Weighing the Week Ahead: An End to the Tapering Obsession?

Over the last two weeks we have had an avalanche of economic data – mostly good news. The market reaction has been mixed, because so much of the "hot money" has a Fed fixation. For much of the last two weeks, every piece of good economic news led to lower stocks, presumably because this would lead to a reduction in QE. Finally, the good payroll news on Friday got the opposite reaction.

The question for the coming week – and maybe the next few months – is will "good news" finally be good news? Put another way,

Will the fixation on the "T word" finally come to an end?

The media, increasingly catering to their trader audience, plays into the constant focus on the Fed. This allows everyone to join in, but it has not provided much actual help for investors.

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

Background on "Weighing the Week Ahead"

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

In contrast, I highlight a smaller group of events, 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 has been very good.

  • China's PMI of 50.8 shows expansion and represents a new recent high.
  • Congress seems to be nearing a deal on the budget. This will avoid another round of debt ceiling and shutdown crises, and it may even open the door to immigration reform. (See The Hill). It will not represent a "grand bargain" which might still be five years away. (See Stan Collender for ten reasons).
  • GDP was stronger than expected in Q3. The revision was mostly the result of inventory buildup, which invites spinning. Bob McTeer is well aware of this issue. It all depends on whether the inventories represent intentional accumulation for anticipated sales, or disappointing current performance.
  • Employment is improving. The weekly jobless claims hit a new low. The monthly employment situation report shows a nice rebound with growth in the household survey and a lower unemployment rate. We are still far from resuming trend growth, but it is an improvement and certainly belies any lingering recession worries. Scott Grannis has a nice summary, including a chart of both the major surveys. He also puts to rest the part-time employment argument, writing as follows:

    Despite what you might have heard repeated many times in the media, jobs growth in the current recovery has not been dominated by part-time jobs. As the chart above shows, there actually has been zero growth in part-time jobs since the last recession, and the ratio of part-time to total jobs has been falling steadily, much as it has in every recession in the past.

Private Nonfarm Employment

Yardeni indicators

  • Michigan sentiment was very strong. I view this as an important concurrent indicator both for employment and consumption. Doug Short's chart is my favorite and his analysis is excellent.

Dshort michigan

  • Housing still looks good – new home sales and permits. See the authoritative work from Calculated Risk.

The Bad

There was not much bad news. Feel free to add suggestions in the comments. These should be items from the current week, not the repetition of something you could have said (and probably did) six months ago!

  • Personal income disappointed, declining in real terms. See Steven Hansen's analysis.
  • The ISM Services index was positive, but below expectations.
  • Holiday sales were soft for some retailers – at least from the early reports.
  • Investor sentiment remains very bullish, a contrarian short-term indicator. Bespoke charts the AAII data:

AAII Bullish Sentiment 112913

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. Thanks to the many readers who wrote or commented suggesting that my analysis of the Morgan Stanley chart on forward earnings should be this week's winner. I cannot give myself the award, but I do urge readers who missed the article to take a look. It was like a movie that got critical acclaim but did not attract a big audience.

Ironically, the original chart I was analyzing pretty much went viral.

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

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 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 two 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 still bullish, but only marginally so.

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 decreased dramatically, meaning that we have more 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

After the post-Thanksgiving data feast, we have a relatively thin week for new data.

The "A List" includes the following:

  • Initial jobless claims (Th). Resuming a key role as the most responsive employment measure.
  • Retail sales (Th). The consumer remains a focal point.

The "B List" includes:

  • PPI (F). Inflation data remains tame, so this is not likely to move the markets.

The speechmaking schedule is still thin. James Bullard of the St. Louis Fed will speak on Monday. Secretary of State Kerry will testify before a Congressional Committee on Tuesday. We will also get more news on the developing budget deal.

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 continues in bullish mode. In our trading accounts we have been fully invested and the positions have gradually become more aggressive. 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 lower ratings, but more sectors in the penalty box. There are still three attractive sectors, but it would not be surprising to see a move toward "neutral" in the week ahead.

Felix gets credit for identifying biotech (IBB) and riding the wave. This has been one of the top-rated choices in our free weekly email update (email address in the "Felix" section above.

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. I am covering some detailed ideas and links in this section, but also see the conclusion.

There is a continuing barrage of "bubble talk." It seems like there is a drumbeat of stories with the same bearish themes, mostly relying on the Shiller CAPE P/E method of valuation and also the argument that profit margins are elevated. These are both rather old and tired arguments, but the refutation gets little publicity. Worried investors should take a few minutes to read these two sources:

Macro Man – analyzing a number of bearish arguments. The entire article is great, but let me focus on the issue of profit margins, where he writes as follows:

[Argument] Earnings as a percentage of GDP are too high. They will revert back to the long term mean, which means substantially lower profits.

That is only true if you look at TOTAL earnings. DOMESTIC earnings are NOT excessively high as a percentage of GDP. Much of the recent earnings growth over the past decade has actually come from abroad:

Image002

Jeremy Siegel, who has been absolutely right about the market, both for the very long term and for the current year. Advisor Perspectives Editor Robert Huebscher had a fine recent interview where Prof. Siegel explains why the market is 10-15% undervalued right now, and has the potential for working significantly higher. He especially responds to arguments based upon his friend Robert Shiller's CAPE ratio, profit margins, and Fed policy.

Here is a summary of 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

We are reaching the end of a year when many scary possibilities did not occur. Since these many scenarios weighed on stocks, it was natural to see a rally driven both by an improved economy and earnings as well as a reduction in fear. Those who attribute everything to Fed policy are simply making excuses for their bad forecasting as I noted in The Fed as a Fig Leaf.

The classic wall of worry concept, which you can learn more about on my investor page, was nicely illustrated by this chart from LPL Financial (via Cullen Roche).

LPL2

If we had nothing to worry about, the Dow would already be at 20K, fulfilling my prediction. I am looking forward to a time of less emphasis on the Fed and more attention to market fundamentals.

Weighing the Week Ahead: Will Consumers Open Their Wallets?

Over the last few weeks I have highlighted several changing market concerns. We worried about the government shutdown and the debt ceiling. More recently my emphasis has moved from earnings and seasonal worries, to the possibility of a year-end rally. Last week we highlighted the "bubble talk" and that proved to be a big theme.

This week the focus will change. With the start of the year-end shopping season, it will be all about the consumer.

Can retail sales hold up in a shortened shopping season?

There are three basic viewpoints:

There is a lot of guessing going on! I am pretty confident that this will be the focus, but not very sure about who is right. I agree with Scott Grannis, who notes that retail is far below trend, especially if one evaluates the "core" purchases (removing autos, building materials, and gas stations). Here is the key chart:

Control group

I will speculate a bit more in the conclusion. First, let us do our regular update of last week's news and data.

Background on "Weighing the Week Ahead"

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

In contrast, I highlight a smaller group of events, 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

This was a light week for news, but what we saw was pretty good.

  • Household debt hit a new low. This has been a preoccupation for many. See Bonddad for a complete analysis and a helpful chart.
  • Rail traffic shows continuing strength. Todd Sullivan has the story, analyzing the chart below:

Screenshot_42

  • Negative equity in homes is lower. (Zillow via Calculated Risk).
  • Truck traffic is strong on a year-over-year basis. (Via Scott Grannis – analysis and chart).

The Bad

The news updates were thin. I did not see too much, but feel free to add suggestions in the comments. These should be items from the current week, not the repetition of something you could have said (and probably did) six months ago!

  • Fed minutes. The market sold off a little on the theme that QE tapering would start sooner than expected. I do the weekly scoring based on what is "market-friendly" regardless of my own take. Since interest rates moved higher and stocks lower, this has to be regarded as "bad" news. It is an advantage for investors to look a bit deeper. Scott Grannis shows that rates have actually moved higher during QE. I do not think it matter than much to the real economy, so I wish we could get it started and get beyond the rhetoric.
  • Sea container counts are weaker. (Via Steven Hansen at GEI).

Z container1

A Time to be Thankful

Like most people, I count my blessings at this time of year.

It has been a good year for us. While I have tried to do my best, I am grateful for the support of family and friends. In my work on "A Dash" I have benefited greatly from the comments and email support from readers, whose contributions encourage and inspire. I appreciate the fine work of those whom I read and cite each week. I enjoy a fine relationship with several sources who republish our articles, especially the team at Seeking Alpha, where I seem to have a lively community discussion each week. Finally, there are those who mention my work in their own posts and on Twitter. For an unpaid writer, this is important validation.

I note that my Twitter audience — @dashofinsight — is far below the top 5. Think Lady Gaga or that Bieber guy — but one has to start somewhere!

I will be enjoying family and doing some travel next weekend, so there might not be a WTWA post, or it might just be an indicator update.

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. (Thanks to reader CS for this suggestion).

This week's award is a little complicated. Dan Greenhaus of BTIG debunked the chart below and was featured by Joe Weisenthal. Greenhaus wrote as follows:

Indeed, we recently devoted an entire conference speech to pushing back on the idea of an equity bubble. How do we know the story remains? The chart below, overlaying the S&P 500 today against equities in the 20s/30s is now starting to make the rounds. Without getting too personal, "chart overlaying" is lazy and this is no less so. But it does remind us that as much as everyone thinks everyone else is "all bulled up," these views still persist and have shown no indication they are going away any time soon.

Screen shot 2013-11-22 at 5.43.20 am

This was good work, exposing a typical bogus chart, but there was much more to the story.

It turns out that the original source was Andrew Wilkinson of Miller Tabak. He did the work to normalize the data, generating equal percentage changes. The result is a chart that is a fair comparison of the two periods. Business Insider also covered this story, in a nice post by Steven Perlberg and Andy Kiersz. Here is the comparison chart from Wilkinson's original piece:

Untitled-134

The entire story illustrates one of the drawbacks of modern social media. People take something out of context and pass it around. The average person sees the message at face value.

This may be our most complicated "Silver Bullet" story, but I found it fascinating. There was a lot of good work. Sadly, my guess is that most recipients of the bogus chart never saw the refutation.

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

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 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 two 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.

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 decreased dramatically, meaning that we have more 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

All of this week's data will be announced by Wednesday in this holiday-shortened week.

The "A List" includes the following:

  • Initial jobless claims (Th). Resuming a key role as the most responsive employment measure.
  • Building permits and housing starts (T). Even more important than usual since both September and October will be reported (a result of the shutdown). I see permits as a better leading indicator, but both are important.
  • Michigan sentiment (W). An important concurrent indicator of employment and spending – sometimes affected by elements like politics and fuel prices. Of special interest right now.
  • Consumer confidence from the Conference Board (T). See "Michigan sentiment" above. I prefer the Michigan version, but usually there is a very close correlation between the two. Wonkblog informs us that confidence tells us little about the actual economy. This is worth more research. I have personally found it helpful on employment.

The "B List" includes:

  • Case-Shiller home prices (T). A delayed look, based on a subset of homes, but widely watched. Also the FHFA release (a different subset) the same day. This is all part of a big week for housing data.
  • Durable goods orders (W). Expected to be week if transportation included –core OK.
  • Chicago PMI (W). This is being released very early due to the holiday. The main interest comes as an advance read on the national ISM report, which comes out on the first of the month. The time disparity may heighten interest in this one.

One thing we might all be thankful for is a lull in the speechmaking schedule! I see little on the calendar this week. One forecast: The President will make an appearance when he pardons a turkey.

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 continues in bullish mode. In our trading accounts we have been fully invested and the positions have gradually become more aggressive. 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 lower ratings, but more sectors in the penalty box. There are still three attractive sectors, but it would not be surprising to see a move toward "neutral" in the week ahead.

Felix gets credit for identifying biotech (IBB) and riding the wave. This has been one of the top-rated choices in our free weekly email update (email address in the "Felix" section above.

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. I am covering some detailed ideas and links in this section, but also see the conclusion.

There is a continuing barrage of "bubble talk." While my own long-term conclusions are not based on technical analysis, I do follow these indicators for short-term timing and adjustments. In particular, I listen to Felix!

Sometimes there is a nice meld of technical and fundamental analysis. My fellow contributor at Seeking Alpha, Chris Ciovacco, wrote this week about 3 Ominous Bear Market Signals. The analysis reviews commonplace assumptions about the current market top (and also the complaints about the Fed). The conclusions are based upon important technical indicators that show why the comparisons are incorrect. Perhaps looking at this example, will encourage you to read the full article. Chris notes that the bond market is often a leading indicator of trouble. Regular readers will realize this theme as part of my use of the St. Louis Financial Stress Index. Take a look at the credit spread for junk bonds in the two charts below.

This is very nice work in using an objective, market-based indicator.

I also wrote about four themes that are very costly for individual investors. While the post was very popular, you should only read it if you are prepared to have an open mind about current conventional wisdom!

Here is a summary of 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.
  • 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

We can expect plenty of on-site interviews and surveys about mall traffic. I have one fearless forecast:

Barry Ritholtz will have a post about the bogus readings from mall surveys!

I look forward to this annual event, which is both accurate and a reality check for those obsessed with media noise. Here is last year's post.

My own guess is for a disappointing season, mostly because the calendar has a late Thanksgiving. I do not think that the economy is so bad, but I am worried about lagging consumer sentiment.

The "breaking news" might have some market effect in thin holiday trading. When we look back in a few months, it will not be important. It is yet another reason why traders might be cautious at the same time investors are seeking opportunity.

Four Costly Ideas

Continuing with the Eight Traits of the Insightful Investor….

The Insightful Investor is open to other viewpoints.

Every question can be approached this way. It is a useful investment skill, but it requires discipline. It is so easy to fall in love with your own ideas and positions. It is especially dangerous when you mix politics with your investing. At the end of this post I am going to highlight the viewpoint that is most important.

Here are four current themes that represent challenges. In each instance I am listing the prevailing viewpoint as the “a” case while the “b” case gets less visibility. Being on the wrong side of these themes is hazardous to your investment health!

  1. Profit margins are at a peak. This issue is the foundation for much current commentary.
    1. Argument – Margins have strong mean-reverting tendencies. Current earnings reflect unsustainable profits.
    2. Response – This is an old argument, advanced for several years. Is there a statute of limitations? There are many reasons to think that margins may remain higher (lack of competition, outsourcing, and productivity). If margins return to historical levels, the change is likely to be part of a general trend to a better economy, higher employment, and higher corporate revenues. (Reference)
  2. A market crash is imminent
    1. Argument – The market is up a lot this year, much more than in the past. We are at market highs. Somebody’s “Omen” or “Syndrome” shows a 100% chance of disaster.
    2. Response — The first 7% this year came from the resolution of the fiscal cliff issue. Has everyone forgotten? If you want to track changes, you must note where things started. 2013 began on a pessimistic note. If you subtract the initial “fiscal cliff” pop, we have a good year, but not an unreasonable gain. As to the bogus recession and crash forecasts, investors must learn to recognize pseudo-science and polemics by those selling fear and gold. (Reference)
  3. The market cycle shows that we are “due” for a decline
    1. Argument — Various sources show the history of past cycles – both for the economy and for stocks. These are generally correct.
    2. Response — This particular market cycle includes a sharp decline and a very gradual recovery. Let us be very clear! There is no “shot clock” on the length of a recovery. Fed policy makes it clear that there will be continuing stimulus for years to come. When we look back on this slow recovery, this will be the key feature. (A recurring theme from my WTWA series)
  4. It is all about the Fed
    1. Argument – Asset market gains are all the result of Fed money printing. It will end badly.
    2. Response – This is the catch-all excuse for those who have been completely wrong about the market. Fed policy has been very predictable, so there is little excuse for getting this wrong. QE3 has actually had only a modest effect. (Reference)

Investment Conclusion

The predominant news flow favors the “A” points above. Those in print or on TV get supporting email and tweets. The negative loop has reinforcement.

If you are wise enough to take a variant perspective, there are plenty of opportunities in the current market. I have written on each of these themes in the past, but there is more to say if anyone is interested.

Here is the key skill: Pretend that you are a pension fund manager. That would put you at the focal point for marginal pricing in stocks and bonds.

Would you be attempting to meet your obligations by going to cash?

Weighing the Week Ahead: Can Investors Think Beyond the Bubble Machine?

In the early days of television (starting in 1955), one of the most popular programs was The Lawrence Welk Show. The audience demographic can be inferred from the sponsors, which featured Geritol (which addressed the issue of "tired blood"), Polident (for dentures) and Serutan (spell it backwards). The effervescent dance sound from Welk's orchestra was called "Champagne Music" and they added to the entertainment value with a bubble machine.

Welk

Just as bubbles increased the audience of yesteryear, we have a modern day equivalent. Instead of merely entertaining, today's bubble illusionists frighten people who might otherwise make normal investment allocations.

It is time to move beyond the bubble talk!

Investors would find it cheaper and more fun to listen to some old bubble music! Suppose that you had to "pay" for each hour of reading that conspiracy site by first listening to one hour of Welk's champagne music….just a thoughtJ (You can check out a famous show with Jack Benny here, or with Welk as a guest on Benny's show here. I hope you have as much fun with these old classics as I did in doing the research.)

Over the last few weeks I have highlighted the changing market concerns. We worried about the government shutdown and debt ceiling. More recently my emphasis has moved from earnings and seasonal worries, to the possibility of a year-end rally. Check out the past three themes:

This has been a pretty accurate read on the changing market mood – and generally done one week in advance. This week we are witnessing another change – a delayed shift away from the focus on spotting bubbles.

Josh Brown highlights the Barron's cover story that "everyone's talking about". Josh explains why Andrew Bary "gets the bubble meme right." One aspect is that the cover has "Bubble?" (With a question mark).

Is there a bubble? Undeniably, there are few of them – in some areas of tech and in the IPO market. Also, some credit bubbles in terms of who can get debt financed at what price. But the entire marketplace or economy is not one giant bubble, as the Prophets of Doom will have you believe. Today's Tech and IPO bubbles are symptoms of the economic improvement this time around – people feeling good about the future – but they are not the drivers of it.

And here is a key segment from Andrew Bary's article:

"The first stage of the bull market was a revaluation to something resembling reasonable levels as it dawned on investors that the world wasn't going to end," says Stephen Auth, chief investment officer at Federated Investors. "The second stage began this summer with a transition to the view that the economy is accelerating and that earnings are poised to increase significantly in the coming years."

Tom Lee, the bullish JPMorgan strategist, says "We're in a secular bull market that will last at least another three years." Adds Jim Paulsen of Wells Capital Management, "If inflation stays at 3% or less, the market P/E could get into the 20s."

This is consistent with my own theme – one that will be familiar to regular readers. I summarized it Friday morning on Scutify, where you can exchange trading and investment thoughts. I am a very lonely voice. Most of my colleagues and the vocal traders see a crash as "when, not if." While I commented on Yellen and other events, here was the key take on bubbles:

I do not see a bubble in the general stock market. Bonds seem way overvalued, as do some spec names, small caps, and pure dividend stocks. There is lots of opportunity to capture rotation.

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

Background on "Weighing the Week Ahead"

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

In contrast, I highlight a smaller group of events, 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

This was a mixed week for news, despite the market gains.

  • The Yellen Confirmation Hearings. From a market perspective, our definition of "good," the hearings were a big success. Yellen was professional, prepared, and responsive. She had met with all of the members in advance. While some disagreed with her policies, she enjoys widespread support as well as acceptance. Her confirmation is not going to be an issue. Communicating Fed policy and unwinding the balance sheet are matters for the future. Those objecting to Yellen were mostly people who question the entire concept of a central bank and/or the stated dual mandate for the Fed. For investors who accept reality, this is good news.
  • The technical picture has improved. I often recommend the work of Charles Kirk. He has a fine weekly chart show that highlights the various bullish and bearish setups. Charles is never doctrinaire. He is willing to change positions with the evidence. His most recent report (small subscription price required) is more bullish, but also shows what is required for technical traders to accept another upward leg in stocks.
  • Banks chasing traders out of chat rooms. If you read some logs of past conspiracies, you will understand why this is good for markets and the average investor. Will traders simply move to Snapchat, perhaps a multi-billion dollar company?
  • US oil production is leading to energy independence. Izabella Kaminska has the story, complete with charts. She cites energy expert Stephen Schork, who argues, "In hindsight, you drive oil to $147 barrel and lo and behold, five years hence the world is swimming in oil. It really is that simple."

EditorialChart-47-272x153

The Bad

The news updates also included some bad news. I did not see too much, but feel free to add suggestions in the comments. These should be items from the current week, not the repetition of something you could have said (and probably did) six months ago!

  • Q3 Earnings beat rate was disappointing, at 58.6%. The chart below is the summary from Bespoke. Year-over-year growth was 5.6% with revenue growth of 3.2%. Brian Gilmartin has the full story, with updates on forward earnings, comparison of Thomson/Reuters with FactSet, and an excellent analysis of the impact of JP Morgan on the overall quarter. Great stuff.

Eps beat rate 1114

Agdqtadj90im3koiwopt9q

The Ugly

The ObamaCare rollout. Putting aside the political viewpoints, we all hope for more general access to affordable health care and insurance. Even those who see the Affordable Care Act as a step forward, acknowledge that the implementation has involved a step back.

There are various investment implications, ranging from a distraction from other business to changing prospects for health care companies. For the moment, it remains an important theme to monitor.

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 David Merkel, cited by Tom Brakke. David explains the various risks in one of the popular choices as investors chase yield – the leveraged, closed-end municipal bond fund. Tom uses his famous charts, and concludes as follows:

Big yields (especially tax-free ones) are so alluring and so dangerous.  Most investors can't parse the risks and, frankly, many of those purporting to provide guidance aren't going to bother to educate them.

A Touch of Humor

A study finds that money managers with doctorates outperform less-educated peers. Good SAT scores also show a relationship. Who would have thought that intelligence and education are relevant? And of course, I know plenty of exceptions!

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

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. Here is the key chart:

Vrba death cross

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 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. Here is Doug's most recent chart of the Big Four indicators:

Dshort big four

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 two 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.

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 decreased dramatically, meaning that we have more 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

We have finally caught up with the delayed data, and this week brings an unusually thin calendar of events.

The "A List" includes the following:

  • Initial jobless claims (Th). Resuming a key role as the most responsive employment measure.
  • Retail Sales (W). Of special interest given mixed announcements from retailers and lower consumer sentiment.
  • FOMC minutes (W). Could move the markets if trader parsing suggests a more hawkish tone.

The "B List" includes:

  • Existing home sales (W). Not as important as new construction, but still a key economic sector.
  • CPI (W). Not very important while it remains so low. Eventually it will be. One of the unusual instances where this report comes before the PPI results.
  • PPI (Th). See CPI comment.

FedSpeak is hitting a near record, with at least six scheduled speeches. For good measure, we also have ECB President Mario Draghi giving the keynote at the European Banking Conference.

The Philly Fed report is significant only when there is a big move, but that is possible this week.

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 continues in bullish mode. In our trading accounts we have been fully invested and the positions have gradually become more aggressive. 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 continue to see somewhat lower ratings and fewer sectors in the penalty box. It is one of the most encouraging combinations in months.

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. I am covering some detailed ideas and links in this section, but also see the conclusion.

  • 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.
  • 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

The bubble theme has been very costly for investors. Research in behavioral economics has demonstrated that even wildly inaccurate concepts have an anchoring effect, distorting the ability of many to reach logical conclusions. The Wiki article on heuristics and decision making is pretty good. Read the anchoring section. Even ridiculous concepts distort perceptions. Many have allowed the incessant discussion of bubbles to distort their perceptions.

The Barron's cover story includes thirteen specific stocks to consider as well as some with excessive valuations. The current market has experienced several years of simplistic trading: risk on, risk off. Things are starting to change.

We are moving from a climate of fear to one of opportunity. Sector and stock picking will be rewarded. There are some good themes:

  • Out of bonds.
  • Out of simple yield plays that trade like bonds.
  • Out of precious metals which depend on either fear or hyper-inflation.
  • Out of stocks that have extended valuations – including some small caps, recent IPO's, and pure dividend names.
  • Into the less-favored sectors – large cap tech, cyclicals, and financials.

And most importantly

The investor does not need to go from zero to 100 in a few seconds. If you are worried about the market, but also worried about missing out, it is easy to start small. There is no need to go "all-in" like the players in the World Series of Poker! You can right-size your risk (via individual bonds or covered calls on dividend stocks) and still benefit from the continuing improvement in the economy and in US equities.

Weighing the Week Ahead: Do Sidelined Investors Face Upside Risk?

Last week I asked whether it was time for the regular year-end rally. This was a pretty good guess about the media focus for last week. With little fresh data on the calendar, it is open season for pundits. Here are the themes I see:

  • Technical traders who see a short-term top;
  • The regular parade of crash predictors; and
  • Those who turn every investment question into a complaint about the Fed.

There is a surprising new theme – the chance that markets might move much higher, and in a short time. Some are using the term "melt-up."

  • Schwab's Liz Ann Sonders, not one given to hyperbole, asks, Why Worry … About a Melt-Up?
    She takes note of short-term sentiment risk.
  • Ed Yardeni, who has been accurately bullish, but certainly not a perma-bull, has a nice interview in the current Barron's. Like Sonders, he notes near-term risks, but sticks with a target of S&P 2014 in 2014. It could happen fast.

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

Background on "Weighing the Week Ahead"

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

In contrast, I highlight a smaller group of events, 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

This was a week of surprising economic strength. It was encouraging that both stocks and bonds interpreted this as good news.

  • Payroll employment showed surprising strength. The October job gains, combined with revisions to the prior two months, suggest a new level of economic growth, consistent over several months. (See Household Employment below).
  • Any Fed "taper" of QE is likely to be offset by lower short-term rates. Joe Weisenthal explains the significance, citing the economist who has been most accurate over the last several years, Jan Hatzius.
  • Rail traffic is strong. (Via Pragmatic Capitalism).

Rails1


 

  • The ISM service index showed strength at 55.4. Steven Hansen notes the expansionary trend and analyzes the internals. He remains skeptical of anything involving a survey question. I think that purchasing managers can be pretty accurate in reporting what they are seeing in their businesses. We have decades of knowledge about how to do surveys. They are not all the same.
  • Gas prices hit another low.
  • Q3 GDP showed surprising strength. There are so many moving parts that even a strong number can be criticized. Inventories increased. Does this mean anticipated demand or lack of sales? Business investment still lags. There will be revisions. And so forth. Even with some allowances, this report seems more consistent with stronger growth. Doug Short's chart shows the components of growth over time, helping us see the drag from government and trade.

Dshort GDP


The Bad

The news updates also included some bad news. I did not see too much, but feel free to add suggestions in the comments. These should be items from the current week, not the repetition of something you could have said (and probably did) six months ago!

  • Investor sentiment has gotten bullish. From a contrarian perspective, this is a short-term bearish indicator. (Via theshortsideoflong).

Investor Intelligence Bull Ratio


  • Mortgage credit remains tight. This is hurting the economy (via Calculated Risk).
  • Michigan sentiment was terrible, once again. Calculated Risk attributes the decline to Washington and expects the upward trend to resume. Meanwhile, this is worrisome for those of us who see it as an indicator of both consumption and employment. Here is a helpful chart:

ConSentNovPrelim2013


  • Household employment survey shows weakness – a drop in labor participation, full-time jobs, and part-time jobs. I am taking note of this, but this survey was more affected by the government shutdown than the payroll approach. The bond market seemed to agree, with rates spiking higher on the news. Another month of data will provide some needed clarity.

The Ugly

The Philippines typhoon – with a death toll of 10,000 – should provide perspective for the routine news of the week.

Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts.  Think of The Lone Ranger. No award this week, but nominations are always open.

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

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.

Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverage
of the ECRI recession prediction, now 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. There is now an updated analysis showing the impact of the government shutdown – moving some measures into "recession warning" territory.

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 two 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.

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 decreased dramatically, meaning that we have more 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

We have finally caught up with the delayed data, and this week brings an unusually thin calendar of events.

The "A List" includes the following:

  • Initial jobless claims (Th). Resuming a key role as the most responsive employment measure.
  • Industrial production (F). A key recession indicator.
  • Yellen confirmation hearings (Th). Senate Banking Committee. The confirmation is unlikely to be derailed, but there could be interesting news along the way.

The "B List" includes:

  • Trade balance (Th). Another GDP component.

There will also be plenty of FedSpeak. Options expiration week could exacerbate what would ordinarily be smaller moves.

I am not very interested in lesser reports like Empire state and wholesale inventories.

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 continues in bullish mode. In our trading accounts we have been fully invested and the positions have gradually become more aggressive. 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 lower ratings and fewer sectors in the penalty box. It is one of the most encouraging combinations in months.

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.

  • 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.
  • Avoiding the "fear trade." I covered this pretty carefully a couple of weeks ago. Those who participated in our "methadone program" for gold addiction enjoyed some nice gains in our substitute, Freeport-McMoRan Copper and Gold (FCX). This made 35% in a few months, counting both dividends and stock appreciation, but we have now moved on because of valuation. Gold continues to lose ground, but the rationale is even more disturbing. The gold traders are intensely focused on the Fed. Since I do not expect any big changes in Fed policy, nor any major effects from the first moves, this is simply a wrong-headed trade. Individual investors have been chased into gold because of fear of economic collapse (via deflation), or hyperinflation, or sometimes both at the same time. Since none of these outcomes is very likely, you should have only a small allocation to precious metals.
  • 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

Risk is not just a matter of the downside. Early in 2010 I wrote an important short post: Upside Risk. I quoted a leading manager explaining the factors that could lead to much stronger stocks.

Earlier this year, when everyone was obsessed with the "T" word, I asked whether investors should be "scared witless" (A TM OldProf Euphemism).

This was a post from June. Much of the story is playing out as predicted, and we are entering the strong seasonal part of the year.

As the investment world returns to a more normal state, we can expect the following:

  • A return to trend GDP – 3%+ or even better
  • Stronger employment growth
  • Higher interest rates – think of 4% on the ten-year note
  • Higher market multiples – because the relationship between stock multiples and bond rates is curvilinear. None of the top Wall Street economists has gotten around to replicating my research, but they will. Unlike them, I'll be happy to share the data for verification.
  • Lower unemployment
  • Reduced profit margins
  • Stronger total profits and revenues
  • Reduced budget deficits, especially as a percentage of GDP

These are all correlated. Bulls cannot cherry-pick the good stuff and ignore the others. Neither can bears. No fair asking what stock prices would be if profit margins and interest rates "normalized" without allowing for other variables to change as well. See here for details.

Investment Conclusion

Stock prices and interest rates are on a path to the Final Destination. This should be your guide to choosing investments.

The worst investments are those linked to interest rates – bonds, utility stocks, and the grandma dividend stocks.

The best investments are those with low current PE ratios and sensitive to the economy. Bernanke told us that he expects stronger economic growth and the pedal will be mostly to the metal even so. This is bullish for technology, cyclical stocks, discretionary consumer stocks, and financials.

I am comfortable with these conclusions, but there is one update. JP Morgan's excellent quarterly analysis supports my point about rising interest rates and P/E multiples. Rising rates have historically been positive for stocks, as long as the ten—year is below 4.5%. This is a valuable and little-known fact.

JPM Interest Rates and Stocks

Investment Implication

There is no need to go "all-in" like the players in the World Series of Poker! You can right-size your risk (via individual bonds or covered calls on dividend stocks) and still benefit from the continuing improvement in the economy and in US equities.

Advice for Young Investment Professionals

Tom Brakke’s work is a consistent source of ideas and inspiration. He recently challenged some of his many admirers to provide a few thoughts for a book project. I eagerly await the result, and I am delighted to be included as someone whose ideas might be useful.

This is a question that I get quite frequently. My answers are often private, and occasionally on the blog. Since Tom invited us to cite or include prior material, he has stimulated me to collect various thoughts from the past, and perhaps to add a few others.

Here is the summary from my past work and thoughts:

  • It is not easy – not nearly as easy as you think. The failure rate – even among those who are intelligent and talented – is extremely high. Remember the TV show about law school where you were invited to look left and right? The odds are even worse. I taught the classes to beginning options traders. The success rate was below 10%, and they had the best preparation from me, from our on-floor team, and plenty of financial backing.
  • The investment business is about sales, not trading. This is the toughest thing to understand. If you want a successful investment business you need to attract customers. The methods to do this are not really correlated with your returns. Many of the most successful managers have poor returns, but they have a good story.
  • Trading is not glamorous. The media picture is that you sit in front of your screen and spot great opportunities. You are constantly cashing in and exchanging high fives. Anyone contemplating a trading career needs to test themselves and their methods.
  • Book knowledge does not matter. Most TV pundits can recite the basic themes from that morning’s Wall Street Journal. This has no edge. None! I would never hire someone whose only “game” was knowledge of the current theme. If you have no idea of where the hockey puck is going, you cannot play in the NHL.
  • Be willing to help people. If you think about every account in terms of profit and loss, your attitude is warped. What goes around, comes around. I have some small accounts that do not generate much revenue, but the clients do good work. I respect that.
  • Honesty is essential. There are many temptations in the investment world. I have heard countless tales of great “insider information.” Most of these tips were wrong, but that is not the key point. If you violate the rules, you might be prosecuted, lose your credentials, pay restitution, or even go to jail. That is still not the key point. If you cannot take pride in what you are doing, the money will not be enough to substitute. It is possible to do well and also to do good. That should be your objective.
  • Learn how to accept adversity. I saved the toughest for last. Even if you have a great method, you will encounter tough patches. Things may not seem to be working. Clients will be edgy. Your main challenge is often to help them fight their basic instincts – selling at the wrong time.

If you want to be an investment professional you must stand for honesty and integrity. Your edge should come from service and research, not from illegal moves or misleading clients. You should look in the mirror every morning with pride. If you can do this, you will enjoy your work and meet challenges with confidence.

Practical Advice

In reviewing my thoughts I see that it all has a theoretical quality. Here are the best specific things you can do:

  • Get hired by Fidelity Investments (or the like). They take the best and brightest and you can manage a lot of money as a young person if you prove out.
  • Get an internship somewhere where they will not make you cold-call people and set up dinner meetings. Learn how the decisions are really made. Maybe you can impress someone with actual hiring authority.
  • Do some paper trading. Make sure that your “brilliant” methods actually work. Start early, so you can build a real record.
  • Do some writing, and expose your ideas to public review. Try to contribute at Seeking Alpha, where they wisely embrace many ideas and also expose writers to public review and comments.

Conclusion

I realize that my advice is rather discouraging, but that is the reality. There are many easier and safer things to do.

If you get past the hurdles I have described, you can have a career that combines financial rewards with helping people achieve their goals. What could be better?

Weighing the Week Ahead: Time for a Year-End Rally?

Two weeks ago (I finally got a weekend away last week) my WTWA theme was a return to normalcy: Less Washington and more market fundamentals. This was pretty accurate in the focus on earnings. Less accurate was my prediction that good economic news would be good news. The market still has a Fed fixation.

Like others, I have looked each week for signs of a significant market correction. One by one we have navigated the various threats through the May to October period of seasonal weakness. Is it now time for the regular seasonal strength?

Is it time for a year-end rally?

There is the typical range of perspectives, but let us consider two dramatically contrasting viewpoints:

  1. Market bubble and/or crash. The roster is growing! It is far beyond the warnings of the leading investment site, the one built on fear. It is beyond the Faber and Schiff themes. Beyond Hussman and Mauldin. We now have reached the mainstream of Business Insider and USA Today!
    1. Henry Blodget summarizes his conclusion about why the market will crash in the next year or two and provide poor returns over the next decade.
    2. USA Today asks "Is Fed inflating stock bubble?"
  2. Bullish. From Oppenheimer's fine Chief Investment Strategist, John Stoltzfus. (I cannot provide a link. You need an OpCo relationship to get this valuable research).

    As the kids and those "young at heart" gear up for Halloween, it appears to us that over the last week or so the same faces that successfully discouraged legions of investors from participating in the rallies that have followed the low of March 2009 have returned in force and onto the media landscape with the same argument that the markets advanced is solely attributed to QE and other extraordinary efforts by the Fed.

    We disagree. Since March of 2009, when equities began their rally from the lows of the Great Financial Crisis, the market, as illustrated by the S&P 500 performance, has reflected domestic and global challenges that ranged from banking sector troubles on both sides of the Atlantic, to fiscal and sovereign debt issues and persistent skepticism of the economic and market recovery.

    Anecdotally we recall that fourth-quarter angst has been nearly as common as a spring (April/May) market peak over the last two years or so.

    We urge investors to stay focused on the many improvements in the economy that have been realized over the last few years, including: falling initial jobless claims, improved economic growth, increased hiring, rising earnings, improved consumer confidence, moderate growth and low inflation, higher home prices, strong car sales. All of the aforementioned have contributed to positive developments in services and manufacturing and have been reflected in the markets. Expect progress, not perfection. Stay tuned. [Emphasis in the original]

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

Background on "Weighing the Week Ahead"

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

In contrast, I highlight a smaller group of events, 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

With the shutdown-delayed news coming out, there are plenty of items to consider. Some of the data is a little old. Since this update covers two weeks, I am reaching beyond last week for a few key items.

  • ISM manufacturing was very strong, the best report in over two years. Calculated Risk includes analysis and the chart below. Steven Hansen of GEI is less impressed, saying that the "index has been in a general downtrend since mid-2011." He includes detailed discussion of the survey items.

ISMOct2013


  • China's PMI is stronger, basically supporting a growth rate of 7.5%. (Via Barron's). The independently determined HSBC survey is a touch lower, but shows the same pattern. Here is analysis from the WSJ. Regular readers know that I share the popular skepticism of "official" data. I also discount non-quantified assertions about ghost cities. I try to stick with the best data we have, and it does not support the multi-year forecast of a "hard landing."
  • Investors are 48% in cash according to BlackRock's survey. Meanwhile, BlackRock's Larry Fink joins the "bubble camp." What conclusion would you draw from this?
  • Earnings "beat rate" is strong at 74% via FactSet with most also beating on sales. (But see "the bad" below).
    Brian Gilmartin also notes that the overall earnings growth rate has been heavily influenced (from 5.9% to 3.3%) by JP Morgan's charge,
  • Case-Shiller home prices increased 12.8%, beating expectations. (Via Calculated Risk).
  • Business lending is higher. Scott Grannis illustrates this relationship, which is important to job creation from small business.

Screen Shot 2013-10-25 at 5.01.29 PM


  • Financial conditions are at a new high according to the Bloomberg Index. Scott Grannis notes that this has been an excellent recession predictor in the past.

The Bad

The news updates included plenty of bad news.

  • Michigan sentiment was terrible. Steven Hansen notes it as the lowest level since December, 2012, and provides plenty of detail.
  • Net Employment growth has declined, apparently at a lower plateau. The September employment report was a disappointment. Last week's ADP private employment gain was only 130K. This is approximately the level needed to maintain the current unemployment rate. I am scoring this as "bad" because that is where the data take us. There is a bright spot from the improvement in the full-time/part-time question. I took up the topic here. My friend Doug Short responded to my "innocent" tweak with a first-rate update of his analysis of the factors behind the shift to part-time jobs. Those who insist on confusing their political viewpoint with their investment decisions should definitely read this discussion.
  • Earnings guidance has been weak (via FactSet). Lowered guidance from 66 companies versus increases from 13. (But see "the good" above).
  • Little headway from the Congressional Budget Conference Committee. Stan Collender expects continuing sequestration, but he warns not to take the early discussions too seriously. I agree.
  • Bearish sentiment is waning. This is popularly viewed as a contrarian indicator. FT Alphaville has the full story from various sources as well as a comment on accuracy. Here is a featured chart:

Bears-1


  • Retail Sales disappointed.
    Bespoke has complete analysis, noting that auto sales were probably affected by the early Labor Day holiday. There are the great charts we expect at Bespoke, as well as this table showing the breakdown by category:

Retailsalesonemonth


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 Stephen Suttmeier and Barry Ritholtz, who take on the oft-cited current levels of margin debt. There are many versions of this chart, but the basic thesis is that peaking levels of margin debt are a sign of a market top. I have looked carefully at the charts and the variation seems largely coincident, with margin levels sometimes leading and sometimes following. This has been on my (ever-growing) agenda, but it requires some careful research.

Merrill's Suttmeier includes the margin debt rate of change as an indicator of whether a rising market is peaking or breaking out. Barry notes, "If the rate of change data somehow corresponds to past shifts in secular markets from bears to bulls, this is potentially a very significant factor."

This analysis is much more sophisticated than what you usually see on this topic. I would love to see more research here, but this provides some needed balance. Here is a summary chart of the basic relationship, but I recommend reading the entire post.

NYSE-Margin-debt



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

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. They have an update on their SuperCycle approach, a method that combines seasonality and recession risk. This chart is an example:

STM_SP500_13


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.

Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverage
of the ECRI recession prediction, now 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. There is now an updated analysis showing the impact of the government shutdown – moving some measures into "recession warning" territory.

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 six weeks Felix has ranged over the full spectrum – twice! The market has been moving back and forth around important technical levels, driven mostly by news.

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 decreased dramatically, meaning that we have more 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 still a lot of data as the delayed reports combine with timely releases.

The "A List" includes the following:

  • Employment report (F). The October report was delayed by a week since the government shutdown interfered with data collection. The survey period is the week of October 6th – 12th, so the data are less current than usual. The Fed's emphasis on employment gives this even more significance than usual.
  • Michigan Sentiment (F). Watched closely because of the consumer reaction to the 2011 shutdown.
  • The ISM services index (T). Will service match the strength in the manufacturing data?
  • Leading indicators (W). Controversial, but still a favorite for many.

The "B List" includes:

  • Initial jobless claims (Th). Less interesting than usual because of the California and shutdown effects.
  • Personal income and spending (F). Important read on the economy but September data.
  • GDP (Th). First report for Q3 already seems dated and will get revised.
  • Factory orders (M). August data

There will also be plenty of FedSpeak in the wake of the FOMC decision as well as more earnings reports.

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 continues in bullish mode. In our trading accounts we have been fully invested and the positions have gradually become more aggressive. 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 both higher ratings and fewer sectors in the penalty box. It is the best combination in months.

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.

  • 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.
  • Avoiding the "fear trade." I covered this pretty carefully a couple of weeks ago. Those who participated in our "methadone program" for gold addiction enjoyed some nice gains in our substitute, Freeport-McMoRan Copper and Gold (FCX). This made 35% in a few months, counting both dividends and stock appreciation, but we have now moved on because of valuation. Gold lost 3% last week, but the rationale is even more disturbing. The gold traders are intensely focused on the Fed. Since I do not expect any big changes in Fed policy, nor any major effects from the first moves, this is simply a wrong-headed trade. Individual investors have been chased into gold because of fear of economic collapse (via deflation), or hyperinflation, or sometimes both at the same time. Since none of these outcomes is very likely, you should have only a small allocation to precious metals.

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

If I were to summarize the current market in a single sentence, it would be the following:

When a market theme hits USA Today, it is too late for action.

The "bubble theory" is so prevalent, that investors hold 48% in cash – owning neither stocks nor bonds.

There is so much bad advice for the individual investor that I despair. Here are a few conclusions. While these are carefully considered, I cannot analyze each in the weekly review. Feel free to take up the issues in the comments!

  • Those who have been completely wrong abandon past indicators and pick new ones. There are good reasons for late-year seasonal strength.
  • Think beyond the next two months. Do not be a slave to the calendar. Many are focused on their annual predictions and bonuses. Bullish predictors have already won, so they skew to a conservative posture. Bearish hedge fund guys need a market decline to meet performance targets.
  • This is not an average cycle – not for businesses and not for stocks. Usually there is a decline and a rebound. This time there was a sharp decline and a gradual rebound. The result? The Fed will be aggressive for much longer. It will probably be 2016 before policy is back to neutral. It is silly to create a template based upon a handful of cycles and expect a new case to fit the model.
  • The YTD gains are exaggerated. We started the year with fear from the fiscal cliff debate. When that was avoided, we had an instant gain of 7%. We should have asked everyone to re-calibrate predictions from that date.
  • There is an epidemic of top-calling. Everyone who has been completely wrong about the market is finding excuses. Since much of the audience for the financial media – both print and TV – consists of those thinking short-term, the fear factor is high.
  • The return of the individual investor is just getting started. Each week I read about mutual fund and ETF flows. The shifts from individual investors are highlighted as late money – dumb. At some point this will be true, but I think it is far in the future. Let us revisit the topic when the average investor is "all in" instead of 48% in cash!

We can all argue about the true contrarian trade. At the moment, I agree with Felix. I see stocks as attractively priced, with plenty of value opportunities. While my predictions for the year have played out pretty well, I prefer to think about rolling twelve-month periods rather than rest on laurels for this year.

Weighing the Week Ahead: Will Disappointing Earnings End the Stock Market Rally?

It is time for a return to normalcy!

I expect much less Washington politics and much more focus on corporate earnings. While economic data reports are still delayed and distorted, we will gradually get back to analysis of economic fundamentals as well.

Last week's theme emphasized the end of the apparent Washington stalemate – no default and a compromise with a smidgen of face saving. I suggested the following:

Daily trading will react and over-react to each piece of news, beginning with a soft opening tomorrow. This will all soon be forgotten, with a renewed focus on corporate fundamentals.

If anything, I was a little too pessimistic. I thought that Senate objections could delay the resolution by a couple of days. Sen. Cruz chose not to filibuster, so the Thursday "deadline" was met. Overall, my analysis of the political shenanigans has been accurate.

The Earnings Question

Ed Yardeni echoes a theme we have cited in recent weeks. (See Brian Gilmartin as well). Yardeni notes that rise in forward earnings and the strong link to actual earnings, including this chart:

Yardeni Forward Earnings


Yardeni expects the current earnings season to be "unsurprising." He notes that there is a multi-quarter pattern. Earnings beat expectations and analysts immediately reduce guidance for the next quarter. If one takes a longer outlook, the picture remains quite positive.

I have some additional ideas on other themes to follow in the week ahead. I'll report on those in the conclusion.  First, let us do our regular update of last week's news and data.

Background on "Weighing the Week Ahead"

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

In contrast, I highlight a smaller group of events, 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

With the shutdown limiting issuance of fresh government data, there was much less (non-political stuff) to ponder. There was some good news.

  • Private economic indicators are strong. The Bonddad Blog, one of our favorite sources, now publishes their invaluable high-frequency indicators at XE Market Analysis. In the absence of regular government data, these are especially important. This is a helpful and comprehensive article, demonstrating a "positive bounce."
  • Rail traffic remains strong, "comfortably ahead of last year" according to Todd Sullivan. Steven Hansen at GEI also slices and dices the data using various time frames.
  • China's Economy continues to grow. John Lounsbury at GEI has a very balanced analysis, highlighting the various threats. There is also this helpful graph, providing little support for those who have been predicting a "hard landing" for the last two years:

33921105China-GDP-Trading-Economics-2013-2Q


  • Initial jobless claims are encouraging. Most are having difficulty interpreting this series. New Deal Democrat (reporting at XE instead of Bonddad) has done a nice job with the data. He has taken the state data, looked at year-over-year, and taken out California. This removes the known source of distortion. It is a week behind, since the state data lags, but it is much better than the headline reports.

The Bad

Despite the data shortage, there was also some bad news.

  • Corporate earnings. The Q3 reports are off to a weak start on earnings beats and even worse on revenue. As always, Bespoke has a great summary of the data and helpful analysis, including the following chart about revenues:

Revesq3


  • The Beige Book suggests very modest growth. It is difficult to gauge expectations for this report, which consists of anecdotal information to supplement the data used at each FOMC meeting. The preparation rotates among the regional Fed banks. Steven Hansen takes on the challenge of parsing the language, with a rather neutral verdict. The market sold off a touch on the news.
  • Structural business problems are on the rise, according to the NFIB. David Beckworth, who writes an excellent economics blog, has been skeptical of the regulation argument, emphasizing lack of demand as the source of economic weakness. This has important policy implications and Beckworth is demonstrating objectivity in noting the change in the data. Here is a key chart:

Nfib2


The Ugly

Shutdown effects. Some will not understand the important economic impacts, no matter how real. These depend upon models and counterfactuals, causing the eyes of most to glaze over. For those who really want to know, I recommend Menzie Chinn's account, showing impacts of up to 1% overall if one includes crisis driven fiscal policy and uncertainty effects.

For those who want tangible examples, I recommend the discussion of the impact on science (via Scientific American). Experiments were interrupted, scientists missed out on trips abroad, surveillance of diseases was halted – and much more. Do you suppose that those in Congress thought about any of these "non-essential" services?

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 Cullen Roche who is debunking "The Biggest Scam in the History of Mankind." Cullen does a careful analysis of a misleading, but convincing video. The source is a convincing rant on "fiat money" with the intent of selling gold and silver. Cullen's post does a good job of exposing the errors.

[For more on gold, please see the investor section below.]


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

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, including this recent update on the world economy.

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. For those interested in gold, he has a recent update, asking when there will be a fresh buy signal.

Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverage
of the ECRI recession prediction, now 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.

Readers should review my Recession Resource Page, which explains many of the concepts people get wrong. There is now an updated analysis showing the impact of the government shutdown – moving some measures into "recession warning" territory, as shown by this chart:

Recession Alert post shutdown


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 month Felix has ranged over the full spectrum – twice! The market has been moving back and forth around important technical levels, driven mostly by news.

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 remained elevated, 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

This week's schedule brings more releases than usual, but the data will be more backward-looking than usual. Despite the extra reports, there are several more that are on a continued delay.

The "A List" includes the following:

  • Employment situation report (T). This is the report for September, based on data for the week beginning on September 9th. This delay came from data compiling. Next month's report will also be delayed due effects on data collection.
  • New home sales (Th). Important as a read on both the consumer and construction.
  • Michigan sentiment (F). The data reflect the period before the debt ceiling and shutdown agreements. Weak sentiment was a big drag after the 2011 debt ceiling deal, so this bears watching.

The "B List" includes:

  • Initial jobless claims (Th). Less interesting than usual because of the California and shutdown effects.
  • Existing home sales (M). Housing remains key to a continued economic recovery.
  • Durable goods (F). Significant element of GDP.

There are many lesser releases, which are unlikely to have any real effect.

Most important of all will be Q3 earnings news – now in the heart of the reporting season.

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 switched back to bullish. For our trading accounts we were never actually short, since the inverse ETFs were in the penalty box. We were only 2/3 long and the positions were rather defensive. 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. The high penalty box rating continues to underscore the uncertainty. The result is that Felix showed some profit during the Washington debate, while taking a lot less risk.

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.

  • 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.
  • Getting back in. Those who have tried to time the market by selling stocks before the shutdown now must decide when to get back in. Josh Brown, who has at least one special nugget for investors each week. This week he had two.
    • The timers and tactical guys will now point to inflation-adjusted measures to convince you that it's not a record high but it is. The newsletter guys will rail about the Fed as they have been for five years now and the TV people will obsess over whether or not you should be "playing it" with retailers or banks or tech stocks.

      Take a moment, from this peak – or way-station toward some higher, future peak – to reflect on who's been wasting your time and distracting you from your retirement goals.

      One of our best commenters, "Left Banker," is now contributing at Seeking Alpha. Welcome! Everyone should read his posts. Get started with his analysis of inflation adjusted cycles and why you should consider "buying in October."

    • Josh also notes a long list of things that could have gone wrong, but didn't. He sees this as "rocket fuel" and asks,
      "What happens from here?  My guess would be that we have all the rocket fuel we need for an explosion."

    Those who lightened up because of Washington need to think about "upside risk" as well as the downside.

  • Avoiding the "fear trade." One of the most profitable activities for an investment manager or a writer is to recommend the purchase of gold. Commissions are high and so is the traffic and advertising revenue. Fear sells! Izabella Kaminska of FT Alphaville does a great takedown on the shallow reasoning from a typical gold site. There is no way to summarize this properly, so just read it. On a similar theme, Eddy Elfenbein thinks that it might be the popping of the "fear bubble." I have a special program for those who are overloaded on precious metals, achieving the same ends without the single-metal risk. Eddy includes this chart:

Sc10142013


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

There are several new themes that I will be watching next week.

  • Good news will be good. And bad news will be bad. With the Fed expected to be on hold for the foreseeable future, the market should celebrate economic strength and good earnings – and be disappointed by the opposite.
  • Volatility will be lower. We will get a respite from headlines.
  • Those who have been completely wrong will find new excuses. Those who claim that politicians are "kicking the can" should look in the mirror. Failed pundits merely extend the time frame for their mistakes.

Cardiff Garcia has a very nice analysis of why last week's compromise might actually work out. He draws upon an analysis from Barclays and features several key charts, concluding as follows:

Still, the chance of another shutdown does seem low. And the strategists did leave out the obvious but important point that 2014 is an election year. Given the disastrous outcome for Republicans this time round, their leadership is unlikely to want a reenactment of the last few weeks.

I strongly agree, and suggested in this post how investors might actually profit from the skepticism. I am looking for opportunity in the week ahead.

Weighing the Week Ahead: An End to the Debt Limit Stalemate?

In chess, a stalemate is a drawn game. Chess players study endgames, where small advantages become big wins. Computers have now solved these endgames – all of them! Some require dozens of precise moves. A mistake converts a draw into a win or a loss. Humans make mistakes.

Political processes are inherently human. It is possible to estimate the outcomes, but there is plenty of room for surprises along the way. I have been analyzing public policy issues for forty years, including the study of hundreds of actual decisions as part of my dissertation – the original research required to get your "professor credentials." I do not have any exaggerated illusions about the predictive power of academic research, but at least for me, the research has helped to identify investment implications.

There are certain principles that hold up with amazing frequency in the US political process, and more generally in democratic systems:

  • If a particular outcome is clearly beneficial to nearly everyone, that result will usually be achieved.
  • The process of bargaining and compromise is always messy. It looks terrible to observers who have never personally experienced it.
  • Compromise does not yield the best possible result. Instead, it generates the best result possible. Outsider each have an idea of the perfect solution. The problem is that there are many differing and inconsistent "perfect" solutions.
  • No one really loves the result of a compromise.
  • Every political issue is subject to compromise, even those that seem to involve strict rules.

Why dwell upon this in a blog dedicated to successful investing?

For the last three weeks I have accurately highlighted the political debate as a major concern for investors. Investors who read last week's post saw that while I did not see a specific outcome in the week ahead, there were five things to watch:

  1. A temporary extension of the debt limit. This will be criticized by the punditry as "kicking the can" but it will serve the function of buying some needed time. The market will respond to the progress, not to the political wails of some pundits.
  2. Minimally, an agreement that provides some tweaking of sequestration and provides Speaker Boehner a chance to claim some credit.
  3. Maximally, a broader compromise on some entitlement and debt issues – less likely and taking longer.
  4. The agreement could be reached overnight or on a weekend, without much notice.
  5. The resulting pop in stocks (just like the fiscal cliff resolution) will leave many chasing the market, waiting for a pullback.

This proved to be a fairly accurate assessment. As I write this, the situation is changing almost by the hour. Yesterday the emphasis was on the Senate. Today it is on the most recent proposals from Republicans in the House.

The biggest element missing from the five points listed above is the political cover for Speaker Boehner. Poll results showing blame falling mostly on Republicans seem to have stiffened the resolve of Democrats. They are now asking for higher spending levels, easing the sequestration rules. The principle highlighted by the administration is not to allow the debt limit threat as the foundation for policy negotiations. The principle highlighted by Republicans is the need to use maximum leverage to achieve goals viewed as important.

An Important Distinction about Politics

Regular readers know that I strongly recommend separating your political viewpoints from your investing. You should join me in being politically agnostic—willing to invest successfully no matter who is in power.

It is fine to have an opinion about ObamaCare, about debt, about European leadership, or about the Fed. Feel free to express your viewpoints in personal discussions or in the ballot box. Stop there. Confusing what you hope will happen with what probably will happen is the fast track to investment losses!

When I discuss policy issues, I am helping you to predict what will probably happen and also the investment consequences. I have been extremely accurate on every important policy decision for many years – Europe, 2011 debt ceiling, fiscal cliff, etc. – often in disagreement with the majority of pundits. I have never expressed personal preferences, but instead emphasize how to profit from likely outcomes. I regularly cite sources covering a wide political spectrum. Discerning readers might note that I find the viewpoints of extremists of all types to be market-unfriendly. Mainstream thought, from whichever party, is better for investments, whatever your personal views.

The implication for investors is that gridlock leading to a default on U.S. debt is bad. This is an investment conclusion, not a vote on ObamaCare.

A New Theme: Earnings

In the absence of fresh economic data, the discussions will start early. The best and most recent update comes from earnings expert Brian Gilmartin. Brian explains why we should watch earnings closely, and especially monitor the forward 4-quarter estimate. He writes as follows:

In a nutshell, the reason we track the forward estimate growth rate and y/y change is that (in my opinion) it is the one metric that validates or "explains" an expansion (or contraction) in the SP 500′s p.e ratio, or what is otherwise known as P.E expansion. Although I can't prove it mathematically, it seems intuitive that if the growth rate of the forward estimate is increasing, then the SP 500′s p.e ratio can "expand" to keep pace with the presumed acceleration in "earnings expectations" or contraction as the forward growth rate slows.

Just like the bond market and the Federal Reserve are more concerned with "inflation expectations" than actual inflation that we can see in the data, I think the one component missed by strategists and the CNBC community is "earnings expectations" and the growth therein, and the one metric that quantifies this expectation is forward earnings, and yet we hear about it so very little.

I expect us all to be seriously focused on earnings by the end of this week.

I also have some thoughts on how the debt limit endgame will play out. I'll report on that in the conclusion.  First, let us do our regular update of last week's news and data.

Background on "Weighing the Week Ahead"

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

In contrast, I highlight a smaller group of events, 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

With the shutdown limiting issuance of fresh government data, there was much less (non-political stuff) to ponder, and very little good news.

  • Janet Yellen was nominated to be Fed Chair. This was widely expected, so it did not have much market impact. Yellen opponents should consult above for the definition of "good" as "market-friendly." Felix Salmon has some interesting ideas on how she can improve communications, an area where many of us have found Bernanke disappointing.
  • Non-government indicators show strength. Scott Grannis has a chart pack that shows some optimistic market-based indicators. This is something we should all read in addition to the headlines!
  • The market bounce was not just short-covering. This is in sharp contrast to general media reports, so it is important to note. Bespoke provides the analysis including this chart:

Decile short 1010


The Bad

Despite the data shortage, there was some bad news.

  • The IMF warned on the threats to global growth and especially from the US debt ceiling issue.

MW-BM677_imfgdp_20131007151843_MG


  • Jobless claims spiked higher. Partly this was the "California effect" as their computers caught up with recent claims. The overall level is still better than recent months, but there is more noise than ever. This will not diminish with the effects of the government shutdown.
  • Consumer sentiment, as measured by the University of Michigan, remains disappointing. There is a real chance that the political issues, even if resolved, will have an impact on confidence and the economy. Doug Short has my favorite chart for this indicator, showing the current level in the context of history and recessions:

Michigan Sentiment Doug Short


Gallup also shows a decline in confidence (via Calculated Risk).

The Ugly

More investor confusion! Mark Hulbert notes that many newsletter writers make impossible, exaggerated claims. These often exceed the results of the best investors.

Who could have known?

One method seems to involve avoiding mark-to-market. You just book the winning trades and ignore the losers. Annualize returns. Presto!

Noteworthy

This week marked the Eighth Blogiversary for Abnormal Returns. Congratulations to Tadas for these years of pioneering excellence. He has helped to define the concept of content curation. His work is indispensable for all of us who follow markets and the economy. I use it constantly. Everyone also enjoys the touch of humor and personal interest links.

Well done!


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

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, including this recent update on the world economy.

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. For those interested in gold, he has a recent update, asking when there will be a fresh buy signal.

Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverage
of the ECRI recession prediction, now 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.

Readers should review my Recession Resource Page, which explains many of the concepts people get wrong. Most importantly, the concepts help you to stay invested when the "R word" is loosely used.


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 month Felix has ranged from bearish to neutral to bullish and now back to bearish. The market has been moving back and forth around important technical levels, driven mostly by news.

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 moved higher this week.  A high rating means 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

This week's schedule will be dramatically affected by the government shutdown. Private data will assume unusual significance. Even if the government reopens, it will take several days to get the data machinery going again, including the September employment report.

The "A List" includes the following:

  • Initial jobless claims (Th). Still interesting as the most responsive employment indicator, but very noisy due to California problems and the shutdown.
  • The Fed Beige Book (W). This provides anecdotal information from around the country. It is part of the evidence in front of FOMC members at the next meeting, and sometimes influences market thinking about the economy.
  • Leading economic indicators (F). Still popular with many market followers.

Bernanke is speaking on Monday. While the topic is the Mexican central bank, there are always policy questions. Bernanke speeches will now have a lower relevance factor.

Mostly we will be watching news about the debt limit negotiations.

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 switched to a bearish posture. For our trading accounts we decreased positions to 2/3 long. The long positions are rather defensive. This is not a short position, but we could find ourselves buying the lightened up at mid-week, but we are once again fully invested. This happens when we find three or more attractive sectors, even in a neutral or soft market. 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. The high penalty box rating continues to underscore the uncertainty.

Insight for Investors

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.

Last week was a perfect illustration of how difficult it can be for investors to adjust when there is breaking news. Many who choose to go "all out" because of fear have no plan for re-entering when the risk is lower. Eddy Elfenbein – as he does so often – provides excellent historical perspective. Much was made of VIX levels (the implied volatility gauge that many view as the fear index) reaching 20. Eddy writes as follows:

But viewed in proper perspective, a VIX of 20 really isn't that high. It's just that recent volatility has been so low. Last quarter, the S&P 500 had an average daily volatility of just 0.45%, which was a seven-year low. The S&P 500's close on Tuesday was 4% below the all-time high close from a few weeks ago. In 2011, the market fell nearly 20%.

(Geeky math interlude: If you're curious as to what exactly the VIX measures, it's the market's estimate for the S&P 500's volatility over the next 30 days. The number is annualized, so we can get it down to one month by dividing the VIX by the square root of 12, which is roughly 3.46. That gives us the market's one-standard-deviation estimate for the S&P 500's plus/minus range for the next month.)

Let's take a step back and remember that during the last Debt Ceiling fight two years ago, the VIX came near 50. During the height of the Financial Crisis, the VIX topped 80. Traders are nervous today over a 20 VIX. The VIX was above 20 almost continuously for five straight years during the late 1990s and early 2000s. The stock market is far calmer today.

I recently wrote about how investors can manage 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.

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

As I have noted in recent weeks it is very difficult to trade around the Washington headlines. For long-term investment positions I use the fluctuations as opportunities to adjust positions, not as major risk factors. My current working hypotheses include the following:

  • There is a real chance that no solution will be reached by the official D-Day – Thursday. Stan Collender puts the odds at worse than 50-50. That was also the verdict on several of the Sunday morning talk shows. Senate action will be further delayed since many procedures require unanimous consent to avoid delay. Some objectors are now calling for votes on unrelated issues.
  • There will not be an actual default on Thursday. Here is a better timeline. We might still be wrapping up this issue next weekend.
  • Whenever you can see overlap in the positions of two opposing parties, the eventual resolution is just a matter of time. There is pressure on the GOP from business leaders. There is pressure on Obama because of the very real effects. There is pressure on everyone from declining approval in polls.
  • The eventual solution will combine some face-saving accomplishments for the GOP while also avoiding any precedent-setting notion of success. This is actually the trickiest point.

Daily trading will react and over-react to each piece of news, beginning with a soft opening tomorrow. This will all soon be forgotten, with a renewed focus on corporate fundamentals.

Biggest risk: The longer the issues drag on, the greater the chance that reduced consumer and business confidence has a real effect.

Weighing the Week Ahead: Will Markets Look Beyond the Washington Logjam?

Is it premature to think ahead, to a time after the budget and debt logjam is broken? Markets are celebrated for anticipatory power. There are already some signs this is happening. We would all enjoy relief from the parade of politicians and pundits –and especially the annoying and unhelpful countdown clock.

For the last two weeks I have accurately highlighted the political debate as a major concern for investors. While I do not see an imminent resolution to the issues, I expect to see more traditional investment themes come to the fore over the next two weeks.

An Important Distinction about Politics

Regular readers know that I strongly recommend separating your political viewpoints from your investing. You should join me in being politically agnostic—willing to invest successfully no matter who is in power.

It is fine to have an opinion about ObamaCare, about debt, about European leadership, or about the Fed. Feel free to express your viewpoints in personal discussions or in the ballot box. Stop there. Confusing what you hope will happen with what probably will happen is the fast track to investment losses!

When I discuss policy issues, I am helping you to predict what will probably happen and also the investment consequences. I have been extremely accurate on every important policy decision for many years – Europe, 2011 debt ceiling, fiscal cliff, etc. – often in disagreement with the majority of pundits. I have never expressed personal preferences, but instead emphasize how to profit from likely outcomes. I regularly cite sources covering a wide political spectrum. Discerning readers might note that I find the viewpoints of extremists of all types to be market-unfriendly. Mainstream thought, from whichever party, is better for investments, whatever your personal views.

The implication for investors is that gridlock leading to a default on U.S. debt is bad. This is an investment conclusion, not a vote on ObamaCare.

Updating the Current Situation

As I expected, the government shutdown was not avoided. Last week I offered nine themes in my own working hypothesis, and things are playing out on schedule. Let us update some key points, both good and bad:

  • Democrats have introduced a discharge petition, an arcane maneuver that provides a method to bring an issue to the House floor when it has been blocked by the leadership. The bill must have been waiting for thirty days, but the Democrats found an older "clean resolution" bill to cite for this purpose. George Washington political scientist Sarah Binder explains why this ploy is unlikely to work.
  • The shutdown and the debt ceiling have become linked in the debate. This is positive, because it reduces the chance that the debt ceiling debate will (once again) continue until the last possible moment.
  • The Obama Administration is emphasizing potential costs, citing a potential 2008 situation.
  • Polls continue to show that both parties will be blamed for the shutdown, but more are blaming the Republicans. There is increasing voter anger. Astute political observer Bruce Bartlett looks beyond the poll results. He wonders who will change votes based upon this issue, tweeting as follows:

    Bruce Bartlett @BruceBartlett

    Dems are picking up votes from Reps who use Obamacare & like it, Rep gov't employees & others. Who are Republicans picking up?

  • Speaker Boehner is privately assuring that there will not be a debt default. (Many sources, but the NYT's Ashley Parker has a good story.)
  • There are various reports of informal talks between Democrats and moderate Republicans.
  • Credit default swaps indicate a U.S. default risk of about 4%. Stan Collender sees 25% and other estimates are in the 10% range.

The default swaps and other "fear" indicators suggest that many think they have seen this show before. Many prominent business leaders are calling for a sensible solution. While there is some market reaction to speeches, it is less significant than it was in the 2011 debt ceiling debate.

A New Theme

Over the next two weeks I expect the market to shift attention to Q3 earnings. In the absence of fresh economic data, the discussions will start early. The best and most recent update comes from earnings expert Brian Gilmartin, who notes the jump in the forward earnings for the next year – but also the decline in year-over year expectations. The full article deserves study, but here is a key quote:

Here are the numbers as they fall out presently:

Forward 4-quarter estimate: $119.04

PE ratio on forward estimate: 14.2(x)

Earnings yield: 7.04%

Growth rate of forward estimate: 6.06%

If these expectations are met, it remains a bullish scenario. Is the bar too high?

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

Background on "Weighing the Week Ahead"

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

In contrast, I highlight a smaller group of events, 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

Despite the stock market reaction, this was a pretty good week for economic data.

  • Gas prices declined further, now down 10% over the year at $3.385 per gallon. (I filled up yesterday at $3.18). Bespoke analyzes the recent trends including a long-term chart. Let us focus on the last twelve months

Gasoline 1 year


  • Global growth is at an 18-month high. John Lounsbury of Global Economic Intersection does a nice job of analysis using the JP Morgan and Markit data.
  • F-Series truck sales show continued strength. Bespoke is reporting monthly on this indicator with the expected great charts of current and long-term trends. They explain the importance as follows:

    Sales of pickup trucks are often a sign of strength or weakness in the small business and construction sectors, as these types of businesses are the most common users of these vehicles.  With that in mind, today's numbers from Ford (F) continue to show strength in these sectors.  During the month of September, Ford sold 60,456 F-Series pickup trucks.  This represents an increase of 9.8% from last year and is the highest level for the month of September since 2006.

  • Weekly jobless claims continued at extremely low levels. This series is often pretty noisy and there has been a recent question about reporting from some states. That has been clarified, and the results are the best since the pre-recession era. We may soon get a spike from unemployed government workers, but the overall trend remains strong.
  • ISM manufacturing was excellent on all counts at 56.2 on the headline and solid on the internals. The employment index was the highest for the year. Calculated Risk has details along with this chart:

ISMSept2013

The Bad

As always, there was a little bad news.

  • The HSBC flash PMI for China came in a point light at 50.2, barely showing expansion.
  • ISM Services missed expectations, while still showing growth. See Steven Hansen's post at GEI for charts and detailed analysis. This featured table shows the story of the internals:

Z-temp8


  • Vehicle sales were down a little on the headline number, but fewer selling days in the month accounted for the change.
  • ADP private payroll gains for last month registered 166K and the prior month was revised lower by 17,000. This continues the weaker net job growth we have seen in recent months. In the absence of the "official" BLS report, the ADP measure has extra significance. (See Calculated Risk for a good discussion).
  • The European trade talks are a casualty of the shutdown. This has important economic significance, described effectively by ft.com. The FT has had broad and effective coverage of shutdown issues.

The Ugly

Investor confusion! Misguided "investors" bought Tweeter, not Twitter. Despite the similarity in names and stock symbols, purchasers really should know better. When the Twitter IPO finally occurs the symbol will be TWTR and it will NOT be a penny stock. The bankrupt Tweeter has the trailing "Q" in the symbol – TWTRQ – the market equivalent of a scarlet letter. It traded up 1800% to a high of thirteen cents, eventually sparking a trading halt. Steven Russolillo of the WSJ was all over this story and has the intra-day chart.

The Beautiful

Occasionally it is nice to offset the ugly with something really nice. The tech-savvy Charles Kirk has done it again. His Weekend Magazine is like a super-linkfest with interesting topics, charts, and pictures. He still has his famous chart show (a mixed picture this week) which I always review in preparation for the week ahead. These are members-only features, but the cost is modest and the value high.


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

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, including this recent update on the world economy.

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. For those interested in gold, he has a recent update, asking when there will be a fresh buy signal.

Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverage
of the ECRI recession prediction, now 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. Doug's most recent comment? "
From a public perspective, the company has apparently gone into hibernation. Over nine weeks later, ECRI's website is still featuring a commentary posted at the end of July…."

Readers should review my Recession Resource Page, which explains many of the concepts people get wrong. Most importantly, the concepts help you to stay invested when the "R word" is loosely used.


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 month Felix has ranged from bearish to neutral to bullish. The market has been moving back and forth around important technical levels, driven mostly by news.

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 moved higher this week.  A high rating means 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

This week's schedule will be dramatically affected by the government shutdown. Private data will assume unusual significance.

The "A List" includes the following:

  • The FOMC minutes (W). The market places excessive emphasis on the smallest change in Fed policy. Especially in the absence of other data, this announcement will get plenty of play.
  • Michigan sentiment (F). This is always important as an indicator of employment and consumption. This week it will also reflect reactions to the political impasse, making it more important than ever.
  • Initial jobless claims (Th).   This is the most frequent and responsive employment indicator, but it tells only part of the story. It will not yet reflect government layoffs.

The "B List" includes the following:

  • Assorted private indicators that normally would get little play, like the small business optimism index, etc.

We'll get some speeches, including ECB President Mario Draghi at the Economic Club of New York on Thursday.

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 switched to a neutral posture. For our trading accounts we lightened up at mid-week, but we are once again fully invested. This happens when we find three or more attractive sectors, even in a neutral or soft market. 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. The high penalty box rating continues to underscore the uncertainty.

Insight for Investors

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.

I recently wrote more about how investors can manage 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.

The Fed

PIMCO's Tony Crescenzi has a great column on the likely long-term course of Fed policy and the folly of fighting it. This work is much, much better than the breathless commentary of those jumping on each new speech to "prove" that the Fed is about to change the world. Here is a key quote:

Let's jump to this note's conclusion: Past is not prologue for the projected path of the Fed's policy rate, which we expect will remain low for a very long time. A baby born today will probably be in kindergarten by the time the Fed adopts a neutral stance on monetary policy.

 

Market Valuation

 

An amazing aspect of the bull market has been the widespread devotion to valuation measures that never generate a "buy" signal. I recommend that investors consider many perspectives. Todd Sullivan highlights an intrinsic value metric for the S&P 500. This approach was accurate for many years, as you can see from the chart. It shows the market as about 13% undervalued. Since it uses forward earnings, it would probably be called a "toy model" by the guy whose own method has not worked so well. Confirmation bias reigns in the market valuation debate!

 

Capture1256-624x321


 

Bubble?

 

I grow tired of reading the "bubble" claims. When the market made a dramatic decline in 2009, it now seems that this was a bit of an overshoot. Last year's "fiscal cliff" discount started the current year about 7% in the hole. It is inappropriate to look at recent gains without any historic context!

 

Scott Grannis shows that we are basically in a long-term channel of market growth.

 

S&P 500


 

Bargains?

 

Josh Brown cites Merrill Lynch's Ten Reasons to Buy Industrials. I strongly agree with this theme. Read the entire post, but here is my favorite from the ten items:

 

9) The big surprise: it's now the highest quality sector
Industrials has the most stable earnings of all ten sectors (even vs. defensives like
Consumer Staples!) but is still penalized for being too cyclical, as it is trading at a
beta of 1.3. There is a glaring mispricing of risk that argues for a P/E re-rating.

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

Whenever you can see overlap in the positions of two opposing parties, the eventual resolution is just a matter of time.

The key point is that the GOP is no longer insisting on changes to ObamaCare. We are back to a discussion of deficits and spending. The Democratic offers overlap with prior GOP demands, so it is just a matter of time.

I expect the following:

  1. A temporary extension of the debt limit. This will be criticized by the punditry as "kicking the can" but it will serve the function of buying some needed time. The market will respond to the progress, not to the political wails of some pundits.
  2. Minimally, an agreement that provides some tweaking of sequestration and provides Speaker Boehner a chance to claim some credit.
  3. Maximally, a broader compromise on some entitlement and debt issues – less likely and taking longer.
  4. The agreement could be reached overnight or on a weekend, without much notice.
  5. The resulting pop in stocks (just like the fiscal cliff resolution) will leave many chasing the market, waiting for a pullback.

This all highlights the difference between trading and investing. If you are waiting for a market decline, you should commit in advance to buying in if you are proven wrong. If you normally have a 60% stock allocation for example, and you decide to go out of the market, you need a plan to get back in. For most people, it is wiser not to make these short-term guesses, accepting the reality of some volatility.

The big danger is an overall loss of confidence. This is what happened in 2011. If the issue continues long enough, perceptions will become reality. Sober Look examines the issue, including this chart:

Gallup Index


While I am optimistic on the final outcome, there might still be a rocky ride.