Weighing the Week Ahead: The Market Risk from Current Crises

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

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

What does this mean for the coming week? In the low-volume August trading environment, it takes less real news to move the market. This may be especially true during options expiration week. The Schwab team thinks the market has a “binary feel” with the chance of a big move in either direction. Jim Cramer thinks that Putin’s use of sanctions (rather than a military action) is bullish. His sources see this as a sign of an eventual diplomatic resolution. Ian Bremmer, President of political risk research and consulting firm Eurasia Group, thinks that a Russian invasion of Ukraine remains very likely. He sees humanitarian aid as a cover for such an action. Mario Draghi sees the economic impacts from Ukraine as limited, instead emphasizing the possible energy effects from Middle East issues. As usual, I have a few thoughts to help in sorting through these diverse viewpoints. First, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information. Last Week’s Data Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:

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

The Good Most of the important news last week was very good.

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

ISM Service Sector

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

Own_rep_approval

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

SRLoanCRE2July2014

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

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

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

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

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

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

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

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

Retirement-plans-2013-SHED1

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

BN-DY350_GDPRES_G_20140802112237

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

Italys-Lost-Decade The Ugly Our “ugly” list for last week was unfortunately accurate. We had headline news from all conflicts with plenty of violence and death competing for our attention. The Ebola crisis, cited a few weeks, has spread to Lagos, a densely populated city of 21 million and a center for travel. With a few US cases from foreign travel, Gwynn Guilford at Quartz explains that people should not be “freaking out” over the risk. Check out her thoughtful piece, which corrects a lot of misinformation. (Also great info from Rand). The Silver Bullet I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts.  Think of The Lone Ranger. Last week I asked whether readers might point out the obvious problems with this chart: cotd-190 The most important thing to note is that the series begins in the middle of a recession. This should always be a warning, especially when it is a subject like tightness in labor markets. Later in the post I provided the reference to the Washington Post article about favorite FRED charts. This was #4, from Michael R. Strain. As you can see, the current levels are not overly tight by historical standards. John Lounsbury of GEI notes that they covered this truncated chart “behind their wall.” Good work! unemployed to jobs ratio Quant Corner Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here. Recent Expert Commentary on Recession Odds and Market Trends Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (2 ½ years after their recession call), you should be reading this carefully. Doug includes the most recent ECRI discussion, which has been consistently bearish, including the blown call on the recession. Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured “C Score.” One of his conclusions is whether a month is “recession eligible.” His analysis shows that none of the next nine months could qualify. I respect this because Bob (whose career has been with banks and private clients) has been far more accurate than the high-profile TV pundits. RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. Dwaine’s “liquidity crunch” signal played out as projected. His market timing method is “armed for the next possible long signal.” Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg’s BCI index also shows no recession in sight. For those interested in hedging their large-cap exposure, Georg has unveiled a new system. Georg now has another new program, with ideas for minimum volatility stocks for tax-efficient returns. He also has new advice for those seeking a safe withdrawal rate, now featuring the use of put options to protect against extreme events. Dr. Ed Yardeni also sees little chance of a recession unless the Fed acts much sooner than expected. Neil Irwin of the NYT looks at the GDP contribution of various market sectors, analyzing the main sources of the continuing below-trend growth. Biggest laggard? Housing. Irwin GDP Sectors The Week Ahead We have a rather quiet week for economic data and events. The “A List” includes the following:

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

The “B List” includes the following:

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

Earnings news is winding down, but there are still some important reports from retailers. There is only a little reported from the Fed “Speakers Bureau.” Vice-Chair Fischer will speak in Stockholm on the Great Recession and the NY and Boston Presidents speak at a conference on Tuesday. While policy comments are not part of the plan, sometimes questions elicit new information. Breaking news from world hot spots will command attention. How to Use the Weekly Data Updates In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a “one size fits all” approach. To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances? My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage. Insight for Traders Felix has turned bearish, but it is a close call with little conviction. Uncertainty remains high – typical for a trading range market. This week we were only partially invested for most of the week and one of the positions is in bonds. Inverse ETFs have positive ratings, but are still in the penalty box. Felix remains cautious, but has not yet gone short. Noah Smith at Bloomberg View warns about blindly following trends. He has a creative example of a strategy that seems to work on that basis (check it out) and this warning as his conclusion:

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

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

Shopping lists? Here are some interesting ideas:

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

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

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

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

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

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

Equities-2

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

If you are worried about possible market declines, you have plenty of company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. You can get our report package with a simple email request to main at newarc dot com. Also check out our recent recommendations in our new investor resource page — a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love and use feedback).

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

Weighing the Week Ahead: Will the Fed’s Experiment End Badly?

 

Put together these ingredients: The biggest weekly market decline in two years, the winding down of earnings season, and a light week for economic data. The result? Financial TV producers will be seeking experts to explain whether we are starting a major correction. Analyzing the Fed will be a favorite theme.

Unless and until we get a bit of a rebound in stocks, I expect a focus on this question:

Will it all end badly?

Prior Theme Recap

In my pre-vacation WTWA I expected that attention would turn to corporate earnings. That was accurate. I also expected that earnings would probably surprise to the upside. So far, so good. I noted that the market had digested a fair amount of bad news. True enough. Finally, I asked whether this might reignite the stock rally. In my final thought, I emphasized the need for right-sizing positions in the face of risk.

The upside breakout in stocks did not occur, and the focus has shifted back to what might be wrong in the world.

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

San Francisco Appearance

I have agreed to speak at the San Francisco Money Show in three weeks. Here is more information. I am working on some special themes. We will have some fun and also identify some good investment ideas. I look forward to meeting some readers in person.

This Week’s Theme

The stock market finally broke from the recent quiescence. Doug Short always captures the week in a single great chart. Things were quiet for my return from vacation – at least until Thursday!

dshort week

What was the cause of the decline? Let us start with what does not make sense, including most of the explanations offered. We saw the typical pundit parade both on TV and from major print and web media. Anyone who had a bearish theme over the last year or so got some exposure. I watch a wide variety of sources, but some of these experts came out of nowhere. Each has a method that has “always” worked when three or four elements happens together. You cannot find the experts with a web search, so there is no ability to check their track records. That does not prevent writers needing a story from featuring the scariest news.

There was some fresh news on Thursday, perhaps enough to spook some nervous traders. First, the employment cost index was up 0.7% for the quarter. Put aside the idea that many have argued the need for better wage gains. This single reading (2% year-over-year) was trumpeted as news that Yellen was wrong about labor market slack. Higher interest rates would be coming soon, etc. This was not confirmed by hourly wage data on Friday, but the damage was done. Second, the sanctions against Russia are ratcheting higher. For financial markets, the question is how this affects trade and the European economy.

I expect more of the same worries to be featured at the start of next week’s trading. Here is a simple guide to the negative side:

  • The issue. In the most recent CNBC survey of “Wall Street Pros” more than 1/3 of respondents said that the Fed’s current policies would “end badly” and another ¼ thought the outcome was a toss-up. Confirming this, about half of those responding believe that the Fed is too accommodative. The survey results are consistent with the daily commentary from many sources. (See Steve Liesman report and also the full results).
  • The criticism of Fed policy makes its way to investment clients. Their skepticism is described by Steven Russolillo in the WSJ.
  • The combination of policy issues and weaker stocks has bears out in force. See Rob Copeland’s WSJ piece or simply turn to the lead page at your favorite finance site. The first sign of selling is cited as confirmation of a wide range of theories about valuation, divergences, market cycles, and assorted indicators.

     

There are also some important counter-arguments:

  • Fed forward guidance can have a real economic effect, perhaps more powerful than QE. Mark Thoma has an excellent explanation that shows the importance of Fed credibility about the future course of short-term rates.
  • Stocks continue to rise even after the start of interest rate increases. Good analysis from Barry Ritholtz.

    When we analyze the data, we find that almost three-fourth of the time when rates were rising stocks tended to rise as well. When we looked at the conditions during these periods of rising stocks and rates, we found that the 10-year bond yield averaged 5.11 percent, the price-earnings ratio of the S&P 500 averaged about 15, and inflation as measured by the consumer price index was more than 4 percent. The average S&P 500 increase during these periods was almost 21 percent.

  • Calm markets are not more susceptible to declines. (Data from Victor Niederhoffer).

As usual, I have a few thoughts to help in sorting through these diverse viewpoints. First, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

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

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

The Good

Most of the important news last week was very good.

  • ISM Manufacturing hit a three-year high. Bespoke has discussion as well as the chart below. Scott Grannis also looks at the index showing the relationship to GDP.

080114ISM Main

  • Earnings reports continued to be strong. FactSet reports a terrific 74% earnings beat rate and 65% beats on sales. The year-over-year growth is 7.5%. Zacks shows even stronger growth. The confirmation of earnings growth also supports the forward earnings estimates. I know that many are skeptical of this approach, but perhaps they should look at the data (also from FactSet).

FactSet Forward Earnings

  • Auto sales remain strong. Bespoke updates the Ford F-Series truck sales, a useful proxy for construction and small business. The level is the best since 2006, despite the impending changeover to a new model.
  • The PCE index shows only 1.6% year-over-year growth. This is the Fed’s preferred measure of inflation and it is well below the 2% target. See Doug Short for full analysis and charts.
  • Conference Board consumer confidence was strong. The data help us to understand job creation, complementing the information about job losses that we get from the initial claims series. Ed Yardeni explains the relationship and provides this chart:

yardeni confidence

  • Employment growth remained strong. The report was mixed versus expectations – a slight miss on the net change in payroll jobs and an uptick in unemployment, but better labor force participation and a reversal of the part-time job worries. The overall story is one of continuing modest growth, but not yet close to the goal line. It seems to provide support for Fed Chair Yellen’s viewpoint (See Jason Lange at Reuters) that there remains some slack in the labor market. (See Phil Izzo’s WSJ update).
  • Q2 GDP showed 4% growth, handily beating expectations. Putting the first and second quarter together suggests a continuation of modest growth similar to the past two years. There is a continuing question about what can drive a higher level of economic expansion. James Hamilton has the thorough examination we would expect from him, with the hopeful note that this could be the first in a string of better reports. Here is his chart of the contributors to growth:

gdp_comp_jul_14

  • Consumers are borrowing again. The end of deleveraging is a market-friendly development. (See The Economist).

20140802_FNC435

The Bad

There was also some negative news.

  • Technical damage. With a near-term focus on trading, I am especially interested in what I can learn from Charles Kirk. His weekly chart show is members-only, but the cost is minor compared to the value. Without giving away his story, let’s just say that Charles is wary and watching possible bearish setups. Even if you are a long-term investor, it helps to know what levels are viewed as crucial.
  • Congress goes on recess. Some would see this as good news. What’s another five weeks after the most unproductive legislative stretch in history? A few years ago it was popular for market participants to view Washington gridlock as good. This may have been based upon earlier eras when there was a partisan split between the Executive and Legislative branches. This often led to bipartisan compromise and moderate policies. Things are different now. From The Hill:

    A measure of members’ ideologies developed by political scientists Howard Rosenthal and Keith Poole finds that Congress is more polarized now than at any time since the end of Reconstruction in the 19th century.

    Their data show the number of centrist members in both parties has fallen from around 40 percent in the early 1980s to under 10 percent today.

    “The effect is rather complete policy paralysis,” said Rosenthal, a professor at New York University.

    “They don’t talk because they’re just so ideologically opposed,” he said.

    Absent negotiations on legislation, both sides now seem to take increasing delight in lobbing blame at each other.

  • Argentina defaulted on its debt. Or maybe not. It depends upon your source. We’ll know soon whether holders of credit default swaps collect. For the rest of us, it does not seem to be a question of solvency. (See Quartz).
  • Pending home sales were weak. Prices are also soft and entering a seasonally weak period. (See Calculated risk here and here).
  • China housing prices dropped 0.8%, the third straight month of decline. The pace is accelerating. (See WSJ).
  • Sanctions on Russian banks may now threaten other markets. So say the banks. (See Fortune). The impact led to a big weekly loss in German stocks.
  • Michigan sentiment is at a four-month low. Doug Short has the story, and my favorite chart on this important measure.

dshort Michigan Sentiment

 

The Ugly

There are continuing conflicts, violence and death competing for our attention. The Ebola crisis, cited a few weeks, ago has entered a new stage. The disease has spread to Lagos, a densely populated city of 21 million and a center for travel. Gwynn Guilford at Quartz has a detailed report.

The Silver Bullet

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

No award this week. Maybe before next week someone will point out the obvious problems with this chart:

cotd-190

Quant Corner

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


Recent Expert Commentary on Recession Odds and Market Trends

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (2 ½ years after their recession call), you should be reading this carefully. Doug includes the most recent ECRI discussion, which has been consistently bearish, including the blown call on the recession. Doug Short has a new version of his “Big Four” chart. It has now been updated for real personal income and the employment data.

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg’s BCI index also shows no recession in sight. For those interested in hedging their large-cap exposure, Georg has unveiled a new system. Georg now has another new program, with ideas for minimum volatility stocks for tax-efficient returns. He also has new advice for those seeking a safe withdrawal rate.

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

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. Dwaine’s “liquidity crunch” signal played out as projected. His market timing method is “armed for the next possible long signal.”

Nikki Kahn at The Washington Post has a great feature article on FRED, “every wonk’s secret weapon.” Readers of our Quant Corner have all seen charts from FRED. In my first uses of this great resource I was still visiting via a dial-up modem! FRED has changed both in the exhaustive coverage of data and the ease of use.

A companion article shows some favorite charts from leading economic observers. They are all interesting, but I especially liked this one from Cardiff Garcia of FT Alphaville. It shows the trends in manufacturing and construction employment, converging before 2007, but sluggish now. Very interesting, and not obvious from most discussions of employment.

employment trends

The Week Ahead

We have a very light week for economic data.

The “A List” includes the following:

  • Initial jobless claims (Th). The best concurrent news on employment trends.
  • Trade balance (W). June data that will affect Q2 GDP revisions.

The “B List” includes the following:

  • ISM Services (T). Good read on the larger part of the economy.
  • Factory orders (T). June data.
  • Wholesale inventories (F). More June data with implications for GDP revisions.

Earnings news will have some effect, with about 25% of the S&P 500 still to report. Events in any of the world hot spots will also command attention.

With the FOMC meeting behind us, the Fed participants will be free to hit the speaking circuit. Some believe that the message is orchestrated. That was true of the Greenspan Fed, but less so now. The modern Fed has plenty of transparency, including the divergent views of members. Surprisingly, I do not see anything on the calendar. We shall see.

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

Felix has remained neutral with confidence greatly reduced. Uncertainty remains high – typical for a trading range market. This week we were only partially invested at first, but fully invested by week’s end. This is a bit deceptive, since one of the positions is in bonds and only one is in US equities. Felix remains cautious.

Brett Steenbarger notes the recent weakness in junk bonds, an indicator of reduced market tolerance for risk. If Felix could read, he would certainly follow Dr. Brett. If you are a trader, you should, too.

Adam Grimes warns that trading is a lot harder than you think. More of it is random and unpredictable. Here is a meaningful quote:

There are things that work in trading, but they probably don’t work as well as you’d like to think. A corollary to that is: most people lie. The guy you are talking to in that trading room who tells you how he has made money every day for the past 5 years buying a candlestick reversal off of a moving average? He’s almost certainly lying. The guy trying to sell you the trading course that promises to reveal “insider secrets” and how to make $33,871 in 30 days? He is also lying. The guy calling out trades every day in stocks? He’s probably trading 100 shares.

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

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The current “actionable investment advice” is summarized here. In addition, be sure to read this week’s final thought.

The market has finally provided some volatility. This is attractive for long-term investors who have a good shopping list. We may some position changes and also added to our Enhanced Yield positions (dividend stocks versus near-term short call options). These new positions are best established on down days.

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

It is a great time to be an individual investor. Tadas Viskanta, our go-to source for what is happening in financial markets, wrote on this theme thirty months ago. His update at The Big Picture reviews how the original concept played out. Many have joined his conclusion, highlighting lower costs and greater opportunities. This is a post that deserves a careful read.

Beware the “popular stocks” says Patrick O’Shaughnessy. He suggest that value investors look elsewhere, and provides some good examples.

Jonathan R. Laing, in a Barron’s cover story, asks Can ETFs Be Derailed? He analyzes some problems with intra-day liquidity. His informative look at the relationship between the ETF price and underlying shares is an important topic for ETF investors. Felix and I have noticed some apparent large discrepancies, and we stick to the high-volume, high-liquidity funds.

Beware of reading entertainment and confusing it with investment advice. Noah Smith provides some great examples, emphasizing those who mix in some politics to gain extra attention. He reviews predictions from some popular sources. There is no good way to summarize this analysis of the clash of the self-taught Austrian economists, but you will benefit from reading it.

If you are worried about possible market declines, you have plenty of company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. You can get our report package with a simple email request to main at newarc dot com. Also check out our recent recommendations in our new investor resource page — a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love and use feedback).

Final Thought

General investment commentary seems to get even worse at times of market stress. The competition for readers or viewers gets even more intense. Have you noticed that extreme opinions become the norm? The Fed story has been the popular recent example.
Investors can be better consumers of this information with a little help from two insiders, Josh Brown and Jeff Macke. During my vacation I finished reading their entertaining and informative book — Clash of the Financial Pundits: How the Media Influences Your Investment Decisions for Better or Worse. I plan to do a complete review, but it is especially timely right now.
As you watch or read the news next week, you should realize the pressure on pundits to be bold, dramatic, and confident – even when their forecasts are a bit shaky. The financial incentives range from selling products to building a big reputation. Their analysis of these forces is supported with some compelling evidence from both history and interviews. Reading this book is inoculation against hype, and it is also a lot of fun.
As so often happens, if you merely looked at the news last week, you would never have predicted the market result. Economic and earnings fundamentals remain sound. Recession risk is low. I expect things to stabilize, but I am not surprised by increased volatility. The story of the change in Fed policy will play out over the next two years, with plenty of chances for both traders and investors.

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

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

Can strong corporate earnings spark a renewed rally in stocks?

Prior Theme Recap

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

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

This Week’s Theme

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

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

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

dshort market week

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

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

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

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

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

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

First, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

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

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

The Good

There was some important good news last week.

Beat Rate Q214

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

15_cbo_budget_outlook_fig1-1

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

 

The Bad

The important economic news last week was mostly negative.

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

Starts20132014June

 

ConSentPreJuly2014

The Ugly

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

The Silver Bullet

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

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

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

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

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

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

Quant Corner

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


Recent Expert Commentary on Recession Odds and Market Trends

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

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (2 ½ years after their recession call), you should be reading this carefully. Doug includes the most recent ECRI discussion, which has been consistently bearish, including the blown call on the recession. We included Doug’s chart of the Big Four last week, but data devotees should check it whenever there is a big release. It has now been updated for the employment data.

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg’s BCI index also shows no recession in sight. For those interested in hedging their large-cap exposure, Georg has unveiled a new system. Georg now has another new program, with ideas for minimum volatility stocks for tax-efficient returns. He also has new advice for those seeking a safe withdrawal rate.

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

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

 

The Week Ahead

We have a moderate week for economic data.

The “A List” includes the following:

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

The “B List” includes the following:

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

Earnings stories will dominate.

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

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

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

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

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The current “actionable investment advice” is summarized here. In addition, be sure to read this week’s final thought.

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

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

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

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

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

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

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

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

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

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

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


If you are worried about possible market declines, you have plenty of company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. You can get our report package with a simple email request to main at newarc dot com. Also check out our recent recommendations in our new investor resource page — a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love and use feedback).

Final Thought

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

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

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

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

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

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

     

And most importantly —

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

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

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