Stock Exchange: Finding Your Trading Sweet Spot

Our last Stock Exchange (two weeks ago) discussed diverse ideas from our experts, and also explained why I vetoed one of the recommendations. When trading using models, you can link directly to a platform if you do many trades and have a very short time frame. Otherwise you should not blindly follow the model. A human who understands the factors used by the model can identify when a situation is truly exceptional.

The current market environment is all about Trump – perhaps excessively so. Everyone worries about what companies are vulnerable to a tweet (which we will call a T-WOP, HT @corporatecommie). Each day includes more speculation about companies that might benefit from policy changes.

How should traders find a sweet spot in this environment?

This week includes both new ideas and reviews of some past highlights. Everyone can benefit from finding the trading model most relevant for your own style.

Let’s look at the ideas from our experts. As usual, I will conclude with a brief observation.

Getting Updates

We have a new (free) service to subscribers to our Felix/Oscar update list. You can suggest three favorite stocks and sectors. We report regularly on the “favorite fifteen” in each category– stocks and sectors—as determined by readers. Sign up with email to “etf at newarc dot com”. Suggestions and comments are welcome. In the tables below, green is a “buy,” yellow a “hold,” and red a “sell.” Each category represents about 1/3 of the underlying universe. 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!

This Week—Finding Your Trading Sweet Spot

Holmes

This week I’m buying good ol’ U.S.A. Macys (M). This stock probably needs no introduction, main street retail store.

This chart strikes me as a great money-making opportunity. My major concern is that this stock keeps making lower lows, but in the meantime it can have some terrific rallies. I see no reason it can’t get back to the mid-30’s. It’s a little comforting to know that there are 18 analyst holds on this stock and their target price is STILL 36. That is consistent with what the charts are telling me.

I’m buying here with tight stop, 29.25, and looking for a move back into the mid-30s. Giving me a nice risk/reward setup.

J: I agree with you about ignoring the analyst ratings. I use it as a contra-indicator. Did you read that recent WSJ article?

H: You know that I do not read! I reach great conclusions from looking at charts. You humans read, but mostly to reaffirm your existing biases.

J: I am delighted that our clients caught this at a lower price, but do you realize the stock was up over $1.50 today?

H: No. I am enjoying the beach in Mexico. I sent in my pick, but that is like working overtime.

J: Oscar’s turf accountant would call your choice “past posting.”

H: Sorry. You are the one who set the schedule for Thursdays. I made the pick earlier, and it is still a good buy.

J: There is a rumor of a possible takeover. Did you know about that?

H: No. I just know a great rebound chart when I see one.

J: Are you going to have any trouble returning from Mexico? The U.S. is taking a hard look at those returning from other countries.

H: My papers are all in order. I’ll be back in the office in a week or so.

 

Athena

I admit it. I still have no new picks. We do not have the fresh, strongly-trending stocks that I prefer. I’m still holding most of my most recent picks, and I have room for one more buy.

J: Maybe you could give us an update on one of your current holdings.

A: Fair enough. I recommended United Rentals (URI) on 12/22, after buying it myself a few days earlier.

J: Isn’t this one of your few picks where I agreed?

A: Yes, I seem to remember that you said the pick was OK, but you did not own it yourself. I have held this one through a month or so of sideways movement, but now it’s starting to pay off in a big way. We’ve seen an increase of roughly 20% in the last two weeks. That means it’s about time for me to hop off this one (as fun of a ride as it’s been).

 

J: That certainly worked well. How are you doing overall?

A: Not as well as the fussy guy and the dog, but that will change soon. I think I am Vince’s favorite.

Felix

I will once again begin with my responses to reader votes for the favorites list.

My list provides rankings within each zone, as well as the basics about buy, hold, and sell. The list includes the top overall vote getters from our (free) subscription list as well as some new requests I got during the week.

J: The list has some interesting changes. I see that AAPL (which we own) is still in “hold” territory despite the major rally after its earnings report.

F: My ratings came before the report. How about AMZN? That did not do so well. My approach is geared to the long term, usually more than one year.

J: Fair enough. Do you have something new for us this week?

F: No.

J: What? I took a long weekend, but the rest of you were supposed to keep working. Only Holmes was on vacation.

F: I worked, but there are no new choices. Patience is called for.

J: Are you trying to get dropped from the weekly discussion?

F: You would not dare! My performance leads the group. In addition, I provide updated information to my many fans. You should be giving me a raise. I am on the job while the dog is in Mexico.

J: OK, we’ll let the readers decide whether they still want your opinions.

 

 

 

 

 

 

 

Oscar

My pick for this week is the Defense sector, shown here by the SPDR S&P Aerospace & Defense ETF (XAR). I liked this one back in early December too – but I got out before the downslide. Now that the price has had a few weeks to level out, I feel more comfortable getting back into this sector.

For my next “investment” – I’ll bet that Belichick can’t put together a defense to stop the Falcons. But that really is another subject…

Here are my ratings for the top reader interests. Keep the questions coming. My sectors are aggressive, but have less risk than Felix’s picks. I avoid the bad news from random, single-stock moves.

J: Interesting. Do you see evidence of that?

O: I hear about it. People are very worried about something called “tweets” that seem to hit their stocks for no reason. Playing sectors reduces that risk.

J: Interesting. The Tweeter-in-Chief has T-Wopped a few of the defense stocks, but most still believe in his support for higher defense spending.

O: I only follow sports tweets, but I know which sectors have legs, and which will fail down the stretch.

J: You really like the Falcons?

O: My week’s pay is on the line!

 

 

 

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 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. Each week features a different expert or stock.

Questions

If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a specialty. Who is your favorite? (You can choose me, although my feelings will not be hurt very much if you prefer one of the models).

Conclusion

The current trading environment is treacherous. Many frustrated traders are bailing out. Or have blown out. Political opinions about policy have proved to be a dangerous foundation for trading and investing.

Our models provide a range of diverse ideas, all successful. Pick one that you like. Use it as a counterpoint for your own method. And keep control of position size and risk.

The Stock Exchange does not have all the answers, but it provides good ideas and a stimulus for your own trading.

Stock Exchange: Great Trading has a Foundation of Focus and Discipline

Last week’s Stock Exchange was about how emotion and symbols affected technical analysis. Could our charts help us when the picture displayed involved some psychological event like Dow 20K?

This week I turn from the charts themselves to the trader who must interpret them. Successful trading requires focus and the discipline to stick with successful methods – even through a bout of bad luck.

Dr. Brett Steenbarger, the leading expert in trading psychology, puts it this way:

A topic that has arisen in recent conversations with traders is the importance of focusing on what has been making you money and sizing up those trades, rather than taking many kinds of trades throughout the day or week and watering down your edge.  So often, the difference between profitability and unprofitability is eliminating marginal trades and trading more confidently with our core strengths.  Perhaps most damaging in taking those marginal trades is that we don’t accumulate those small wins that allow us to go after larger ones.  It’s difficult to build confidence when oscillating between winning on good trades and throwing money away on so-so ones.

Dr. Brett writes almost every day about helping human traders achieve their best results? Does this have meaning for our models? Let’s start with a look at their current ideas.

Getting Updates

I have offered a new (free) service to subscribers to our Felix/Oscar update list. You can suggest three favorite stocks and sectors. We will report regularly on the “favorite fifteen” in each category– stocks and sectors—as determined by readers. Sign up with email to “etf at newarc dot com”. Suggestions and comments are welcome. In the tables below, green is a “buy,” yellow a “hold,” and red a “sell.” Each category represents about 1/3 of the underlying universe. 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!

This Week— Focus and Discipline in Trading Systems

Holmes

I love chances to buy on a dip, and this is quite a dip. United Health Services, Inc. (UHS) is down 8% in the last month alone – more than likely an overcorrection. While I like it for short term turnaround potential, I’m not just going to buy and hold. If things keep going south, my active approach to trading stops will get me out of this position before I take too big of a hit.

J: Do you realize that the new President is going to repeal ObamaCare?

H: We have a new President? What is ObamaCare?

J: I know, I know. You do not read news; you just look at charts. But you might have a point here. The original repeal will be rich in symbolism, but is not likely to end insurance for millions of people. There is a lot of selling in this stock based upon fear – not actual knowledge of what will happen. You could have a winner.

H: I usually do.

Athena:  I generally go for stocks that are already popping upwards. This week’s pick, United Rentals, Inc. (URI) is no exception. A substantial jump over the past two months really put this one on my radar, and I like the potential for future growth in the next 4-6 weeks. The rankings on the Relative Strength Index don’t particularly scare me. A high-volume event could push the stock well above the current price, yielding a tidy profit.

J: This idea also has some support from the fundamentals. The FAST graph shows the strong earnings growth and the underlying value.

A: I know you look at P/E ratios and such, but that is not necessary to find a great trade.

J: Shouldn’t you have bought this one in 2015? It has doubled from the bottom?

A: I did not exist in 2015.

J: You were just a glimmer in Vince’s eye.

A: You must learn to look forward. We can all wonder why we did not take some action in the past. That is a waste of time. It is more important to make good decisions in the future.

Felix

I will begin with my responses to reader votes for the favorites list.

As you can see from my presentation, which is neater and more informative than Oscar’s, I show the answers for last week as well as now. I also provide rankings within each category so that you can see which stocks are moving from one group to another.

Bristol Myers (BMY), for example, became a marginal “buy” while Apple (AAPL) dropped into the “hold” group.

J: You have nearly twice as many stocks listed as we agreed upon.

F: I am giving my readers more information. Do I get paid more for that?

J: No. And you must start reducing the list. Just go with the top vote-getters. What is your featured stock for this week?

F: I like Rice Energy, Inc. (RICE) as a long-term investment. A couple sharp declines in the past quarter put the 50-day moving average on a downward trend, but we’re still up on the 200-day moving average. My bet is we’ve bottomed out on this one, and it should be a solid holding looking 10-12 months ahead. That said, a few additional drops wouldn’t surprise me. This is a solid pick if you don’t panic, and keep your timeframe in mind.

J: Isn’t selling losers a part of trading discipline? The other models all do it with trading stops or a similar technique.

F: It is also part of my method. I am just not so quick on the trigger. My performance is similar to that of the others, but has a longer holding period. Some people must pay taxes, and prefer long-term gains. Oscar does not think about that.

J: What about Holmes and Athena?

F: Dogs and goddesses do not pay taxes.

 

Oscar

Here are my ratings for the top reader interests. There are still five open slots, so keep the questions coming.

While no one asked about it, I’m big into trucking this week – think of your power running backs from Alabama. For our purposes the IYT Transport ETF will do. This area has experienced broad-based gains through the last quarter. I’m of the opinion we have some time before we peak. When you come across a 200-day moving average this flat, it’s hard to believe you’ve hit the ceiling.

J: How often do your ratings change? Are these listed in any particular order?

O: Any changes are strictly the result of the stock chart. If the markets change, my ratings will as well. I report the list in order of my strength ratings.

J: Are those like the ratings you use for your fantasy football team? I see that you switched to college football for this week’s column.

O: My fantasy teams depend upon a different algorithm, but it is also a good one.

J: Is that available to our readers?

O: Not unless you give me a raise!

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 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. Each week features a different expert or stock.

Questions

If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a specialty. Who is your favorite? (You can choose me, although my feelings will not be hurt very much if you prefer one of the models).

Conclusion

Human traders are constantly at war with their own emotions. Losing streaks are inevitable – just part of the job.

Our models do not know, of course, when they are in a bad performance streak. Using models is a great way to maintain focus and discipline. That is not, however, the final word. As long as humans remain in control, there will be psychological issues. Is your model still “working?”

Maintaining confidence in your model or trading system is just as important as confidence in your own trading skill.

Stock Exchange: The Experts Like Energy

Technical experts are a rich source of new stock ideas. Our models, Felix, Oscar, and Holmes each specialize in a different time frame and level of risk. Before their weekly poker game, they spend a few minutes trading ideas. They like to call this their “Stock Exchange.” Here is the cast of characters:

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not usually announce new picks, but he will answer questions, saying what he thinks about specific stocks.

Oscar is naturally optimistic and a bit excitable. He definitely likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

Jeff sometimes joins the discussion with some comments about stock or market fundamentals.

This Week’s Ideas

My purpose is to show how different approaches – all sound methods – often lead to different conclusions. Technical versus fundamental, trader versus investor, short-term versus long-term — all make a difference. I hope you will find the weekly discussion interesting and become a part of it.

Each member of the group, independently, comes up with an idea. To my surprise this week was all about energy.

Felix

I am liking oil and gas this week. I particularly like SM Energy (SM). There is a lot of movement and great long-term opportunity for more growth.

 

Oscar

I’m still holding onto Regional Banks, but my latest sector pick is Refiners. Just a glance at this YTD chart for CRAK and you’ll see a strong element of seasonality in this sector. I don’t think we’re anywhere near this year’s peak just yet.

Most stocks in this area have been quietly jogging through this low volatility period, waiting to break out into a sprint. I know I’ll be watching when they cross the finish line. Will you?

Holmes

I do not talk as much as Felix and Oscar, but my stock picks are still ahead of the humans. Last week’s bumpy ride has not changed my bullish outlook. Here is one I bought this week: Solar City (SCTY).

Jeff

The aptly named CRAK focuses on the key element for refiners, the crack spread. This tracks the difference in price between their input, crude oil, and the refined product they sell. When oil prices fell most people missed the opportunity in refiners. One way to keep an eye on this is to watch the forward curve on crack futures. Yes, there is such a thing. The spread declines seasonally into the end of the year, and looks nicely higher net year. Oscar might be disappointed in how long this takes.

Felix seems to think that SM Energy will return to the good old days when it traded 80. Time will tell. In last week’s question about AAPL he thought the chart was too messy, but I liked the stock. I would point out who is leading on that question, but it is best not to talk trash around Felix.

Holmes picked Solar City, which is showing some volatility. Holmes is quick to exit trades that are not working.

Questions

Each week we will answer questions. Feel free to address any of us.

One reader noted insider selling in CAH. This can be an important fundamental factor, more typically when there is buying. Holmes does not consider it because the information is not released quickly enough to be helpful in his time frame.

Another reader suggested that the group needed a female perspective. That is interesting, since there will be a new member of the poker group soon. She is quick-thinking and fast-trading. She knows a good chart when she sees one.

An Important Note to Readers

Felix, Oscar, and Holmes are all models, carefully engineered and tested by one of the leading developers of the last thirty years. They are highly-modified momentum models, with different time frames and features.

I humanize them because it makes it easier to understand the characteristics in their design. I always remind readers that my posts are informational, not investment advice, but special emphasis is needed here. While we are trading based upon all three models, we are always watching and can act quickly when necessary. The models are not suitable for all investors.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned.

Felix, Oscar, and Holmes Talk Stocks

Fans of the Odd Couple know about Felix and Oscar’s regular poker game. While Holmes is a dog, everyone knows that they play poker as well. They have all agreed to take a few minutes away each week to talk with us about stocks. Here is the cast of characters:

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not make any picks, but he will answer questions, saying what he thinks about specific stocks.

Oscar is naturally optimistic and a bit excitable. He definitely likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

To provide occasional representation for those of the fundamental persuasion, I will sometimes include a human in the discussion.

 

This Week’s Ideas

My purpose is to show how different approaches – all sound methods – often lead to different conclusions. Technical versus fundamental, trader versus investor, short-term versus long-term — all make a difference. I hope you will find the weekly discussion interesting and become a part of it.

Felix

I see good value in precious metals. What to buy? Gold or silver? Metals or mining? Royal Gold (RGLD) is an attractive choice.

Question: Felix, what is your opinion of Apple (AAPL).

Felix: Too messy! It is barely acceptable.

Jeff: Earnings and cash will eventually lead the stock price higher.

 

Oscar

“Felix may be in it for the long haul, but there are plenty of ways to cash in faster! There is a football game tonight, for example. But you want to know about stock sectors. My pick of the week is Regional Banks (KRE). They started with an early slump in January but now there is a hot streak – just check the 50-day moving average! I don’t want a floor for my portfolio; I want to blow the roof off!”

 

Holmes

I do not talk as much as Felix and Oscar, but my stock picks are ahead of the humans. This record market has my tail wagging! Here is one I bought this week: Cardinal Health (CAH).

 

An Important Note to Readers

Felix, Oscar, and Holmes are all models, carefully engineered and tested by one of the leading developers of the last thirty years. They are highly-modified momentum models, with different time frames and features.

I humanize them because it makes it easier to understand the characteristics in their design. I always remind readers that my posts are informational, not investment advice, but special emphasis is needed here. While we are trading based upon all three models, we are always watching and can act quickly when necessary. The models are not suitable for all investors.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned (individual banks rather than KRE).

Questions are welcome about both stocks and sectors. I will pass them along.

A Great Time to Invest? Right Now!

As markets make new highs many traders and investors have been left behind. Some are now considering climbing aboard. Fair enough, markets making new highs usually move even higher. Some worry that they have missed a false rally. Mrs. OldProf is encouraging me to keep it brief for a change, so you can just read the statement below if you want. Those who want some reasoning need to go through the rest. I have summarized the most important current issues as briefly as possible.

This is a good time to invest, and an exceptional one if you choose your holdings wisely.

What not to do

  • Do not worry about what stocks will do over the next ten or twelve years. You can and should revise your asset allocations regularly.
  • Do not obsess about the latest list of alleged “headwinds.” There is always such a list.
  • Do not fall for the pseudo experts on the Fed. Explaining markets by Fed actions alone is simplistic and inaccurate.
  • Do not worry about someone saying the stock market is “not cheap”. None of these methods work in real time and the inventors don’t even follow them.
  • Do not pile onto the crowded trades that worked last year. We are at a point of extreme distortion of sector valuations.
  • Do not let your political opinions undermine your investment success.

Ignore Economic Commentary

Most investors cannot distinguish the good from the bad, so it is better to ignore it! Here is why it is mostly biased and inaccurate.

  • Popular sources have media business models based on selling fear.
    • The biggest investment blog makes millions for the owners. Their readers have made even less than the “zero” quoted in their name!
    • Many prolific writers earn subscriptions, conference fees, and book deals with repetitive crash predictions. You know who they are, and probably read them regularly.
  • Many widely-quoted experts are simply pro-bonds, anti-stocks. If someone sells only bonds or runs a research operation for the bond community, you know what to expect.
  • Many noisy commentators are selling high-commission products based upon fear.
    • Read the fine print on “structured products.”
    • Do not get dazzled by the multi-page annuity proposal. The one where you are supposed to initial each page. Email me first for a second opinion.
    • Beware of gold purchases with big commissions and little liquidity. If you want gold, make sure it is a reasonable part of your asset allocation.
  • Election season emphasizes negative sound bites. Candidate competition, and especially parties out of power, want to paint the worst case. This is not a partisan political point; it happens whichever party is in power.

The combination from all of these sources creates a negative picture that is difficult to put aside – especially since part of the story is true.

The Investment Climate

The current climate has two very distinct parts:

  1. Popular. Anything that has an attractive dividend or captures a popular buzz has been bid up to a high price.
  2. Unpopular. Anything that depends upon economic growth and improving prices has been out of favor.

Your Playbook

Whenever there are extremes it represents an exceptional opportunity for the insightful investor. You may never find a better time to buy cheap stocks (on a P/E basis) in cyclicals, energy, materials, technology, and financials.

The new market highs are a bullish sign. The market may move higher, as the astute Eddy Elfenbein is suggesting in this CNBC segment. (In 2010 I predicted Dow 20K rather than Dow 5000, a popular theme at the moment. Eddy suggests that it could happen this year). The anchor acts like Eddy is crazy. It is only an 11% gain from here. CNBC regularly features people calling for market declines of 40-50%. This segment has some good stock ideas as well, including Goldman Sachs, IBM, JP Morgan, and Microsoft.

The media world has turned into a silly competition to present the direst prediction. Some forecasters are determined, for whatever their motives, to scare you witless (TM OldProf euphemism). Those who are bullish are scorned for suggesting that the new highs might lead to another 10% or so. In fact, if you pick the right stocks, the gain could be much greater. I find a lot of stocks that are 25% or more undervalued.

If you do your homework, it is pretty easy to construct a portfolio with a P/E that is significantly lower than the overall market – even sticking to large or mid-cap stocks that anyone might want to own. Apple is an obvious example. Ford? Best earnings ever and the best-selling vehicle. P/E under 7 and dividend yield almost 5%. That is an excellent example of the intense skepticism of this market.

Conclusion

There is definitely a bubble, but not where most think. Look at any stocks in the “quest for yield.”

Even if you do not expect big gains from the overall market, there are plenty of sectors ready for an explosion. It is a great time to invest in stocks, or to improve your asset allocation. You have a lot at stake.

Weighing the Week Ahead: What will higher interest rates mean for financial markets?

Friday’s employment report, rightly or wrongly, confirmed expectations for a December shift in Fed policy. There will be a parade of Fed speakers. We can expect daily discussion about the implications. The punditry will be asking:

What will higher rates mean for financial markets?

 

Prior Theme Recap

In my last WTWA (two weeks ago) I predicted that the market story would focus on the FOMC and a possible change in policy. This was a good guess about the recurrent theme, although there have also been plenty of big earnings stories. To get the full story, let us look at Doug Short’s weekly chart. Doug’s full post discusses the muted effect of Friday’s strong payroll report. (With the ever-increasing effects from foreign markets, you should also add Doug’s World Markets Weekend Update to your reading list).

SPX-five-day

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

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

This Week’s Theme

The economic calendar is modest and earnings season is winding down. The entire market mood shifted with the employment report. A 2015 rate hike that seemed very unlikely two weeks ago has now become the conventional wisdom. Markets made a quick adjustment on Friday, but is there more to come? Providing some help (??) we will have a weeklong series of speeches from Fed Governors and Presidents.

There will be many opportunities to opine on Fed policy and the consequences. Everyone will be asking:

What will higher rates mean for the markets?

Let’s divide this into two themes – the overall impact and specific markets.

  1. Overall we have the three camps we have identified in the past:

     

    1. The market strength rests upon worldwide liquidity. Changing this could halt the rally.
    2. No. Fed policy has done little to help the economy, so gradual cuts will make little difference.
    3. No. As long as rate increases match economic growth, the market will respond well.
  2. Sector effects are quite different, and vary widely.
    1. Bank stocks jumped about 2.8%.
    2. REITs declined.
    3. Utilities dropped 3.5% — almost a year’s worth of dividends in one day.

There are sources taking each of these positions. I expect it to be fiercely debated in the week ahead.

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

 

Last Week’s Data

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

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

The Good

The news of the week was mostly good.

  • Signs of compromise in Washington. A highway bill and extension of the Export-Import bank passed in the House with bipartisan support. The vote was forced via an arcane procedure – the discharge petition – used when committee leadership is blocking a vote. (The Hill) Compromise will be needed to avoid a government shutdown with a deadline of December 11th. (The Hill) Bob McTeer objects to handing the bill to the Fed.
  • Construction spending beat expectations with a monthly increase of 0.6%.
  • Home prices increased 6.4% year-over-year according to CoreLogic. This is more recent (September) data than other measures and consistent with the prior month’s report. (Calculated Risk)
  • ISM non-manufacturing was very strong at 59.1. Steven Hansen at GEI has the full story, with plenty of charts and comparisons. This table is particularly helpful.

77661609ztemp

  • Private employment growth beat expectations. The ADP report showed a monthly increase of 189K private jobs. This is a totally different method from the government surveys and provides useful confirmation.
  • Auto sales were very strong. The sector is “on fire” says Scott Grannis, who notes that the annualized rate of increase is 11% since 2009, 10% in the last year. Bespoke also notes the strength in F-150 sales, an interesting overall indicator.

Auto Sales

  • The monthly employment report was strong. The employment news has so many dimensions that it is easy to spin. This time even the persistent critics had trouble finding a flaw. (Good WSJ summary of the numbers and additional commentary from New Deal Democrat).
    • Headline net job gains of 271K beat expectations by about 90K.
    • Labor force participation held steady at 62.4% and employment via the “household” report increased.
    • The unemployment rate dropped to 5% and below 10% on the U6 measure, which includes discouraged workers and the under-employed.
    • Voluntary versus involuntary part-time employment improved.
    • Average hourly earnings increased – now up 2.5% year-over-year. (Calculated Risk)

WagesOct2015

 

The Bad

There was some negative news as well.

  • Keystone pipeline rejected. The President finally acted on the Keystone pipeline, citing environmental and some economic reasons. I am scoring this as “bad” by using our stated criterion of what is “market-friendly” – not making a judgment of the environmental arguments. Republicans were close to a veto-proof majority on this legislation early in 2015, and probably could have done some horse trading for a few more votes. The proposal might resurface in 2017, depending upon the election results.
  • Initial jobless claims moved higher. The level of 276K is still low by historic standards. The recent week was not part of the survey period for the October job report.
  • ISM manufacturing was barely positive, at 50.1. Flat manufacturing activity is disappointing, even though the result was in line with expectations. Most people do not realize that the manufacturing index can and does signal economic growth even when below 50. According to the ISM, the current report is consistent with economic growth of 2.2%.
  • Disappointing earnings. The worst since 2009, says Bloomberg. Beating on earnings expectations, but not on revenue, says FactSet. They also note that the averages were dragged down by companies generating more than half of their sales outside of the U.S., a 12.5% decline for the group. Brian Gilmartin is more upbeat, noting the distortions of 2008-09 and the recent impact from energy stocks. He sees a current world of stable and consistent earnings growth.

 

The Ugly

Complex, high-commission investment products. There are two in the news this week. Either might be suitable in the right circumstances, but sadly, that is not how they are often marketed.

Josh Brown takes up the non-traded REIT, where the salesperson gets an upfront 7% commission, He cites Simon Lack’s book, Wall Street Potholes, and then adds his own take.

Sen. Elizabeth Warren issued a report on conflicts of interest in annuity sales. Slate has a summary of the concerns, describing both the high commissions and additional perks for those selling.

At the heart of the controversy is a public expectation of a fiduciary interest on the part of the sales rep.

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts.  Think of The Lone Ranger. No award this week, despite the abundance of really bad analysis. I am thinking of starting a nominee section. This would include items that have obvious errors but which have not attracted any replies or refutation. Almost any two-variable chart these days is a candidate.

 

Quant Corner

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

Recent Expert Commentary on Recession Odds and Market Trends

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

Georg Vrba: An array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal. He gets a similar result from the Business Cycle Indicator, updated this week.

Doug Short: Provides an array of important economic updates including the best charts around. One of these is monitoring the ECRI’s business cycle analysis, as his associate Jill Mislinski does in this week’s update. The ECRI story is becoming repetitive and even more unhelpful. It seems too related to commodity prices, and only slightly changed from their failed recession forecast. It would be refreshing to see them do a complete reset and adopt a fresh approach.

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

This week Dwaine highlights a recession “warning” (next September) from his proprietary indicators. Since these have not yet been tested in real time, he recommends a watchful approach before making an official forecast. Read the entire story here.

New Deal Democrat updates a number of long-leading indicators, suggesting no recession before next year’s election. See the full post for analysis.

It is time for another update of Doug Short’s excellent Big Four series, where he tracks the most important indicators used by the NBER in recession dating. Check out the full post for detailed analysis of each component.

dshort big four

 

The Week Ahead

It is a moderate week for economic data. While I highlight the most important items, you can get an excellent comprehensive listing at Investing.com. You can filter for country, type of report, and other factors.

The “A List” includes the following:

  • Retail sales (F). Gasoline savings getting spent?
  • Michigan sentiment (F). Good read on employment and spending.
  • Initial claims (Th). Fastest and most accurate update on job losses.
  • JOLTS report (Th). Getting more attention as an indicator of labor market tightness.

The “B List” includes the following:

  • Wholesale inventories (T). September data, but relevant to final Q3 GDP.
  • Business inventories (F). More GDP impact from September data.
  • PPI (F). Will not have much significance until there are a few hot months.
  • Crude oil inventories (Th). Focus on oil prices keeps this report in the spotlight.

This may be a record week for FedSpeak with at least one person taking a rostrum every day. Expect each appearance to be parsed for a validation of the new expectation of a December rate hike.

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

Felix has remained bullish, and we increased our commitment accordingly. The penalty box indicator remains relatively low, increasing our confidence in the multi-week bullish call. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com. Felix appears almost every day at Scutify (follow him here).

Dr. Brett Steenbarger continues to “bring it” for traders – post after post. This week he has two great articles. One shares his experience in hiring traders for prop firms and hedge funds. He notes two important predictors of success: originality and flexibility.

In the second he emphasizes the importance of intuition – when it works, and when it doesn’t. This counters some recent stories about experts, but I think it is correct and deserving of more study.

Insight for Investors

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

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

Other Advice

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

If I had to pick a single most important article, it would be the KraneShares post, A Tale of Two Chinas. The story of China weakness, with overemphasis on manufacturing, has diminished over the last few weeks. Partly this is because more seem to understand the implications of the changing emphasis in the Chinese economy. This has been crucial in the shift in investor attitudes about the global economy and recession odds.

 

Many China indices have not kept pace with China’s shifting economy and still have heavy concentrations in China’s manufacturing industries. Additionally, many news reports continue to view China’s declining manufacturing numbers as a holistic representation of its entire economy. We believe this thinking was partially responsible for the rise in correlation between traditional sectors and “new China” sectors of China’s economy over the summer. Many investors turned indiscriminately averse to China, which detracted from the stock performance of companies that were otherwise growing healthily.

See the full article for charts and more details.

 

Stock Ideas

Chuck Carnevale’s most recent post for retirement investors is valuable for everyone. He highlights attractive undervalued stocks in the defense sector, attractive and less attractive names in health care, and explains the need for patience when taking a value approach. There are plenty of ideas, charts, and great explanations.

Jack Hough at Barrons.com has some ideas for cheap alternatives to the market-leading FANG stocks. We own two of the three.

Watch out for….

 

Hedge funds – – most not doing well. (Eqira).

 

Bitcoin – Jamie Dimon says that governments will crack down. (Fortune)

 

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for ten year. The average investor should make time (even if not able to read every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. As always, there are several great links, but I especially liked this explanation of why you should keep stock market apps off your phone. Hint: Frequent monitoring is likely to reduce your performance via “myopic loss aversion.”

There is a reason why brokerage firms make trading easy and accessible. And you are not really going to get a visit from Kevin Spacey.

Are you a baby boomer? Kate Davidson at the WSJ has a good explanation of the savings gap facing potential retirees. This chart tells the basic story.

BN-KX481_SAVING_G_20151023155957

Value Investing

Eddy Elfenbein comments on the continuing lag in the value investing approach. With a bow to some academic opinion, he suggests that a lingering 2008 effect on financial index may be spilling over to many of these names. If so, a rising interest rate regime may be positive for these names.

Alpha Architect takes up a similar theme, citing (as usual) some good academic work and concrete examples. Hint: In the long run, three years of lagging performance from a strong method means little. For investor, especially those getting older, it causes them to lose confidence.

Economic Outlook

Neil Irwin (The Upshot at the NYT) conducts an interesting debate – with himself! He raises and responds to the important current economic arguments. He acknowledges and responds to the key worries. Whether you agree or not, it is a good summary of the issues.

Market Outlook

Cullen Roche opines that the bull market is built upon fears of another financial crisis:

What we had early this summer was an environment in which a lot of people were convinced that 2008 was occurring all over again and sold, sold, sold. Meanwhile, the macro data in the USA wasn’t really changing all that much.  Yes, many multinationals are seeing hits to their earnings thanks to weak foreign sales and the rising dollar, but much of this is an energy story.  While blended earnings are down 2.2% year over year, the exclusion of energy from the S&P 500 results in a 5% increase in year over year earnings.  And the energy story is hardly surprising to anyone at this point.  It was priced into energy stocks as oil prices cratered last year.

Callum Thomas charts the story.

CS3PcNnUkAAe55V

Final Thoughts

Friday’s trading provides some clues to the likely reaction of various markets. Here are my (tentative) conclusions.

  1. The impact on the overall market averages will be modest and perhaps positive. (JP Morgan via MarketWatch)
  2. Bonds will (finally) weaken.
  3. Sector impacts will be significant – bad for utilities, modestly bad for other “dividend” stocks, modestly negative for biotechs and story stocks, and good for banks.
  4. U.S. companies heavily reliant on exports will be hurt by a stronger dollar. So will companies making much of their revenue in foreign currencies. The question is whether the dollar will stabilize or continue to strengthen.
  5. Emerging markets will have slightly more competition for investments.

But we should not get carried away. There were significant market reactions on Friday, and the path of increases is likely to be long and shallow. There is plenty of time to adjust positions.

Two weeks ago I stated my contrarian opinion that a December policy shift was still possible, but not important for long-term investors. I expected more of a knee-jerk negative reaction, but the market seems to have been prepared.

Investment Ideas

Rates will increase gradually and in line with economic strength. This suggests banks (I prefer the regional banks versus money center names), technology stocks with reasonable growth, and cyclical stocks priced as if a recession is imminent. Homebuilders will eventually be affected by higher rates, but the prices allow plenty of room to run.

We own stocks in all of these sectors.