Weighing the Week Ahead: The Market Risk from Current Crises

(August 10, 2014) In the past week there has been a dramatic change for the worse in everything we have been tracking in our “Ugly” section. Risks that are generally described with the euphemism of “geopolitical” have become expanded military actions – Ukraine, Gaza, and Iraq. With no sign of an early resolution, the crises deserve additional thought. I expect financial media to ask: How will the “headline risk” from crises affect financial markets? Prior Theme Recap In last week’s WTWA I expected that attention would focus on the Fed and the end of QE. That was accurate only for about two days! World events quickly provided more dramatic stories. We face much the same problem this week. In the absence of a clear economic or earnings theme, the impact from the world’s hot spots become even more important to financial markets. 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. That is the purpose of considering possible themes for the week ahead. San Francisco Appearance I have agreed to speak at the San Francisco Money Show on August 23rd. Here is more information. I am working on some special themes. We will have some fun and also identify some good investment ideas. I look forward to meeting some readers in person. This Week’s Theme The stock market’s small change on the week masked some big daily swings. Doug Short always captures the week in a single great chart. There was pretty strong selling from Monday afternoon through Friday morning, giving the week a very negative feel. Many active traders were satisfied with short positions, which reached peak value during the overnight hours before the Friday opening. The chart dramatically shows how quickly a headline or two can change the markets in the current environment. dshort market week What explains last week’s market action? The answer helps in deciding what to expect in the week ahead. The headlines started on Tuesday afternoon, with a statement by Polish Foreign Minister Sikorski speculating about the meaning of massed Russian troops on the border with Ukraine.

  • Technical factors. Art Cashin (via Barry Ritholtz) argues that the Monday and Tuesday action represented a rally and a failed retest of prior highs. Cashin also notes that gold and oil markets did not react as one would expect in a crisis. He concluded that the Sikorski comments were merely coincidental.
  • Ukraine effects. Others (including Jim Cramer) saw the market reaction as trading directly with the Ukraine news. This viewpoint gained support when Thursday news of a possible Putin “emergency” speech coincided with mid-day selling. There was further support when Friday’s stock rally followed news that Russian troops had “completed” a military exercise.
  • Iraq. Overnight futures declined with news of US air strikes in Iraq.

What does this mean for the coming week? In the low-volume August trading environment, it takes less real news to move the market. This may be especially true during options expiration week. The Schwab team thinks the market has a “binary feel” with the chance of a big move in either direction. Jim Cramer thinks that Putin’s use of sanctions (rather than a military action) is bullish. His sources see this as a sign of an eventual diplomatic resolution. Ian Bremmer, President of political risk research and consulting firm Eurasia Group, thinks that a Russian invasion of Ukraine remains very likely. He sees humanitarian aid as a cover for such an action. Mario Draghi sees the economic impacts from Ukraine as limited, instead emphasizing the possible energy effects from Middle East issues. As usual, I have a few thoughts to help in sorting through these diverse viewpoints. 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 Most of the important news last week was very good.

  • ISM Services did even better than the manufacturing version, hitting a post-recession high at 58.7. Scott Grannis looks at the internals and concludes, “All of this adds to the already-long list of indicators pointing to continued growth and forward economic momentum.” This chart also adds the Eurozone service index:

ISM Service Sector

  • Rail traffic was strong – the best July in history. See GEI for complete analysis and charts.
  • Congressional approval hits an innovative new low. Historically people have had disapproval for Congress as a whole while supporting their own representative. This implied little chance for change even when performance was very poor, especially since incumbents already enjoy a big advantage. Vox highlights the findings, but warns not to expect big changes any time soon.

Own_rep_approval

  • The failure of Portugal’s Banco Espirito Santo is an exception, showing that European banking regulation is getting better. George Hay at Breakingviews contrasts the process and outcomes with the Cypriot bank rescue as well as the bailouts of five years ago.
  • The prime working-age group is growing again. Calculated Risk has an analysis of the demographic trends as well as some helpful charts. He concludes that this is a positive for future economic growth.
  • Earnings growth remains solid. Brian Gilmartin reports on the strong (and almost final) results from Q2 and also notes that, unlike most recent years, the estimates for the rest of the year have not been revised much lower. Brian’s updates are very helpful for investors trying to focus on fundamentals.
  • Banks are easing lending standards. This is part of the answer to the low velocity of money and the high level of excess reserves. The Fed’s QE programs, despite the hype, have not really had the hoped-for impact on economic activity. Commercial lending is especially important. Calculated Risk examines the survey results (See also Sober Look on loan growth) and provides the following chart for commercial real estate (CRE):

SRLoanCRE2July2014

  • High frequency indicators remain positive. Sometimes it is difficult to find the “hook” for the excellent weekly update from New Deal Democrat. I always read it, and so should you. (I wish he had a different pseudonym since some people probably do not give sufficient credit to the economic analysis. I feature a very wide range of perspectives, including economic analysis from conservative Republicans and Libertarians, but these may not be so easily recognized because of the names). This week there is a nice summary of the entire picture. I am going to quote at length, hoping that readers will embrace this source:

    Summary:  There was no big change this week.  All of the long leading indicators,  excepting mortgage applications, were positive, including money supply, bank lending rates, real estate loans, corporate and treasury bonds.

    The short leading indicators also all positive.  The 4 week average for Initial jobless claims is at a decade+ low. Credit spreads have widened slightly in the last few months but remain near their post-recession low. Temporary jobs were again close to their seasonal all-time high.  Commodities were positive. The Oil choke collar has seasonally disengaged. Housing prices still appear to be at or near an interim peak.

    The coincident indicators were mixed.  Two measures of consumer spending was positive, but Gallup has turned negative again.  Steel production was positive, as was rail traffic although less so than recently. Shipping has declined recently but has stabilized.

    Growth for the rest of 2014, and early 2015, looks intact.   But weakness in the housing market evident in the first part of this year may be spreading into the rest of the economy, suggesting that growth will slow down.

  • Bearish sentiment hits a 52-week high. This is viewed as a contrarian indicator, so it is a market positive. Bespoke has the analysis and charts, including this one:

AAII Bearish 080714 The Bad There was also some negative news.

  • Wholesale inventories were disappointing. This is difficult data to interpret. It is noisy and we also always wonder how much is actually planned. Steven Hansen at GEI has a thorough analysis, concluding that it is a mixed picture. I am calling it “bad news” since I expect it to be a negative adjustment to Q2 GDP.
  • US Households are in poor financial shape according to a recent survey by the Fed. Matthew C. Klein at FT Alphaville has a good report, noting the following highlights along with a helpful chart of retirement plans:
    • Among Americans aged 18-59, only a third had sufficient emergency savings to cover three months of expenses.
    • Only 48 per cent of Americans could come up with $400 on short notice without borrowing money or sell something.
    • 45 per cent of Americans save none of their income.

Retirement-plans-2013-SHED1

  • Home price increases are slowing. The CoreLogic data confirms other sources. The year over year increase is 7.5%, but Calculated Risk notes the reduction in the pace of increases and expects the trend to continue. See the full report for details and charts.
  • 1/3 of Adults have Debt in Collection. Jeanne Sahadi at CNN Money has the story.
  • Housing drag on GDP continues. Nick Timiraos of the WSJ highlights five charts – all interesting and helpful. Here is one that illustrates the specific GDP impact:

BN-DY350_GDPRES_G_20140802112237

  • Italy has a triple-dip recession. Much of the concern about worldwide growth funnels through Europe with Italy a major drag – economic performance even worse than Japan. Matt O’Brien at Wonkblog has a good analysis, summarized with this chart:

Italys-Lost-Decade The Ugly Our “ugly” list for last week was unfortunately accurate. We had headline news from all conflicts with plenty of violence and death competing for our attention. The Ebola crisis, cited a few weeks, has spread to Lagos, a densely populated city of 21 million and a center for travel. With a few US cases from foreign travel, Gwynn Guilford at Quartz explains that people should not be “freaking out” over the risk. Check out her thoughtful piece, which corrects a lot of misinformation. (Also great info from Rand). 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. Last week I asked whether readers might point out the obvious problems with this chart: cotd-190 The most important thing to note is that the series begins in the middle of a recession. This should always be a warning, especially when it is a subject like tightness in labor markets. Later in the post I provided the reference to the Washington Post article about favorite FRED charts. This was #4, from Michael R. Strain. As you can see, the current levels are not overly tight by historical standards. John Lounsbury of GEI notes that they covered this truncated chart “behind their wall.” Good work! unemployed to jobs ratio 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 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 includes the most recent ECRI discussion, which has been consistently bearish, including the blown call on the recession. 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. RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. Dwaine’s “liquidity crunch” signal played out as projected. His market timing method is “armed for the next possible long signal.” 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. Georg now has another new program, with ideas for minimum volatility stocks for tax-efficient returns. He also has new advice for those seeking a safe withdrawal rate, now featuring the use of put options to protect against extreme events. Dr. Ed Yardeni also sees little chance of a recession unless the Fed acts much sooner than expected. Neil Irwin of the NYT looks at the GDP contribution of various market sectors, analyzing the main sources of the continuing below-trend growth. Biggest laggard? Housing. Irwin GDP Sectors The Week Ahead We have a rather quiet week for economic data and events. The “A List” includes the following:

  • Initial jobless claims (Th). The best concurrent news on employment trends.
  • Michigan sentiment (F). Watch closely for any rebound from recent weakness.
  • Retail sales (W). Not much expected from this important coincident growth indicator.
  • JOLTS report (T). I am promoting this in importance because it provides information on structural unemployment.

The “B List” includes the following:

  • PPI (F). Inflation is still not a matter of key concern and this report does not yet have much impact.
  • Industrial production (F). A noisy series, but a key element of GDP.
  • Business inventories (W). June data relevant to Q2 GDP revisions.

Earnings news is winding down, but there are still some important reports from retailers. There is only a little reported from the Fed “Speakers Bureau.” Vice-Chair Fischer will speak in Stockholm on the Great Recession and the NY and Boston Presidents speak at a conference on Tuesday. While policy comments are not part of the plan, sometimes questions elicit new information. Breaking news from world hot spots will command attention. 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 turned bearish, but it is a close call with little conviction. Uncertainty remains high – typical for a trading range market. This week we were only partially invested for most of the week and one of the positions is in bonds. Inverse ETFs have positive ratings, but are still in the penalty box. Felix remains cautious, but has not yet gone short. Noah Smith at Bloomberg View warns about blindly following trends. He has a creative example of a strategy that seems to work on that basis (check it out) and this warning as his conclusion:

The moral of this story is simple: The trend is your friend till the bend at the end. Don’t be fooled by it. Sometimes the world really has shifted under your feet, but most of the time the risk is just hidden, and normality is waiting for the chance to reassert itself with a vengeance.

You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com. 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. In addition, be sure to read this week’s final thought. The market has finally provided some volatility. This is attractive for long-term investors who have a good shopping list. We may some position changes and also added to our Enhanced Yield positions (dividend stocks versus near-term short call options). These new positions are best established on down days. Here are some key themes and the best investment posts we saw last week. Looking for the best investment advice? I emphasize this theme, recommending against sources that make macro commentary designed to sell a single product, be it bonds, stocks, gold, or annuities. But what about those who recommend stocks that they already own? Seeking Alpha’s David Jackson explains why this is both legitimate and valuable. I agree about the concept and the value of the comments at SA. It is important to verify and to monitor anonymous authors so that there is genuine accountability.

Shopping lists? Here are some interesting ideas:

  • Cheap stocks with big dividends. YCharts continues the flow of great analysis and ideas with this article.
  • Russia plays? I am not ready to move on this, but it is an interesting theme to watch. At some point there will be news of improvement in the Ukraine conflict. You might miss the initial pop, but there will still be opportunity. The bold could start to nibble early. Here is another YChart article with ideas.
  • Cheap stocks according to CAPE? If you want to use the Shiller method to pick stocks instead of to time the market, here is a list – ten cheapest and ten most expensive — to consider (via Josh Brown).

Worried about market valuation? Many discussions about how to value stocks seem rather biased, emphasizing only part of the story. LPL Financial takes a more careful look at data concerning the length of bull markets and also the oft-cited CAPE ratio.

Investors should not be trying to time a possible market correction. Barry Ritholtz spells it out in plain language, citing all of the bogus catalysts that have preceded the current issues:

Consider the various narratives that have been used as an excuse for a correction. The downgrade of U.S. debt by Standard & Poor’s was going to be a deathblow; it wasn’t. Treasuries rallied on the downgrade, just to prove that no one knows nuthin’. The sequestration of government spending was sure to cause a slow down in markets; it didn’t. Rising interest rates, the Federal Reserve’s taper, earnings misses, and of course, our winter of discontent, were all cited as triggers for corrections. And did I mention the Hindenburg Omen?

The punditry then shifted to valuations: We have heard repeatedly that markets are wildly overpriced, that we are in a bubble. Or if not a broad market bubble, then a tech bubble or an initial-public-offering bubble or a merger bubble. Some advanced the theory that Twenty-First Century Fox’s bid for Time Warner was itself proof of a top.

Evaluating dividend stocks versus bonds is a big question for most investors. This analysis from Alliance Bernstein compares the income from dividend investing to gains from bonds, testing rolling ten-year periods starting in 1968. In nearly all of the cases, investors get back the original capital and earn significantly higher returns from the equity approach.

Equities-2

If you sell near-term calls against your dividend stocks, you can imitate our Enhanced Yield program and collect call premiums as well as dividends. (We will share how we do it if you request info from main at newarc dot com).

If you are worried 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. You can get our report package with a simple email request to main at newarc dot com. Also 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 There is some truth in each of the explanations for last week’s trading. Much of the daily activity reflects the actions of traders who are watching key levels of perceived support and resistance. Trading algorithms parse fees of breaking news emphasizing speed over nuance. Headline risk (in both directions) is great. My sense is that the reciprocal sanction story was a negative for stocks last week. Why? There are direct economic consequences for Europe, and it hit at a time of concern about slowing growth in Italy and even in Germany. Anything that suggests an end to the Ukraine conflict could spark a nice rally in stocks. The other conflicts are all very important in a human sense, but translate into economic impacts only through the effect on energy prices. Steven Russolillo of the WSJ has a nice Friday wrap-up piece explaining why stocks could rally with the world on edge. Dividend stocks like utilities seem to be trading with the bonds — part of what I have called the quest for yield. The lower bond yields seem to be following lower European yields. Those seem to be dropping with the European economic news and the recalibration of the impact of reciprocal sanctions. Some market participants are trading each of these relationships, or at least reacting to the relative value. The potential for extreme volatility can provide an opportunity if you have a plan. Beware of instant experts on geopolitics — all willing and eager to guess Putin’s next move!

Weighing the Week Ahead: Can Earnings Growth Reignite the Stock Rally?

To the surprise of many observers, stocks have survived a series of recent challenges. As Q214 earnings reports starts begin, the questions has changed:

Can strong corporate earnings spark a renewed rally in stocks?

Prior Theme Recap

Two weeks ago I expected that speculation about a market correction would dominate the time before earnings season began. This proved to be accurate, especially when assorted news items were linked to a market decline of more than 50 bps. It does not take much these days to get the financial media excited, e.g. The Dow is down triple digits!! Whoever happens to be on TV at the moment is asked to “explain” the decline.

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. That is the purpose of considering possible themes for the week ahead.

This Week’s Theme

The stock market has successfully shrugged off a series of recent challenges, including the following:

  • A Portuguese banking “crisis”;
  • A front-page New York Times story explaining that all investments are “expensive”;
  • A streak of weak economic data;
  • A series of geo-political concerns – Ukraine, Iraq, and Gaza.
  • Some advice on stocks from Fed Chair Janet Yellen. (See Steven Russolillo’s WSJ piece and Neil Irwin at The Upshot to get some grounding on this issue!)

Doug Short always captures the week in a single great chart. This one shows the resilience last week.

dshort market week

The chart would be even more dramatic if it included overnight futures trading on Thursday. Those of us sneaking a peek or two in the wee hours noted that futures were down “triple digits” on the Dow. More on that subject in this week’s Final Thought.

After surviving these various tests, it may be time to consider the upside. Will earnings growth be enough to propel stocks higher?

Barron’s cites “earnings based optimism” as the source of strength.

Eddy Elfenbein notes that estimates have come down less than we usually see, and also warns about the deviations in various earnings sources.

Brian Gilmartin confirms Eddy’s observation and also notes that we are seeing some revenue beats as well this quarter.

I am not seeing major sources projecting that earnings will be poor, but feel free to highlight such forecasts in the comments. I have some final thoughts, as usual, but focused more on world events than earnings.

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 some important good news last week.

Beat Rate Q214

  • Yellen’s Congressional testimony was market-friendly. Reassuring and no missteps. Whether or not you agree with the plan, investors should take it for what it is. Here are four good takes on the story.
  • Health care spending cost forecasts are improving. The non-partisan CBO shows health care taking a lower share of GDP than projected a few years ago. Health policy remains a hot-button political issue. Everyone on all sides is either assigning blame or taking credit. As investors, we should be interested in facts – especially if worried about the budget deficit. Matthew Yglesias at Vox reviews data from a Brookings study. Here is a key chart:

15_cbo_budget_outlook_fig1-1

The CBO still sees the “risk of a fiscal crisis” without policy changes.

 

The Bad

The important economic news last week was mostly negative.

  • Industrial production missed expectations. Growth of 0.2% is disappointing.
  • Tax inversions will cost the US $20 billion in the next decade unless there is action. (Via WSJ).
  • Housing data missed badly. This included both housing starts and building permits. Calculated Risk is our favorite source on housing. Bill acknowledges the miss, but still sees the single-family data as consistent with his “broad bottom” thesis. To be fair, this has been his viewpoint for many months. He has plenty of good charts, but let’s focus on the bad news from this month:

Starts20132014June

 

ConSentPreJuly2014

The Ugly

The ongoing conflicts and resulting death and injuries. Whether terrorism or war, the issues seem intractable.

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 John Lounsbury at Econintersect for his careful and educational analysis of Japanese machinery orders. Your favorite doomer site (a happy hunting ground for those seeking to win the Silver Bullet) garnered plenty of attention and page views with the “Japocalypse” headline. It is so easy to take a volatile data series and pick a single point out of context. It is especially effective when many see Japan as a good analogy for issues in the US.

John Lounsbury looks at the complete data history, showing both the raw data reports as well as long and short-term trends. His charts tell the whole story, but here is the key summary:

Whether the May readings have any special significance or not will not be known at least until the June data is reported, and probably not known with any certainty until at least three more months are on the books.

In the meantime, terms like “Japocalypse” can be put back on the shelf (under a dust cover) in case they are actually needed later when the long-term wild up and down swings in new machinery orders are ended with an extended move to the downside.

For another side of John, read his post on employer discrimination against Republicans. (If you have any questions about this one, please check the end of this article).

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

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

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 includes the most recent ECRI discussion, which has been consistently bearish, including the blown call on the recession. We included Doug’s chart of the Big Four last week, but data devotees should check it whenever there is a big release. It has now been updated for the employment data.

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. Georg now has another new program, with ideas for minimum volatility stocks for tax-efficient returns. He also has new advice for those seeking a safe withdrawal rate.

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.

The National Association of Business Economists survey puts the odds of a recession in 2014 or 2015 at less than 10% (looking farther into the future than we find comfortable). They also see the date of the first Fed rate hike coming sooner.

 

The Week Ahead

We have a moderate week for economic data.

The “A List” includes the following:

  • Initial jobless claims (Th). The best concurrent news on employment trends.
  • CPI (T). Real concern about inflation is still not imminent, but the recent increase has attracted more attention and comment. Remember that the Fed is seeking an increase and also uses the PCE, which is still benign. If the measures diverge, it will become controversial, so I am promoting this to the “A list.”
  • New home sales (Th). Important driver of economic growth.

The “B List” includes the following:

  • Existing home sales (T). Less economic significance than new home sales, but still a good concurrent read on housing.
  • Durable goods (F). Bounce back in June data expected.

Earnings stories will dominate.

Events in any of the world hot spots could also command attention.

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 turned neutral with confidence reduced. Uncertainty remains high – typical for a trading range market. This week we were only partially invested in one or two of the top sectors for our trading accounts. That remains our position going into the week ahead, although some of the strength is outside of the US.

You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

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. In addition, be sure to read this week’s final thought.

The market still did not provide the “dip to buy” sought by so many. The gentle upward action is fine for long-term investors and excellent for those trying out our Enhanced Yield approach. We added positions in stocks that represented good value with solid income from call premiums.

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

Worried about a market top? Josh Brown provides a short lesson about market tops, comparing key points from the current situation with 2000 and 2007. As he often does, he hits the most important element of the difference, low interest rates and resulting private growth. Barry Ritholtz also has a column showing the huge extremes of investor behavior at market tops and bottoms. (Summary: We are not close yet).

Stock ideas? Some of our holdings have hit their price targets. Unlike some Wall Street analysts we adjust these regularly, not just when they are hit! This means we are always on the lookout for ideas. It is fine to do screening, but sometimes the quantitative rules do not tell the whole story. Here are two sources with some stocks worth considering. Do your own research, as we do.

Morgan Stanley – via Elena Holodny at Business Insider – ideas for the next 12 months.

Larry Robbins of Glenview Capital discussed holdings at ideas at the Delivering Alpha conference.

Portfolio management? Brian Gilmartin explains the role of bonds in adjusting your overall volatility. He illustrates with helpful data from Morningstar. I strongly agree with the idea of understanding and limiting risk. We use both our Bond Ladder and our Enhanced Yield programs to generate some return from the safer parts of the portfolio.

Avoid scams. Read about an FBI Pump-and-Dump scam to learn the signs.

Upside? Richard Bernstein Advisors (HT reader CS) has an interesting explanation for the high equity risk premium: uncertainty on the part of investors and corporations. He has data and charts to prove his point, concluding as follows:

RBA’s corporate motto is Uncertainty = OpportunitySM. Certainty implies risks not anticipated, and potential disappointment. Uncertainty, however, often suggests higher- than-normal risk premiums and investment opportunity.

A broad swath of data, whether focused on investors or corporations, continues to suggest meaningful uncertainty. Accordingly, we continue to believe this may be an elongated cycle that still offers unrecognized investment opportunities.


If you are worried 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. You can get our report package with a simple email request to main at newarc dot com. Also 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

I expect next week’s theme to be earnings, but given current events it is also important to consider world events and risk. Josh Brown, after expressing concern for those suffering casualties, takes the role of the professional investment manager, writing as follows:

Suffice it to say that there is never any more or any less risk of geopolitical threat in the world – there are only changes in perception and the attention paid to the various threats, new and old, that have been with us since the dawn of time.

The notion that there is more uncertainty now than there was last month because of a plane being shot down in the Ukraine or an Israeli incursion into Gaza is both childish and ahistorical. Just because we choose not to be concerned with uncertainty at a given moment – like on September 10th, 2001 for example – that doesn’t mean an outbreak of violence or hostility is any less likely to occur.

So what we’re discussing here now is not a rise in uncertainty itself – but a rise in the awareness of that uncertainty and its subsequent effect on stock prices.

This is very good advice for the average investor, but let me add a few thoughts.

  • Many big world changes – end of the cold war, trade expansion, etc. – take longer and provide a longer recognition period. Cam Hui, who has recently been cautious, asks if this is a modern Archduke Ferdinand. Good question! Read his post.
  • Some events do provide new information. You need to know what to watch. In the current crises that meant chances for a direct military conflict between Russia and Europe or the US, sanctions on Russia that would affect the world economy, something in any conflict that would further increase oil prices.
  • If you know what to watch for, you wake up during the night and check news. For most investors, the specific news would not help.
  • Knee-jerk reactions are usually wrong. Investors who sold on Thursday probably did not get back in on Friday.

     

And most importantly —

If you were frightened about your investments last week, your stock positions are too big. You cannot react logically and effectively if you are paralyzed with fear.

[Final notes – The John Lounsbury piece on discrimination against Republicans is satire – a clever way to show the potential confusion between correlation and causation. I trust that most readers of “A Dash” did not need this help, but sometimes the political agenda gets in the way of clear thinking.

I will probably not write WTWA next weekend, but I hope to do some interim posting.]

Weighing the Week Ahead: Time for a Mid-Course Correction?

After an event-filled 3 ½ day trading week, it is time to pause and reconsider. There is little fresh news in store this week, and therefore plenty of time for calendar-driven introspection.

Is it time for a mid-course correction?

I expect the punditry to assemble the evidence, with each concluding that (s)he has been right all along!

Prior Theme Recap

Last week I expected that plenty of data packed into a 3 ½ day week could lead to some fireworks. While the market move was not overwhelming, the basic concept proved out. Economic data generated repeated upside surprises and stocks pushed to new highs. The theme guess was as good as any, unless you wanted to focus on the Dow 17K party watch.

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. That is the purpose of considering possible themes for the week ahead.

This Week’s Theme

Last week I emphasized the economic themes. In the coming week I expect more attention to stocks. We started 2014 with a wide range of forecasts. With half of the year behind us – and little else to talk about this week – I expect the parade of pundits to review the evidence and consider the possibility of revisions. Let us call it a mid-course correction. Here are the prevailing market viewpoints:

  • The end is near. It will all turn out badly. (These sources are pretty easily found. If you are having trouble, just use The Google to find Schiff, Durden, or Faber).
  • A correction is coming. The main argument is often called “statistical” but is not really based upon statistics. It is merely an observation that the market historically has shorter cycles than we are currently experiencing. (Sources too numerous to mention).
  • QE is ending. Since the market has depended on this liquidity, stocks will now falter. You can easily find a two-variable chart to prove this point. (Check here for a Silver Bullet candidate in waiting).
  • Things are better – the economy, earnings, and future prospects. Take a few minutes and watch this discussion from Rebecca Patterson, Bessemer Trust Managing Director. She has been right on the market and has clients overweight in stocks. She also has advice for those just thinking about stocks. This is a good example of mainstream buy-side thinking.
  • Things can get even better. Jeremy Siegel sees Dow 18K and maybe even 20K by the end of the year. Here is why.

Which of these viewpoints is correct? As usual, I have some thoughts that I will share in the conclusion. I am devoting extra emphasis to investment analysis in this mid-year post (and I might be off next weekend).

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 some important good news last week.

S-P 500 Negative - Positive Preannouncements Q112 2013 Q214 -Jun 30 14

  • ADP private job growth for June was strong – 281,000. Steven Hansen at GEI has the story with both analysis and charts. He has also written that the ADP is actually doing better at measuring job changes than the BLS. I have long maintained that the ADP report should be viewed as an independent measure of employment using a sound but different methodology.
  • Eurozone unemployment remains high at 11.6%. (ABC News). But it was the best in almost two years.
  • Auto sales were strong. Some of this was a rebound from the winter damper on sales, but the run rate has been excellent. Scott Grannis has the story and charts, including this one:

Auto Sales

  • The Official employment report was strong. The spinmeisters were out with their best shots within a few minutes of the data, but this time they are really reaching. The basic take is a net job gain of 288K on the payroll survey and a decline in the unemployment rate to 6.1%. This is good news and was interpreted as positive. In addition, most new jobs have high pay. The idea that more than half of the jobs pay above the average wage should not really be a surprise, but there has been a buzz suggesting that new workers are all burger-flippers. Here is the reality from MarketWatch.

MW-CL448_jobs_p_MG_20140703122843

The Bad

The economic news included some negatives as well. Most of the fresh negatives were small misses in economic data. Feel free to add things that I missed in the comments, but please remember – this is a weekly update focused on fresh information.

  • Overall employment growth still disappoints. It seemed like the sources who reliably paint a negative picture had less to say this month. There are some negatives, and Ben Leubsdorf of the WSJ stuck with solid sources to name three (See also NDD at Bonddad):
    • Average hourly earnings are only up 2% barely matching inflation. Joe Weisenthal notes the positive aspect of this – no wage pressure on the Fed.
    • Labor force participation was unchanged at 62.8%, down from 65.3% a year ago.
    • Part-time employment accounts for much of the gain in jobs.
  • Gas prices are higher than last year and many writers jumped on the theme of the year-over-year increase for holiday drivers. The WSJ says, Gas Prices Wallop Wallets. Those who join us in reading New Deal Democrat’s weekly update of high-frequency indicators know that this is an old story, as he notes:

    The price of gas has been flat for almost three months.  It is slightly above its price of 1 and 2 years ago, but less than its price of 3 years ago.  The 4 week average for gas usage has remained positive for a long time. Typically by now the year’s high price for gas has been set. If so, this will be the third year in a row of a decline in that peak price.  It also means the Oil choke collar is disengaging, despite ongoing turmoil in Iraq.

  • Mortgage and refinance applications are down – back to post-recession lows. New Deal Democrat covers this one, too.
  • F150 sales declined. Bespoke has the story and a helpful chart. They also note that the upcoming release of a new model is a factor. This has been a good read on construction and small business.

F150 June 2014

  • ISM manufacturing and services – both a slight miss. Overall the indexes are still pretty strong. Bespoke has the story and also a chart showing a helpful combination of the data:

070314 ISM SVCS Charts

The Ugly

Ebola. The spread in West Africa is accelerating. There is no cure and a 90% death rate. Health workers are affected, and many local victims actually believe that the health teams brought the disease. (LA Times).

Inside Story

Eddy Elfenbein is a constant source of both wisdom and wit. For this week’s chuckle, see how he takes a pedestrian story (Booze at the Fed) and makes it humorous.

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.

A more careful look shows that the surge in Millennials living at home has been overstated (including my citation as “bad” last week). Derek Thompson (The Atlantic) looks into the Census data and shows that the oft-cited numbers include students living in dorms. (HT Calculated Risk). With the increase in students in recent years, the figures have been distorted. “Almost half of young people ‘living with their parents’ are in college….campus housing.”

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

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

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 includes the most recent ECRI discussion, which has been consistently bearish, including the blown call on the recession. We included Doug’s chart of the Big Four last week, but data devotees should check it whenever there is a big release. It has now been updated for the employment data.

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. Georg now has another new program, with ideas for minimum volatility stocks for tax-efficient returns.

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.

Bob also does a comprehensive analysis of the monthly employment situation report (part of a paid subscription with varying levels). It has plenty of insight that I do not see elsewhere. Taking one key point from this week, let us consider his discussion of part-time employment. This was part of the job gain – jumped on by some to imply that part-time employment was forced. Bob carefully notes that the surge in part-time employment was mostly voluntary, not an increase in the failure to find full-time work. He does this by comparing this year with past June reports. Just as importantly, he tees us up for what might happen in September. This is excellent work that you do not see in the regular media. Here is a key chart on part-time employment:

Dieli part-time

 

The Week Ahead

We have a very light week for real news.

The “A List” includes the following:

  • FOMC Minutes (W). Despite the announcement, the press conferences and the speeches, expect intense scrutiny.
  • Initial jobless claims (Th). Lost in the avalanche of data last week, but still the best fast read on employment trends.

The “B List” includes the following:

  • JOLTS report (T). This report is starting to get some attention, but most still miss the key points. Job openings. Quit rate. This is not a way to back into net job growth, which is done better in many other ways.
  • Wholesale inventories (Th). May data, but still relevant since inventories are the key aspect of the debate over GDP.

This is a big week for FedSpeak. While there is no reason to expect a surprise, the market will pay attention to each and every utterance.

While the financial markets have adjusted to the current Iraq story there is continuing attention to any breaking news. There is also the possibility of further escalation in Ukraine.

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 remains bullish and with a touch more confidence. The positive elements remain modest in strength. Uncertainty remains high – typical for a trading range market. This week we were fully invested in three of the top sectors for our trading accounts. That remains our position going into the week ahead, although some of the strength is outside of the US.

You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

The single best advice I have for traders this week is to read the wisdom of my friend, Dr. Brett Steenbarger. He took a new job and moved away from our home town (Naperville) a few years ago. I miss our occasional discussions over coffee and also his blog. His work requirements prevented him from writing for a time. Brett is back in action, so traders should listen up. His current advice resonates strongly with my own experience. If you are just doing the routine – reading the same material and following the tried and true – you have no edge. He explains why, and what to do about it.

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. In addition, be sure to read this week’s final thought.

The market still did not provide the “dip to buy” sought by so many. The gentle upward action is fine for long-term investors and excellent for those trying out our Enhanced Yield approach. We added positions in stocks that represented good value with solid income from call premiums.

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

Ignore hysterical headlines! Josh Brown provides an excellent case in point, showing a series of headlines designed to attract your attention. The question is whether they are helpful and profitable for the average investor. I cannot even give you a taste without spoiling the story, so please check it out.

Upside rate risk is a concern for interest-sensitive investments. Michael Aneiro of Barron’s quotes BAML’s head of global rates and currencies research, David Woo, who thinks that Chinese buying has served to dampen rates – so far.

Woo doesn’t expect the Chinese shopping spree to persist to the same degree for the rest of the year, however. He sees a combination of slowing Chinese purchases and an accelerating U.S. economy finally pushing yields higher in the second half of the year—perhaps to as high as 3.5% on the 10-year note from the recent 2.6% area.

Aneiro also cites Deutsche Bank’s chief international economist, Torsten Slock, who sees a near-term “non-linear inflection point” for fixed income. See also Alen Mattich at MoneyBeat, Are Markets Underestimating Rate Hike Risks?

 

Beware of chasing returns through market timing. A new study from the St. Louis Fed, Chasing Returns Has a High Cost for Investorslooks at fund flow data, comparing return-chasing behavior to buy-and-hold over a five-year period. The cost of this aggregate chasing behavior was a loss of 2%. It would have been higher if the holding period were longer than five years.

What has worked so far in 2014 and what might be over-owned. Blaine Rollins of 361 Capital does a fine briefing which I read every week. This week he has a good summary of the best and worst ETFs and stocks for the first half of 2014. He goes on to show the sectors that are currently over and underweighted compared to historical averages. See the full post for plenty of helpful tables and charts.

Some people cannot even get started with investing. William Cowie offers some ideas about how to get started. (HT Charles Kirk, whose weekly magazine is always a great source). Cowie analyzes the sources of fear and how to handle it. Be sure to read to the end for the Alaskan pilot story.

What I was afraid of, and what most people who aren’t investing are afraid of, is:

Fear of failure (emotionally: I don’t want to look like an idiot)

Fear of failure (rationally: I don’t want to lose money)

Fear of getting taken (for a ride, or for a fool)

Fear of being exposed as unintelligent when I don’t get it.

Do not try to buy at the market bottom. Here is some amazing research from Ben Carlson. Assume that you only invested within 17% of the market bottom. (If you think anyone can time better than that, you need a reality check). It turns out that the results are not far from buy-and-hold and even worse for some indexes. (Regular readers will note that we cited prior research showing that you did not lose much from investing at market tops).

bottom

If you are worried 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. You can get our report package with a simple email request to main at newarc dot com. Also 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

Of the four candidates listed in the introduction, my conclusions are somewhere between #4 and #5 – the good and the really good. Here is why.

Many pundits have been completely wrong. Those predicting hyperinflation and spiking gold prices have been the worst. Those predicting a deflationary collapse have also been wrong. Many have insisted on seeing everything through the prism of their view of the Fed. When their economic and market theories have failed, they just bash the Fed. (The Fed as a Fig Leaf)

This error will become more obvious as the Fed tapering continues. Remember the questions about “who will buy our bonds?” that were offered a year ago. It turns out that there is a solid market for bonds, which I explained three years ago. Remember how stocks were supposed to collapse as soon as the Fed started to taper? Not happening. As the Fed steps back, the evidence will be clear.

Each of us needs to ask what could make us wrong? What evidence would change our plans?

In my own mid-course analysis I need to ask five things:

  1. What is working as expected?
  2. What is a surprise?
  3. What changes are implied?
  4. What are the biggest risks –What would change my mind?
  5. What is the objective?

I will comment briefly on each, keeping in mind that the WTWA series summarizes conclusions rather than providing the full analysis.

  1. Corporate earnings are coming through pretty well. The multiple on forward earnings is increasing, as I have consistently predicted would happen when earnings confidence increased.
  2. The biggest surprise was the economy in Q1. Economists expect improvement because there are slack resources – both labor and capital. The default trend should be improvement. Q1 was a big miss for those forecasts.
  3. The markets seem to have supported my general thesis. Stocks have improved (but with a big drag) because of earnings. Bonds have also been strong because of weakness in the worldwide economy. I am encouraged that both bonds and stocks have reacted as expected, so my thesis is unchanged. I expect a stronger economy. This means better earnings and higher interest rates. This is dangerous for bonds, bond funds, utilities, and other yield-based investments. It is fine for stocks, as long as rates stay below 4.5% or so on the ten-year note.
  4. The biggest risks include the following:
    1. Geo-political that is not on the current radar – a true black swan.
    2. An increase in the PCE index that was not accompanied by strong economic growth.
    3. Wage increases that were not accompanied by strong economic growth.
    4. Declining profit margins that were not accompanied by strong economic growth and increased revenues.
    5. An increase in the chances for a business cycle peak (the official definition of a recession). Remote at this point.
    6. An increase in financial stress to our trigger point. Remote at this point.
  5. In the absence of a recession, the current economic cycle could continue for much longer – two years or more. Looking at the length of past cycles or a CAPE ratio based on short cycles is no help in this environment. There was a sharp decline and a slow recovery. It would not be surprising to see earnings of $130 on the S&P 500 and a multiple of 18.5 (see chart below). That would be another 20% or so. If it happens, you will read articles explaining that it is completely consistent with past markets, and not even the bullish peak. It would achieve the Dow20K target I introduced four years ago, when many thought I was crazy.

Is it a surprise that the rebound is more gradual? The most difficult investment decisions involve rejecting prevailing wisdom. When everyone is itching to call for a correction, a recession, inflation, deflation, or anything else that will generate page views, it can be difficult to stay the course.

As the economy improves and interest rates rise a touch, expect that new alarms will be sounded. It is important to remember that the first leg up in rates is merely a return to normalcy. JP Morgan’s quarterly guide to the markets is well worth some thoughtful consideration. Here is a key chart. It shows that rising rates are consistent with higher stock prices when the rates are below 5%. As I have often explained, this is because the extremely low rates to which we have all become accustomed are associated with a weak economy and extreme skepticism.

jpm interest rates

To summarize our conclusions, check out Josh Brown’s colorful commentary, including this snippet about those parsing everything through Fed policy:

We were told by many experts over for many years that good economic news – which probably couldn’t be produced anyway – would be bad news once it eventually came.

Well, it’s here and the market likes it. How about that?

Postscript

This post is even longer than usual. The topic is important and the issue is timely. Rightly or wrongly, I have placed more emphasis on the WTWA articles, giving up plenty of Saturdays and not doing as many shorter weekday posts. I am pleased to see that this has earned some professional recognition (#4 and not even counting my vibrant community at Seeking Alpha) in the latest list of blogs by financial advisors. As I look at the list I am delighted to be in this company. So many other investment news sources have an agenda – newsletter, conferences, page views, or sale of a single asset. In sharp contrast, the financial advisors on this list do not benefit unless their clients do as well. Those listed are generally like me – recommending a range of products and finding what best suits a particular client. I do not need a rising market to succeed, and neither do they. We just need to help clients match risk and reward in a way that fits their needs. It is a special group, and I am proud to be a member.