Weighing the Week Ahead: More Clarity from the Market Message?

Do you have an opinion about stocks or bonds or foreign exchange? If so, it is easy to find a market message that will support (or contradict) your viewpoint.

The “message” of the market has rarely been this confused. With plenty of important news and data this week, the theme will be: Can we find clarity in the market message?

Prior Theme Recap
Last week I expected a focus on housing. The short trading week would start with Prof. Shiller (that was right) and end with discussion of pending home sales (also right). In between, there was plenty of filler because nothing much seemed to be happening. I lost count of the number of stories about the driverless Google car – interesting, but not very relevant for the markets.

Forecasting the theme is an exercise in planning and being prepared. Readers are invited to play along with the “theme forecast.” I spend a lot of time on it each week. It helps to prepare your game plan for the week ahead, and it is not as easy as you might think. Feel free to suggest your own likely theme in the comments.

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

This Week’s Theme

What is the “message” of the market? Will it be clarified this week?

Here are three perspectives, from three different markets:

  1. Stocks are at new highs. Historically, stocks have been a leading indicator for the economy, reflecting expectations about future earnings.
  2. Bonds are rallying. Many view this as a sign of economic weakness. Those who are bearish on the economy like to insist that the bond market is “smarter” than that for stocks. Santelli watchers get this viewpoint every day. Cullen Roche offers some alternative concepts. I analyzed several explanations two weeks ago in this WTWA post.
  3. The VIX (the volatility index) is making fresh lows. Most pundits argue that this demonstrates unwarranted complacency. It is a warning to equity investors. (See a good argument at Free exchange. See also Cam Hui for a more nuanced interpretation).

The market message is confused and inconsistent!

As usual, I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

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

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

The Good

There was plenty of encouraging news.

  • Consumer confidence improved. This is the Conference Board version. It usually tracks with Michigan, but not always. Doug Short has good analysis and charts.
  • Chicago PMI was very strong at 65.5. This is the best read on the national ISM manufacturing report. It gets more attention when there is a weekend before the national report. It is good news, but we’ll know a lot more on Monday.
  • Case-Shiller home prices beat expectations rising 1.2%.
  • Capital spending should improve. Even bearish economists note the importance of capital spending. Dr. Ed Yardeni explains the relationship with forward earnings, which continue to improve.

Yardeni capital spending

  • Initial jobless claims improved dramatically. This is a noisy series, but one of the best concurrent economic indicators. It helps us to understand the number of job losses, but we still need to learn about new job creation.
  • Durable goods orders were strong, up 0.8% seasonally adjusted and even stronger on non-adjusted data. Steven Hansen at GEI has complete analysis and charts, including this one:

91184213ztemp

The Bad

There was a fair share of bad news last week.

  • Sentiment is more bullish. This is a contrarian indicator. Bespoke tracks the American Association of Individual Investors series. Their typically fine chart shows the current gain, the biggest jump in more than a month. They also note that it is not yet at the average for the entire bull market – 38.4%

AAII Bullish 053014

 

  • Personal spending declined by 0.1% in April. Personal income growth was acceptable at 0.3% (Calculated Risk).
  • Michigan sentiment disappointed with a final May reading of 81.9. I view this series as important (and not just because I am a Michigan man). My own research shows it to be a good indicator of spending and employment. Doug Short does a regular update of the series which includes my favorite chart. You can find it here.
  • Pending home sales disappointed, with growth of only 0.4%. Sober Look argues that lower mortgage rates will not help. Bonddad remains bearish.
  • GDP declined 1% in the first quarter of 2014. I am scoring this as “bad news” since it was a significant downward revision and GDP is the final measure of economic performance. In fact, the market shrugged off the news. Dan Gross notes the inventory effect (accounting for the entire revision). Personal consumption increased 3.3% and durable goods increased 1.4% despite weather effects. (Hale Stewart). Prof. James Hamilton provides an even-handed take. He notes the weather and the consumption increase, but also observes that part of the spending increase was on health care. Business fixed investment and new home construction declined. “I am still expecting numbers for the rest of the year to come in much better. But there’s no getting around the fact that 2014 got off to a pretty weak start.”

    One way of view the data is in terms of real GDP per capita. This method is recommended by my Scutify jousting colleague Simon Constable in his award-winning book on economic indicators – an excellent reference. (Curiously, I act more like a consumer of data while Simon claims an advantage over the economists he covers as a journalist. Maybe we should switch jobs!) Doug Short does a regular update of GDP in these terms. His fine chart (one of many good ones) shows the sad story of continuing disappointment in the US economy. (Doug’s charts should be classroom examples for those trying to explain data – log scale when appropriate, helpful trend lines, accurate sourcing, good description, multiple variables all clearly included, and helpful callouts.)

    real GDP per capita

     

 

The Ugly

Detroit rebuilding costs. Knocking down abandoned property is an inevitable part of fighting blight in a city that has gone from a population of 1,850,000 in 1950 to 700,000 last year. The abandoned homes will never be used again. Even destroying those leaves problems of lead and asbestos abatement. The cost estimate is $850 million. Fewer than half of property owners pay taxes. 118,000 properties are on track for tax foreclosure, but who will buy them?

There are no easy solutions.

The Silver Bullet

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

This week’s award goes to Paul Kasriel (via GEI), who shows the error in knee-jerk analyses of the unemployment rate. He writes that everyone has been trained to do a quick comparison of labor force participation with unemployment to see if the rate is providing a clear message. This is not enough. He writes as follows:

… (A) decline in the labor force does not always reflect an increase in so-called discouraged workers. And, in fact – well, fact may be too strong a word, but according to data contained in the April Household Employment Survey – the number of people not in the labor force in April but who did want a job changed by a big fat ZERO.

This is something to watch for on Friday.

 

Quant Corner

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

indicator snapshot 053114

Recent Expert Commentary on Recession Odds and Market Trends

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg’s BCI index also shows no recession in sight. For those interested in hedging their large-cap exposure, Georg has unveiled a new system.

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

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured “C Score.” One of his conclusions is whether a month is “recession eligible.” His analysis shows that none of the next nine months could qualify. I respect this because Bob (whose career has been with banks and private clients) has been far more accurate than the high-profile TV pundits.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (2 ½ years after their recession call), you should be reading this carefully. Doug also has the best continuing update of the most important factors to the NBER when they analyze recessions. In general, you need to have a business cycle peak and then a significant decline. In contrast with Bob Dieli’s method, this approach shows a possible peak in some of the elements.

dshort big four

 

The Week Ahead

We have plenty of data this week including the most important reports. The WSJ focus on the big news is helpful – a useful alternative to the comprehensive list.

The “A List” includes the following:

  • Employment report (F). Rightly or wrongly, this remains the most important data for the market.
  • ISM index (M). A sensitive gauge of manufacturing trends with some leading components.
  • ECB policy decision (Th). Important not only for forex, but for stocks and bonds as well. Here is a guide about what to watch. And also here.
  • Initial jobless claims (Th). Best concurrent read on employment.

The “B List” includes the following:

  • ISM services (W). More businesses covered than manufacturing, but a shorter history for the series.
  • ADP employment (W). This measure of private employment deserves respect, and gets it from most Street economists.
  • Auto sales (T). Good read on possible consumer rebound. Watch the F150 indicator of construction activity.
  • Beige book. (W). This is the “color” provided to FOMC participants at the next meeting – anecdotal evidence from each Fed district. Will it confirm the official interpretation of data?
  • Construction spending (M). April data, but an important sector.
  • Factory orders (T). More April data.
  • Trade balance (T). April data, but relevant for Q2 GDP, which will be a subject of great interest.

There will be plenty of FedSpeak and also news from the G-7 Summit in Brussels.

 

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 is a bit more upbeat this week. There are more fresh buys in the ETF universe, including QQQ. The high penalty box level implies less than normal confidence in the ratings. We briefly cut our trading position size during the week, but finished the week fully invested in three top ETF sectors.

The overall call is very close between bullish and neutral. Even in a neutral market there are often good sectors to buy.

Insight for Investors

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

The market did not provide much opportunity for fresh buys. The gentle upward action is fine for long-term investors and excellent for those trying out our Enhanced Yield approach.

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

Doom and gloom sells – like sex, writes Howard Gold at MarketWatch. He is keeping score at taking names! This is so much better than the TV folks who pander to viewers by trotting out these pundits without any reference to past record. He writes:

It draws viewers to TV, eyeballs to websites and buyers to books from “Crisis Investing,” published in 1980, to “Surviving the Great Depression of 1990” to “The Collapse of the Dollar and How to Profit from It” (2008).

The financial crisis and Great Recession created a bull market in doom and gloom. But nearly six years after Lehman Brothers’ collapse, the worst hasn’t happened — unless you consider a 180% advance in the S&P 500 Index a disaster. Which it was, to those who avoided U.S. stocks because they believed the doom-and-gloomers.

So, now, enough time has passed to label certain outrageous forecasts as just plain wrong and to call out the people who made them.

Here are the four worst predictions to gain traction over the past few years.

Regular readers might want to guess before reading!

Could there be a “stealth recovery” in the economy? The analysis from HighTower Advisors includes this interesting quotation from Richard Bernstein:

Bear markets are made of tight liquidity, significantly deteriorating fundamentals, and investor euphoria.  Although the Fed is starting to reverse course, there are no signs yet of a significant tightening of liquidity.  Rather, the data are beginning to suggest that private sector credit growth is starting to replace the Fed as the provider of liquidity

Sell in May did not work. (WSJ). Serial correction forecasters will insist that it is now “Sell in June” or something else. The reality, an answer to my client questions nearly every week:

  1. There will be a market correction of 15-20%. Look at a long-term chart. It is a regular event.
  2. You cannot predict when these will occur and neither can the supposed experts. If you get good evidence on their market timing records, you will see. Check out my post on the Seduction of Market Timing.
  3. Those trying to time this correction have already missed a big move. Ironically, this does not convince them of a mistake. Instead, they are even more determined to wait.
  4. A better approach is to watch the fundamental indicators (recession odds and financial stress) and quit trying to time the smaller swings.

You pay too much attention to financial news. Morgan Housel describes this so well! Here is the daily story:

NEW YORK – S&P 500 companies earned $2.71 billion of net income on Tuesday. $890 million of that will be paid out as dividends, with the remainder retained for future growth.

That’s it. The report would be the same tomorrow, the next day, and the next. Figures would be updated quarterly, but the format wouldn’t change, ever.

This would not be very good for ratings, but it would help your bottom line.

Take advantage of pessimism writes Scott Minerd of Guggenheim partners. After noting the recurring prophesies of doom, he suggests that central banks remain active on the other side. He writes as follows, providing a helpful chart as well:

U.S. and European economic data have been on an improving trend, helping to bolster the outlook for the global economy. As output accelerates in advanced economies, countries around the world should benefit from increasing demand for manufacturing inputs. With the investment cycle turning in the United States and Europe, global trade should accelerate in the near term, helping kick-start growth in some struggling emerging market economies.

Trade data via Guggenheim

 

If you are obsessed about possible market declines, you have plenty of company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. Check out our recent recommendations in our new investor resource page — a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love and use feedback).

Final Thought

The very concept of the market message should be troubling for active investors. If you think that markets are efficient, you are wasting time trying to gain an advantage. If you deny the efficient market hypothesis, what is the point in searching for a message?

Most cite the market message when it supports their viewpoint and ignore it otherwise.

I recommend that you reach your own conclusions based upon fundamental data. Since my indicators show an improving economy and little recession risk, I interpret the strength in bonds as a reflection of other factors – low inflation expectations, favorable comparisons to European yields, and traders caught “offside” on the bond trade. (I sympathize with that!)

To the extent that the message is inconsistent, I expect yields to rise over the remainder of the year. I do not see “complacency” in the stock market. It is better described as an uneasy balance of nervous viewpoints on both sides.

And by the way….so many treat the VIX as an indicator rather than a market. That is an error. If you really believe that the VIX signals complacency you can step right up and buy options on the underlying stocks or else the VIX itself.

Why would anyone think that the options market is less sophisticated than that for stocks or bonds?

Weighing the Week Ahead: How Should Investors Judge the Prospects for 2014?

Sometimes the calendar of news and events makes it easy to predict what will grab our attention in the week ahead. In the last few weeks leading up to the Fed tapering announcement, I highlighted the following:

I certainly don’t always get it right, but it has been a pretty good run.

The accident of the calendar, mid-week holidays for two consecutive weeks, has created an extended vacation for many market participants. There is little earnings data or important reports, but plenty of football.

The field is open for pundit prognostication!

The predictions cover a wide range, including one featured columnist who sees a 90% chance of a market crash. There is another series on how to prepare for a total collapse, including a link to a survivalist “grab-and-go” bag. I am not including it here, since I clicked on it myself and it now pops up on every page I visit! (Amazon is sold out, at the moment…. Hmm).

How should you navigate the varying forecasts?

  • Consider the track record. Anyone can improve, but sometimes it requires accepting new data. You can start with my featured “hot and not” list for last year. There are some sources that just do not understand earnings, the economy, and the Fed. It is past time to tune them out.
  • Try to find balance. Seeking Alpha is once again drawing upon a range of sources to help individual investors. I always find this to be a balanced and helpful source and I hope to contribute again this year.
  • Demand data, not examples. Do we really care how many times a big market year was followed by another, going back to the Taft Administration? These are anecdotes disguised as data.
  • Look for some reasoning based on economic fundamentals and data, not just vague opinions. In particular, ask if the analysis fits where we are in the business cycle.

To start your thinking, Andrew Thrasher suggests that we are just entering Stage 4.

Im-10-cycle

I have a little more to suggest in the conclusion. First, let us do our regular update of the last two 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, including some you have not seen elsewhere.  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. Each week I consider the upcoming calendar and the current market, predicting the main theme we should expect. This step is an important part of my trading preparation and planning. It takes more hours than you can imagine.

My record is pretty good. If you review the list of titles it looks like a history of market concerns. Wrong! The thing to note is that I highlighted each topic the week before it grabbed the attention. I find it useful to reflect on the key theme for the week ahead, and I hope you will as well.

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

Most of the recent news continues to be good.

  • Q4 earnings still look good, according to earnings expert Brian Gilmartin. He has been very accurate, using both forward earnings and actual reports as part of his regular analysis. Concerning the upcoming reports, he writes as follows:

    What is fascinating is, the q4 ’13 earnings warnings seem pretty dire, as CNBC has detailed, but the expected q4 ’13 earnings growth rate for the SP 500 as a whole, is now projected to be 7.6% as of this week’s “This Week in Earnings” published weekly by Thomson Reuters, which is the HIGHEST rate of expected earnings growth to start a quarter since q1 ’12. The fact is q4 ’13 will be quite robust when companies begin reporting in 2 weeks.

    Our estimate for q3 ’13 earnings growth of 7% – 8% was right on, and we now expect the 4th quarter of 2013 to be plus 10% by the time the 4th quarter is fully reported by mid-March ’14.

  • LA port traffic shows solid growth. (Via Calculated Risk).
  • Durable goods orders surprised on the upside. (Via Steven Hansen).
  • US oil production is surging – good news on the surface. James Hamilton explains why this will not necessarily translate into lower prices. Essentially, it is offsetting prior tight supplies and there is more demand from emerging markets.

Oil_price_proj_dec_13

  • Q3 GDP was revised higher, to an annual rate of 4.1%. The biggest factor was increased consumer spending. Inventories still constitute a big component, whether by accident or design… a big question. Most analysts are now upping their estimates for Q4. (See analysis at Calculated Risk, Doug Short and Steven Hansen at GEI, and Ed Yardeni on inventories.)
  • Initial jobless claims dropped. I am registering this as “good” but it is a complex and noisy story. Doug Short’s fine analysis and charts help to clarify a complex story. See comparisons that help you navigate the seasonal adjustments and other noise. Meanwhile, here is a key chart:

Dshort Jobless Claims

The Bad

There has not been much bad news over the last two weeks. Feel free to suggest items in the comments

  • Investment sentiment remains very bullish, generally viewed as a contrarian market indicator. Bespoke analyzes the AAII series, where bulls are over 50% for the first time since January.

Aaiibull1226

  • The Budget Deal may be overrated says Stan Collender in his 5 myths story. The myths include some conclusions that I have featured here, so readers should take a look at what this former staffer and current consultant has to say. Over the last two years I have been more accurate than he has, but I always read his work with respect.
  • High frequency indicators are still positive, but softer, according to New Deal Democrat. NDD’s weekly commentary has moved to XE.com but it still includes a fine summary of important data you might otherwise miss. Some soft spots he cites this week are money supply growth (M2) which is below the desired economic trend and weakness in steel production. I always read the entire post, and so should you.
  • Dodd-Frank will be futile according to departing CFTC Commissioner Bart Chilton. He describes Wall Street’s four-pronged strategy, the D.C. Quadra-Kill. (Defeat the bill, limit funding, negotiate on regulations, and litigate). William D. Cohan at Bloomberg has a great story.
  • Personal income growth has been disappointing. Steven Hansen has a good analysis, featuring this chart:

Fredgraph

The Ugly

Holiday shopping SNAFU’s. We still do not have the final verdict on the brick-and-mortar shopping season, but we know it was affected by calendar compression and cold weather. The online experience was disappointing for many, as last-minute purchases did not arrive as promised. We still do not know the economic effect on retailers, who may have to issue some refunds. Or else! So says Sen. Richard Blumenthal.

Another disturbing retail story is the hacking of Target’s credit card data. The immediate reaction was to limit some debit card transactions right during the shopping season. Target claims that the hackers cannot break the “strong encryption” of the pin data, but many are not taking any chances. Blumenthal, former Connecticut Attorney General, is weighing in on this issue as well, offering Congressional cooperation with the FTC.

Silver Bullet

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

This week’s award goes to Paul Krugman and John Lounsbury. While most of us are enjoying the holidays, John is reading Krugman papers from six weeks ago! I know that many readers just tune out anything from Krugman, but this is poor practice for investors. One of the key stories of the year has been the austerity debate and the flawed work of Rogoff and Reinhart – still continually cited by those who think you are uninformed. A key question is whether there is a debt “trigger point” that causes a decline in economic growth. Once again, I care as an investor, not as a voter – despite the politically charge that has been applied to the issue. So here are the facts in two charts.

The first shows the relationship with Japan as an outlier.

51062179debt-interest-rates-krugman-fig.1-2013-nov

The second shows the members of the EU with a different marker.

6981316debt-interest-rates-krugman-fig.2-2013-nov

See John’s post for the full explanation about why it helps to have your own currency.

The Indicator Snapshot

It is important to keep the current news in perspective. I am always searching for the best indicators for our weekly snapshot. I make changes when the evidence warrants. At the moment, my weekly snapshot includes these important summary indicators:

  • For financial risk, the St. Louis Financial Stress Index.
  • An updated analysis of recession probability from key sources.
  • For market trends, the key measures from our “Felix” ETF model.

Financial Risk

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 recently edged a bit higher, reflecting increased market volatility. It remains at historically low levels, well 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 Odds

In 2014 I will have a new format for this section. It is important, but the changes occur slowly and require more highlights. Suggestions are welcome.

I feature the C-Score, 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 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.  RecessionAlert has developed a comprehensive package of economic forecasting and market indicators. Their most recent report provides a market-timing update for those considering whether to “buy the dips.”

Georg Vrba’s four-input recession indicator is also benign. “Based on the historic patterns of the unemployment rate indicators prior to recessions one can reasonably conclude that the U.S. economy is not likely to go into recession anytime soon.” Georg has other excellent indicators for stocks, bonds, and precious metals at iMarketSignals. His most recent update revisits Albert Edwards’s year-old prediction that the Ultimate Death Cross was imminent. Georg refuted the claim at the time, and now takes a more complete look.

Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverageof the ECRI recession prediction, now more than two years 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. The ECRI approach has been so misleading and so costly for investors, that I will soon drop it from the update. The other methods we follow have proved to be far superior.

Readers should review my Recession Resource Page, which explains many of the concepts people get wrong.

Here is our overall summary of the important indicators.

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.  Over the last three months Felix has ranged over the full spectrum – twice! The market has been moving back and forth around important technical levels, driven mostly by news. The current values are now neutral. There are still many positive sectors, but few with real strength.

Felix does not react to news events, and certainly does not anticipate effects from the headlines. This is usually a sound idea, helping the trading program to stay on the right side of major market moves. Abrupt changes in market direction will send sectors to the penalty box. The Ticker Sense poll asks for a one-month forecast. Felix has a three-week horizon, which is pretty close. We run the model daily, and adjust our outlook as needed.

The penalty box percentage has increased dramatically, meaning that we have less confidence in the overall ratings. 

[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

There is a little data –some important – in the holiday-shortened week.

The “A List” includes the following:

  • ISM manufacturing (Th). Important concurrent economic indicator.
  • Initial jobless claims (Th). Best fresh data on employment.
  • Consumer confidence (T). Good read on both employment and consumer spending.
  • Auto sales (F). Growing attention as recent increases fuel economic growth.

The “B List” includes:

  • Pending home sales (M). Housing remains crucial for the 2014 economic outlook.
  • Case-Shiller home prices (T). Slightly lagging data, but widely followed.
  • Chicago PMI (T). Probably the best regional series for predicting the national number, out two days later.

The American Economic Association annual meeting will feature presentations by several Fed presidents and Chairman Bernanke. Some of these will occur on Friday and others on Saturday. There may also be advance copies available. With continuing quiet trading, some will try to squeeze out some fresh Fed news.

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 in neutral, although we are still mostly invested in the top two sectors. Felix’s ratings have been in a fairly narrow range for several months. The rapid news-driven shifts are not the ideal conditions for Felix’s three-week horizon. This week we see somewhat higher ratings, and many sectors in the penalty box. There are still two attractive sectors, and we may add to positions in the week ahead.

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. Each week I try to highlight something special for the long-term investor.

I try to refresh the concepts and ideas each week, emphasizing the best themes from my reading. My overall recommendations do not change as rapidly – nor should they. I am considering some format changes for next year, helping to highlight the specific new recommendations.

One of my major themes for the year has been the “great rotation” from bonds to stocks. This has three aspects:

  • Bond yields are so low;
  • Bond prices have fallen, leading to absolute losses for conservative investors;
  • Stocks have surged.

This should not have been a surprise for those paying attention. It is just getting started. As he often does, Josh Brown captures the main theme in this post about the rotation. He is quoting the chief market strategist at ConvergEx Group:

In short, the trade in 2013 has been out of munis and gold, and into the world’s stock markets.  Look a little deeper, and the headline becomes “Mutual fund buyers are finally back”.  Just 2 years ago the U.S. mutual fund investors were net sellers of financial assets, to the tune of ($27.5 billion).  The year 2012 saw them tiptoe back, with positive flows of $117.6 billion, but still redeeming stocks for bonds.  This year inflows are $164 billion with two weeks or so remaining and substantially all of that into stocks.

This rotation is just getting started. Our own themes are the same, but I will also do a “year ahead” preview pretty soon.

Here is a summary of our own current recommendations for the individual investor.

  • Headlines. The challenge for investors is to distinguish between the major trends and the short-term uncertainty. The main themes are not related to headlines news, even though sentiment may drive market fluctuations. Do not be seduced by the idea that you can time the market, calling every 10% correction. Many claim this ability, but few have a documented record to prove it. Most who claim past success are using a back-tested model. Please see The Seduction of Market Timing.
  • Risk Management. It is far better to manage your risk, specifically considering the role of bonds and the risk of bond mutual funds. As I emphasized, “You need to choose the right level of risk!” Right now, it is the most important question for investors. There is plenty of “headline risk” that may not really translate into lower stock prices. Instead of reacting to news, the long-term investor should emphasize broad themes.
  • Bond Funds are Risky. Investors have been surprised at the losses, which will continue as the long end of the interest rate curve moves higher. You need to have the right mix of stocks to benefit from a rising rate environment.
  • Stepping in gradually. If you are completely out of the market, you are not alone. Consider buying dividend stocks and selling calls against them. This strategy has been working great both for our clients and for many readers. (Thanks for the email responses!) This will work in a sideways market. You can also buy some stock in the sectors with the best P/E ratios.

And finally, 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

It would be silly to predict the market in the final week of the year, with tax trading and window dressing in the first two days, and “new” positions in the last two.

My general sense is that many are still looking for an entry point. I was impressed (negatively) by a Barron’s columnist this week. After noting the 2-1 odds that stocks would be higher (which I have already suggested that you ignore) he emphasizes the 33% chance of a decline. OK.

Then he dredges up a list of warmed-over worries that might resurface. OK.

This is all true, and might happen. But get the final stanza:

Still, the biggest risk to the U.S. could be the gift that has topped our wish list for years: a much stronger economy, which could ignite inflation and force the Fed to hike interest rates sooner than expected. It’s getting hot out there: Sales of durable goods and new homes have been much stronger than forecast.

While the Fed’s favorite inflation gauge, the PCE deflator, remains stuck near 1%, the GDP price index rose at an annual rate of 2% during the third quarter, suggesting inflation might be running higher than policy makers expect, says Michael Shaoul, CEO of Marketfield Asset Management.

Should that prove the case, the Fed’s plan to gently reduce its bond-buying, which will start next month with a $10 billion taper, would be thrown into disarray. The pace of the taper would have to increase, and an interest-rate hike could come quickly. “Everyone wakes up, the Fed is miles behind the curve, and everything needs to be torn up,” Shaoul says. “That’s when you go through a 1994- or 1987-style adjustment.”

In other words, on the one hand there are a lot of economic risks. If these are avoided and things get better, the Fed will bring it to a swift end.

I strongly recommend that investors ignore pundits whose analysis has no provision for “buy.”

Weighing the Week Ahead: Lessons from 2013

This is a special edition of Weighing the Week Ahead.  With holidays and market closings in the middle of the next two weeks, we can expect a time of relative quiet.  It is a good time to review the lessons from 2013.  I'll have a regular WTWA next week and (soon) my regular preview of the year ahead.

Here is a pictorial review of 2013 from the perspective of the individual investor.  It is not based upon page views or ratings, but rather upon the economic, market, and public policy themes that could have helped you the most.

I managed to stay on the right side of most of these trends, and I hope you did as well.  Here are the most important trends of the year — what was hot versus not and especially profitable versus costly.

The winners next year might be different, and some who lagged this year will remain in denial.  I strongly recommend that you consider each comparison with an open mind.

Disagree?  Other nominations?  That is fine.  Join in the comments!  This is my scorecard, but I welcome dissent and discussion.  I am including a few links, but in most cases the verdict should be obvious.  I hope everyone enjoys this as much as I did in working on it!  Slide12

It was a "risk-on" year.

Slide17

Mr. B knows how to have fun!  Who's that guy he is playing against.  Here was his advice about gold, going "long on fear."

  Slide6

Doug Short's charts make the data speak to you.  There is no higher praise.  Selling short?  Not so good last year.

Slide14

Fundamentals, represented by Chuck Carnevale and his relentless theme — Earnings Determine Stock Price — triumphed over the gadgets, seasonality, waves, and omens.

  Slide8

Kelly Evans is intelligent and informed, reaching to a larger audience–the winner from Maria's departure.  Rick Santelli's message still gets the background cheers, but the audience is shrinking, perhaps because he has been so wrong.

Slide1

Centrist compromise versus the liberal wing.

Slide3

Centrist compromise versus the Tea Party wing.

Slide2

Disciplined forecasting method gaining widespread recognition.  Owning silver?  Not so good!

Slide13

Being rich and having a lot of assets under management does not assure success.  You are as good as your last trade in the big-name hedge fund business.

 

  Slide7

Understanding the business cycle is really important.  Many economists know that the ECRI has been wrong – -more than two years past the 100% forecast, and still not giving in.  I am featuring Bob Dieli since he focuses on the full business cycle and has been calling it right in real time for more than 30 years.  More here.

Slide11

We all know and use Twitter.  The Columbia Journalism Review explains about the sad decline of longform.

Slide4
Josh Brown keeps bringing it no matter how many characters he has available.  He has exceled on Twitter, blogging, and TV.  Downtown Detroit?  A sad story for the city of my roots.

Slide5

Two respected economists were bearish.  One kept his indicators and changes his opinions (See fine Ritholtz discussion).  The other kept his opinions and changed his indicators.

 

  Slide10

Professor Shiller has a Nobel prize and some new gigs as a partner in equity funds.  These new projects do not involve market timing using his famous CAPE ratio.  There is a growing realization that when something has not worked for several decades, it might be time for a review.

Slide9

Musk acclaim is well-deserved.  Johnson had good ideas for the wrong company at the wrong time.

Slide15

Stimulus triumphed over austerity.  A big surprise is that the true believers keep quoting Rogoff and Reinhart without any awareness of the errors.

Slide16

The choice of Congress for the final "not hot" award will not be controversial.  I understand that Bernanke has been a polarizing figure.  Many believe that it will all end badly.  For 2013 they were wrong, and those of us who did not fight the Fed were right.

 

Will Janet Yellen bat cleanup in this post next year?