in the next 8 days.

J: Haven’t you picked this stock twice before?

RR: Yes. The first time, in March resulted in a decline of about 3%. The last time, earlier this month, featured a gain of over 10%. It is a good channel.

J: Very good. We should not expect winners every time.

Oscar:
This week I have no new choices.

 

J: You had a tough day today.

O: Yes, although my biotech holdings had given me a good lift going into today.

J: Last week you featured bonds. How are those working?

O: Not so well. I do not choose based upon diversification, but I do follow the action. Bonds and stocks are getting hit together. Normally I would expect better results from my position.

J: You do not hold tech stocks or chip stocks, even though those are at the top of the ratings.

O: The list shows requests from readers. With those in hand, I report results.

J: You are saying that they are not asking the right questions?

O: Let us just say that the list reveals the interest of readers – which might be misdirected. I do report honestly, each week, on a featured sector.

 

 

Conclusion

The buzz over basing decisions on evidence is rather surprising. This has been the standard practice of many, including us. I certainly endorse the improvement in methods. What I do not understand is why those who are so late to the party have such pride in their discovery. There also is a bit of confusion about what evidence tells us. Evidence should provide a strong, quantitative basis for finding undervalued stocks. It can provide a warning about “storms ahead” in economic conditions. It can highlight attractive technical setups.

There are many ways to profit in the markets, including all of the above.

What Dr. Brett accurately calls “counting” and looking at winners versus losers is a routine procedure for a good system developer. All of our models are trained on one period for setups, with thousands of cases. They are then tested on an out-of-sample data set on thousands of other potential cases. We monitor the real-time results closely to make sure that each model is trading as expected.

Anyone who reports a super-high level of winners is probably making a rookie mistake or pulling a Madoff-style move. Our models show a modest +/- ratio usually accompanied by greater wins than losses. That is what you should expect.

Here is a summary of the cast of our characters. Find your own favorite!

Stock Exchange Character Guide

Character

Universe

Style

Average Holding Period

Exit Method

Risk Control

Felix

NewArc Stocks

Momentum

66 weeks

Price target

Macro and stops

Oscar

“Empirical” Sectors

Momentum

Six weeks

Rotation

Stops

Athena

NewArc Stocks

Momentum

One month

Price target

Stops

Holmes

NewArc Stocks

Dip-buying Mean reversion

Six weeks

Price target

Macro and stops

RoadRunner

NewArc Stocks

Stocks at bottom of rising range

Four weeks

Time

Time

Jeff

Everything

Value

Long term

Risk signals

Recession risk, financial stress, Macro

 

 

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 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!

 

 

What are the Limits of Technical Analysis?

In my days writing for TheStreet.com, the fiercest controversy raged whenever there was disagreement over whether to use technical or fundamental analysis. For simplicity, let’s call the protagonists “technicians” and “fundamentalists.” The technicians can find successes from charts which apparently revealed moves totally unexpected by the fundamentalists. The fundamentalists describe chart reading as subjective and undependable. If you search for this question you will get 16 million results.

With fear and trepidation, I suggest – for discussion – my own conclusions on this topic. Some are just ideas, but there is one important item on which I feel quite strongly.

But first – please consider this chart. Is it bullish? Do you agree with the annotations by the analyst whom I consulted?

Please give this a little thought before reading on.

The Fundamentalist Side

There are many possible candidates, but I suggest this post on Why technical analysis is shunned by professionals. Andreas F. Clenow covers many aspects of this argument, but this early discussion of just how to define technical analysis sets the tone:

There is no definition. Anyone can make up anything and call it technical analysis. The field now seem to encompass everything from drawing trend lines to astrology.

Technical analysis started out with quite simple concepts, which are not all that dumb. In the early days, it was about looking for directional trends in prices and divergences between related market indexes.  Experience told traders that when prices start moving in one direction, they are more likely to continue than to reverse. Technical analysis was just a way to visualize this concept.

He illustrates with this chart:

The Technician Side

Once again, there are many advocates. I like the explanation from Michael Kahn, writing at Forbes.

Critics will point out that forecasting future price movement based on past price movement is akin to reading tea leaves or divining the future from the textures of chicken entrails. Many of the high priests of fundamental analysis are quick to call technical analysis the financial world’s alchemy. Indeed, chart watchers cannot predict the future any better than your broker, your spouse or a Ouija board.

But what they can do better than most is make a decision about what to do–buy, sell or hold–based on the probabilities of the actions of others given certain conditions. In other words, if a pattern on the chart appears, a chart watcher can create a framework for what the market might do if and when prices break free from that pattern. It does not work every time, but past performance does give us an idea of what will happen so we can do something about it.

Who is right?

Although my own analysis is primarily fundamental, I look at a chart before any trade. My interpretation is rather like what we hear from the Dean of NYSE floor trading, Art Cashin. He regularly cites support and resistance levels, noting what is likely to happen if these are breached. He is an excellent source of trader thinking.

Using my own experience, I know that market psychology depends heavily on the original basis. An investor who is losing on a trade has buyer’s remorse. “If only the stock would get back to where I bought it….” This is probably the wrong time to sell, but it is how people think. Whenever I see a long period of trading at a price level, I know it was a battleground with many buyers and sellers.

I also know that we should respect trends, perhaps the most successful trading strategy. Is there more?

A Questionable Application of Technical Analysis

The limits of technical analysis is topic that has been on my agenda for a long time. A recent popular post (over 33,000 page views) pushed it to the top. Jonathan Garber, writing at Business Insider, asserts that “A key predictor of the health of the American economy is inching closer to signaling a recession.”

This would be fair enough, although my own weekly update of the very best recession forecasters goes beyond the yield curve – and explains why. What troubled me was his use of technical analysis to predict future yield curve moves. Here is the chart:

There is no pure index representing this spread. With the short end not moving much, bond traders are more likely to be trading the ten-year note. They are a small segment of that market. This chart is not a meaningful forecast for the yield curve.

 

My Conclusions on Technical Analysis

As I noted above, technical analysis is fine in determining support and resistance. It is good at identifying trends. There are some other chart patterns that are widely followed, and may well be tradable. Our weekly Stock Exchange emphasizes technical choices, as well as highlighting the debate.

But what about indicators and charts that no one is even trading?

There is no battleground. There is no complex head and shoulders pattern, because no one is looking at that chart or trading on it. If ever there was a case for the relevance of technical analysis, can it work in a market that doesn’t exist? Where there are no traders. I have seen it applied to sentiment indicators, or diffusion indexes – with no market for any of them. This is absolutely nonsensical.

We are all familiar with the philosophical question of whether a tree falling in a forest makes a sound, when no one is there to hear it. This is more like hearing a sound when there is no tree!

And finally, returning to our bullish chart for your consideration, it is a price-weighted index of companies with headquarters in my home county, DuPage. The stocks exist, but the index does not. No one is trading it. Would you bet your money on psychology when there are no traders?