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.]

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

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

Is it time for a mid-course correction?

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

Prior Theme Recap

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

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

This Week’s Theme

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

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

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

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

Last Week’s Data

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

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

The Good

There was some important good news last week.

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

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

Auto Sales

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

MW-CL448_jobs_p_MG_20140703122843

The Bad

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

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

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

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

F150 June 2014

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

070314 ISM SVCS Charts

The Ugly

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

Inside Story

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

The Silver Bullet

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

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

Quant Corner

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


Recent Expert Commentary on Recession Odds and Market Trends

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

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

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

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

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

Dieli part-time

 

The Week Ahead

We have a very light week for real news.

The “A List” includes the following:

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

The “B List” includes the following:

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

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

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

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

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

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

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

Insight for Investors

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

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

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

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

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

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

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

 

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

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

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

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

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

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

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

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

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

bottom

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

Final Thought

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

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

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

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

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

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

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

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

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

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

jpm interest rates

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

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

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

Postscript

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

Weighing the Week Ahead: Economic Fireworks?

(6/28/14) With the stunning decline in Q1 GDP, the health of the US economy has once again taken center stage. The week ahead is shortened by a Friday holiday, but is packed with important data releases. It will all be over Thursday morning, when many will quit early and head for the beach.

In a quiet, low volume trading environment, we could see some early fireworks!

Prior Theme Recap
Last week I expected plenty of inflation talk leading up to the release of the Fed’s preferred measure, the PCE index. That assessment was accurate. I also speculated that there might be a final GDP revision exceeding 2%. That was an underbid! The story made plenty of news, but caused only a temporary reaction in stocks. Bonds strengthened (lower yield) emphasizing the continuing disparity between those 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.

This Week’s Theme

With the Q114 GDP decline as context, the economic debate is once again wide open. It is time for a mid-year reality check, with possible fireworks in store. I expect the media and punditry to examine a full range of economic possibilities. Here are the candidates.

  • Stagflation – Combine economic weakness with inflation and it is the road to the 70’s. The Fed is “boxed in” and “between a rock and a hard place.” Watch the early warning signs. Here is an example of this thinking.
  • Poor economic policy – ObamaCare, tax policy, regulation. (WSJ commentary reflects this viewpoint).
  • Exceptional circumstances – weather, sluggish health care enrollment, inventories. (Analysis and charts from Hale Stewart).
  • Things turned in March – noted by those who follow frequent data. (Extensive discussion from New Deal Democrat).
  • Expect a rebound — weather delayed demand, health care rebounded, inventories will be rebuilt. (Morningstar). (Also Jared Bernstein via Mark Thoma).

Same data, many interpretations. Some positions reflect underlying policy and political preferences. Investors must use care, especially on issues of this type. We must not confuse what we hope for with reality and sound investments.

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

Last Week’s Data

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

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

The Good

There was some encouraging news last week.

  • Consumer confidence registered 85.2. This beat expectations via the Conference Board. The Michigan Sentiment report also showed a slight beat. Doug Short updates both indicators (and the NFIB optimism index as well). The charts are all great, but I will highlight the Conference Board result – now beating the declining trend, but well off of historic highs.

dshort conference board

 

  • Stock Buybacks support the market. Ed Yardeni shows the trend and the data. He describes the causality and warns about the impact of a recession. If this does not seem like good news, check out TrimTabs (below).

    As I have often observed in the past, corporations have an incentive to borrow in the bond market and use the proceeds to buy back shares when their earnings yield exceeds the corporate bond yield. That’s been the case since 2004 thanks to the Fed’s easy monetary policies under both Alan Greenspan and Ben Bernanke, and now Janet Yellen.

    Buybacks are a form of financial engineering since they boost earnings per share whether a company’s fundamentals are improving or not. They’ve certainly contributed to the bull market’s great run in an economic environment that has been widely described as “subpar.”

yardeni stock buyback

  • Earnings estimates grind higher. Brian Gilmartin does a great job on this topic, as well as coverage of many specific companies. We think of him as the earnings guru. His current update post reflects some conversations we have had in recent years. I like to think we have both benefited from a focus on the truth in earnings forecasts. Most observers casually dismiss one of their most helpful sources. Earnings estimates start out as too bullish, mostly when made two years in advance. By the time the report is announced, the beat rate is over 60%. They have to be right at some point!
  • Housing data improved. New home sales were up over 18%. Calculated Risk, our favorite source on housing, has a more measured take – less enthusiasm about the spike in new home sales (up 2% y-o-y), less pessimism about the decline in existing home sales (reflecting fewer foreclosures and short sales).

 

The Bad

The economic news included some negatives as well.

  • Boomerang kids won’t leave. The sluggish recovery is playing havoc with “traditional” family life. Young adults are returning home. This can be financial necessity, but it can also make sense. Adam Davidson’s NYT Magazine piece attracted plenty of attention this week. There are implications both for employment and housing.
  • Margin debt increased at the NYSE. I am scoring this as “bad” because that is the way it is generally portrayed. Doug Short posts it with a question mark, but others using his work are less equivocal. Some also see a decline in debt as bad, since that triggers the warning for stocks (which is either 3 months or 6 months or a little longer). I am uncomfortable with indicators that are viewed as positive (or negative) no matter whether they go up or down!
  • Planned stock buybacks are in a dramatic decline.The overall levels are still high, but down significantly from Q1. (TrimTabs via MarketWatch).
  • Personal spending disappointed. The personal income gain met expectations with a growth of 0.4%, but spending was only up 0.2%. (Via Calculated Risk). Steven Hansen at GEI sees this as bad sign for Q2 GDP.
  • Durable goods orders declined 1%. (See WSJ). Also several helpful comparisons and charts from Doug Short.

dshort durable goods

  • GDP declined 2.9% for Q114. The decline is much greater than we typically see outside of a recession. Even if the recovery is continuing, it underscores how dramatically economic performance lags potential. Scott Grannis discusses these relationships, including a good chart on each point:

Nom vs real GDP qoq

 

Real GDP vs trend 50

The Ugly

Ukraine. The ceasefire in eastern Ukraine is “under stress.” (Via BBC).

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.

Normally the award goes for a single refutation of a single bad claim. Barry Ritholtz often uses a weapon that is both more modern and more powerful than the Lone Ranger’s. Please read his analysis of a general failure in causal reasoning. Here are some recent examples, cut down with a Gatling gun instead of a six-shooter.

What are a few examples of the single factors that have been making the rounds these days?

GDP: “We have never had a negative 2.96 percent GDP report and not gone into recession…”

Rising Rates: “The U.S. stock market doesn’t do well when interest rates are rising.”

Earnings Surprises: “Earnings are good this quarter, better than expected, and therefore, the market’s going higher.”

New Financial Products: “These new products are being adopted, therefore it means the bull market is coming to its peak.”

Death Cross/Golden Cross: “When the 50 and 200 day moving average cross to the upside (downside), it bodes well (poorly) for any trading vehicle.”

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.

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.

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.

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 also continually updates the “Big Four” indicators used in recession dating by the National Bureau of Economic Research (NBER). With all of the data for May in the books, it is time for another look at the key chart, but see the full article for comprehensive discussion.

dshort big four

Another great source is Janet Yellen’s Dashboard from Brookings (HT Jeff Sandene @MarathonWealth). This is a wonderful interactive tool. The Lauren Nassef illustration captures the concept.

Yellen Dashboard

 

The Week Ahead

We have plenty of news in a holiday-shortened week.

The “A List” includes the following:

  • Employment report (Th). The complex, heavily revised report is still the most important evidence for markets.
  • ISM index (T). Good read on manufacturing trends with some leading qualities. Continuing strength?
  • Auto sales (T). After the seasonal fluctuations, will strength continue? And check out the F150 small business indicator.
  • ADP employment report (W). An alternative measurement of private job growth. Deserves more respect.

The “B List” includes the following:

  • ISM Services (Th). Covers more of the economy than manufacturing, but still not as influential. Many will be on the way to the beach by the time this is released!
  • Construction spending (T). Important sector – May data.
  • Chicago PMI (M). The regional survey most reflective of the national data.
  • Pending home sales (M). May data, but everyone cares about all things housing.
  • Trade balance (Th). May data relevant for Q2 GDP.

Despite the start of summer, the speaking calendar includes SF Fed President on Tuesday and Chair Yellen on Wednesday.

While the financial markets have adjusted to the current Iraq story (see here for confirmation), there is plenty of attention to any breaking news. There is also the possibility of increased conflict in Ukraine.

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

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

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

Insight for Investors

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

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

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

Often the best advice helps the investor learn what to ignore.

  • Worry about low volatility. The scary stories say that it reflects dangerous “complacency.” Dan McCrum at FT Alphaville highlights some great research from Citi. There is less volatility in earnings. The research also shows the complete lack of correlation between volatility and stock returns for the next year. Case closed.

    QE has not just propped up asset prices, it has also helped to stabilize economies and corporate profits. As long as the eventual withdrawal of QE coincides with continued fundamental stability, then there may be less of an increase in market volatility than many fear.

Screen-shot-2014-06-27-at-8.55.56-AM

BN-DL084_1929pa_G_20140626115826

On the positive side, there are some good stock ideas.

Goldman Sachs shares some choices (via Steven Russolillo at MarketWatch for the underlying rationale). Skeptics may ask why they would share ideas, but that is the modern method of the big firms. They need to show a little. We own some of the names and others are on our watch lists for various programs, so the ideas are interesting.

MW Goldman Buy LIst

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

The weakness in Q1 GDP is not consistent with the wide range of economic data that we track. There is no indication of a recession using the indicators tracked by the NBER, even during the first quarter. Growth has been sluggish, but steady. This feels like a recession to most average people, who consistently respond to surveys that the Great Recession has not ended.

Meanwhile, the business cycle hit a trough in 2009 and shows no sign of reaching a peak. Michigan economist Justin Wolfers, writing in the New York Times, observes as follows:

The most important indicators of our economic health are telling very different stories. On Wednesday, news reports made much of the fact that gross domestic product fell at an annual rate of 2.9 percent in the first quarter of this year, a decline largely attributable to bad weather. That brings growth over the past year to a disappointing 1.5 percent. Yet the labor market continues to deliver good news, and over the same period, the unemployment rate fell by more than a full percentage point.

He notes that the past year has defied the relationship between unemployment and economic growth, Okun’s Law. The chart below shows that current results represent a dramatic outlier.

Defying Okun

I do not expect any instant economic solutions, but the evidence supports continued reversion to the long-term growth trend. This will continue until we see more signs of a tight labor market — not just more jobs, but more hours and higher wages.

That is why the data this week are especially important. Any break from the recent trend of modest growth could lead to some early holiday fireworks!

Weighing the Week Ahead: Is the Fed behind the Curve?

6/21/14 Once again, the market focus has turned to the Fed. For many months the official Fed policy has included an inflation target, an annual rate of 2%. For many months I have written that inflation will not matter until this level is in play. Suddenly, after a single month of data approaching this range, some believe that inflation is a threat.

There is plenty of economic data next week, and there could well be a fresh theme from housing news. Despite this, I think that the economic stories will all be interpreted through the lens of last week’s news. Expect a hair-trigger sensitivity to price increases and a special focus on the PCE index release. The media and punditry will engage in their favorite sport – second-guessing the Fed!

Prior Theme Recap
Last week I expected some early news on Iraq before a mid-week shift to the Fed. That was pretty accurate. The Fed news was the major event of the week. On Friday we had the lowest volatility of the year, despite a “quadruple witching” options expiration. Doug Short has a regular feature capturing the week just past with one of his terrific charts – the whole story in one picture.

dshort market week

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

With plenty of economic data and little earnings news, expect anyone with a microphone to ask interview subjects if the Fed is “behind the curve.” They will all oblige with an answer. Joe Weisenthal always has the pulse of the financial community, and he sees this as the big story of the summer. He highlights Fed Chair Yellen’s answer that recent price increases were “noise” and the skepticism from the Street.

With that in mind, let us start with some factual background.

There are many different measures of inflation. The Fed prefers the Personal Consumption Expenditure Index (which will be updated this week).

  • Why? It better captures the impact on consumers than the CPI. From The Economist:

    The two indexes frequently diverge because they are constructed differently. While the weights in the CPI basket change only every few years, the PCE’s change each month, better capturing consumers’ tendency to shift from more expensive commodities and outlets to cheaper ones. The CPI’s weights are also determined by what consumers say they spend, whereas the PCE index is based on what they actually spend, or what is spent on their behalf, such as the employer’s portion of health insurance, and what the federal government spends on Medicare. As a result the CPI assigns much more weight to rent and housing and much less to health care. PCE inflation over time typically runs about 0.3% below CPI inflation, but the current divergence, at 0.7%, is the largest in more than a decade, according to Goldman Sachs.

  • Some Fed participants might not agree. (See the St. Louis Fed message).
  • The overall effect of PCE is a lower estimate of inflation. (Chart from Doug Short).

dshort pce

Is Fed policy too relaxed? Here are the key perspectives:

  • Inflation is already above the 2% target. There is less labor slack than the Fed believes. Even if recent price increases are temporary an economic rebound will rekindle the price pressure. (Martin Feldstein op-ed).
  • Inflation is just about right, given the Fed target. (Ed Yardeni).

    Where do I stand? I am in the middle, predicting that economic growth will stay moderate and that inflation will remain modest (or vice-versa). Admittedly, the core CPI inflation rate, on an annualized three-month basis, has been rising rapidly recently, from 1.4% in February to 1.8% in March to 2.2% in April to 2.8% in May.

    Looking at the various components of the CPI shows that the recent flare-up in the core inflation rate has been relatively widespread. So there may be something to the reflation story, but we aren’t convinced just yet. In any event, we are feeling more comfortable with our 2.5%-3.0% range for the 10-year Treasury yield than we did on May 28 when the yield fell to the most recent low of 2.4%.

  • Inflation concerns are overblown. (Analysis from Mark Thoma).
  • Janet Yellen is actually an inflation hawk, given the economic forecast. (Fed Expert Tim Duy).
  • The US is in line with long-term inflation trends and is certainly not like Argentina! (Scott Grannis – good charts).

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

Last Week’s Data

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

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

The Good

There was some encouraging news last week.

  • Homebuilder sentiment moved higher. The reading of 49 beat expectations, but it not quite positive. (Reuters).
  • Investor sentiment has turned negative –and that is a contrarian positive. The sentiment from the AAII was in the “bad news” just last week, so it is making some quick changes. Bespoke has the story and a beautiful chart showing the big shift:

AAII Bullish 061914

  • Leading indicators were in line with expectations, but that confirmed positive news.
  • Industrial production beat expectations, growing 0.6%. (See the WSJ).
  • Commercial credit is rising. Joe Weisenthal calls it the “best economic news of the week.” Most people do not understand that a key economic issue is that the liquidity provided by the Fed is not finding its way into the money supply. Bank lending is a key, especially to small businesses. Here is the chart:

creditgrowth

  • The St. Louis Financial Stress Index registered an all-time low. I have been highlighting this indicator for years. One of my top researchers spent a summer analyzing the past data, helping to develop a method for risk control (free paper available on request). It is amazing how many investors prefer to be scared witless (TM OldProf) rather than monitor this objective measure of risk. Here is the story and chart from the St. Louis Fed.

slfsi

 

The Bad

The economic news included some negatives as well.

  • Oil and gasoline prices move higher. New Deal Democrat’s excellent weekly summary of high-frequency indicators highlights this move as the most important feature of his report. He writes as follows:

    The oil price spike due to Iraq continued this week. This will bleed through to gas at the pump in the next few weeks.  The Oil choke collar is re-engaging, and if Iraq falls apart, or if its oil exports are disrupted, there will be economic consequences here.

    There is no denying the increase in energy prices, but there are different interpretations of the effects. Michael Santoli suggests, “Yet better average gas mileage, higher wages and a dramatic decline in miles driven since 2008 means a further climb in gas prices probably wouldn’t pinch consumers noticeably unless it reached the new “pain point” of about $4.25 a gallon”.

    Prof. James Hamilton, our go-to expert on energy and the economy, reviews his research and also includes a helpful calculator showing the relationship between oil and gasoline prices. If you pick $4.25 as your “pain point” that implies about $137/barrel for Brent crude. $4.00 per gallon is about $10/barrel lower.

    Higher energy prices are like a tax on consumers with no corresponding payoff. There is also no specific trigger point. Not everyone will react in the same way of course, truly a case of YMMV.

  • Confidence in Congress hits a new low. (Some might see this as “good news” since it suggests possible change!) It is not quite that easy. People typically blame the institution of Congress while re-electing their own representative. Viewed from the other direction, making the right decision requires some support and compromise. Gridlock has not worked very well. Here is the recent chart (via Gallup).

du9t15coj02ep4ueaaztjq

 

  • The Iraq conflict is threatening refineries. This is the step that would really affect oil prices and the world economy. This Canadian story emphasizes the effects on consumers. GEI highlights a BBC video explaining ISIS, the Sunni group behind the insurgency. Do you have 90 seconds to spare?
  • Americans go further into debt to pay the basics. (MarketWatch OpEd, but compare above and note the difference in borrowers). The credit card companies can borrow at near-zero rates, which helps to reduce lending standards. While we could have paid cash for Mrs. OldProf’s new wheels, why not finance at zero percent for five years when that beats the cash incentive? These measures of debt are challenging to interpret.
  • Sea container counts are lower. It is the second consecutive month. Steven Hansen, writing at Global Economic Intersection has the complete story with excellent data comparisons and charts. We also wish to congratulate GEI on their well-deserved surge in the blog rankings. As an early contributor, friend, and occasional critic (constructive I hope), I am delighted to see the success of my friends.
  • Building permits and housing starts were weak – very weak. This happened in spite of the rebound in builder sentiment. Bespoke has a great overall summary with tables and charts. Calculated Risk, our featured source on housing matters, still believes the story will improve because of year-over-year comparisons and general growth. See Bespoke’s full story, but here is one helpful table:

061714 Table

The Ugly

Cheating. Here are three examples in recent news.

The World Cup: The New Yorker’s Cheating the Beautiful Game

Chess: How To Catch A Chess Cheater: Ken Regan Finds Moves Out Of Mind

Bridge: The Captain of the US Senior team on how they exposed the German pair of “coughing doctors” in the World Championship Final in Bali. (Appeal pending).

These are not the only examples from sports and games, of course. You could also make up a list from politics, business, and finance. In the examples I suggest, the violations are all the result of studying records after the fact.

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. Nominations are always welcome!

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.

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.

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.

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 also has the best continuing update of the most important factors to the NBER when they analyze recessions. This week he updated the retail sales indicator, illustrating the recent weakness:

dshort retail sales

Where is the US economy growing? Vox has a state-by-state breakdown. Perspectives might differ accordingly.

gsp_0614

 

The Week Ahead

We have a very big week for economic news and data.

The “A List” includes the following:

  • Core PCE Prices (Th). Given the buzz over CPI and Yellen, the Fed’s favorite indicator makes the “A list.”
  • New home sales (T). May data. Housing remains a big question mark for the rebound in the US economy.
  • Initial jobless claims (Th). Best concurrent read on employment.
  • Personal income and spending (Th). Important growth component.
  • Consumer confidence (T). The Conference Board version informs about employment and spending in a concurrent fashion.
  • Michigan sentiment (F). Similar to the Conference Board in overall results, but uses a continuing panel as part of the survey.

The “B List” includes the following:

  • Existing home sales (M). A good economic read, but less significant for growth than new home sales.
  • Durable goods orders (W). A key coincident indicator.
  • Case-Shiller home prices (T). This always gets attention, despite the lagging and narrow nature of the index.
  • Q1 GDP (W). This is normally not interesting since in market terms it is ancient history. This week it will be newsworthy because of the expected revisions. Some believe that Q1 will go into the books with a 2% decline.

In the week after the FOMC meeting we can expect plenty of FedSpeak. Several appearances are on the calendar.

While the financial markets have adjusted to the current Iraq story, there is plenty of attention to any breaking news.

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

Felix grew a bit more cautious last week – fewer positive sectors, lower median score, and greater uncertainty. Our three-week forecast is still bullish, but it is a closer call. This week we were fully invested in three of the top sectors for our trading accounts.

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

Here is some great advice for traders from Ryan Detrick, one of our favorite sources. He lists ten things he has learned in his decade of trading experience. The list reflects my own experience and also the behavior of the best traders I know. It is difficult to pick a favorite, so you should read them all. Forced to pick one, I choose “There’s no wrong way to make money…..If you are lucky enough to find one thing you are good at, do it and perfect it.”

Insight for Investors

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

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

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

Beware of “liquid alternative” funds. Jason Zweig’s must-read column, The Intelligent Investor, covers this story in the context of a recently failed fund. These investments might be a good fit, but be careful! Jason writes:

Liquid-alternative funds generally offer the prospect of doing well when U.S. stocks do poorly. That hope comes at a price, however: Such funds, which tend to charge high fees, typically do poorly when U.S. stocks do well. Investors who don’t understand this link will inevitably be sorry.

Tadas Viskanta, who writes Abnormal Returns (which is universally used to keep track of important events in the financial blogosphere) is taking his annual brief and well-deserved vacation. He solicits some comments on important questions, and publishes the results during his week off. These are all great reads, full of links and ideas. Here is the advice for novice investors (which has value even for those with experience). And here are great suggestions about what to read. Only Tadas could create so much content while taking time off!

Bond funds are a continuing source of risk. Is there really consideration of an “exit fee?” I rather doubt it, and also question whether it would work. The very idea of this discussion is something of a warning. (Barron’s). People expect these investments to represent the safe part of their portfolio. If we really do get the inflation that the Fed is seeking, interest rates will rise and bond prices will fall.

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

Writing about inflation is a thankless task. Readers begin by thinking they know all of the answers. We all shop, right? It is the most popular subject for bamboozling people, since it is easy to find examples of rapidly rising prices. It is by far the most deceptive trap for those who might confuse politics with investing.

You have a simple choice:

  1. You can reinforce your beliefs and take joy in how stupid our leaders are. You and your favorite blogger, pundit, Congressional candidate, etc. have all of the answers. You are all smarter than the isolated, ivory-tower academics at the Fed. Please note that this was the trap that ensnared leading experts and wise observers like John Hussman and the ECRI – just to mention two of the most prominent examples who have had disastrous results over the last few years.
  2. You can accept the fact that the Fed has the power to set policy. It is wiser and more profitable to understand what they are doing and just go with the flow. You can grumble with your friends at the bar, vote your conscience at elections, and still profit from your investments.

I have been extremely accurate in my Fed forecasts, but I am not claiming any prizes. It has not been difficult. I simply read information carefully and understand that it is a committee at work. Here are the key takeaways. You will disagree. You will hate them all. Keep reminding yourself that even if you are right and Yellen is wrong, you will lose on your investments. The Fed has the power. Figure out how to use the knowledge to your advantage.

  1. The Fed is attempting to increase inflation. They seek 2% on the PCE index. This runs about 0.5% cooler than the CPI.
  2. The Fed does not measure inflation through commodity prices.
  3. The Fed believes that 2% is price stability. They think that traditional measures overstate inflation. They do not subscribe to ShadowStats (and neither do any of the people they respect). They also see a touch of inflation as easier to fix than deflation. They bias is toward stimulus.
  4. The Fed will tolerate as much as 2.5% inflation (on the PCE index) for a time.
  5. The Fed has a dual mandate – inflation and employment. It does not protect savers or emerging markets. Learn to live with it and ignore pundits who think this is important.
  6. The Fed sees food and energy as noisy components of inflation – wild movements that do not relate to the dual mandate. If food prices are up because of a drought or disease in hog herds, how could this be controlled by raising interest rates? Middle East geopolitics and oil? Same question. These price changes are certainly real, but they are volatile and not relevant for policy.
  7. The Fed does not shift policy based upon small monthly changes in data. Longer trends are demanded.

     

The conclusion is that Fed policy is on a relatively stable course, but data dependent. The market does not like this, since the preference is for certainty.

If you think about it, even just a little, you can see an obvious edge for investors. You need only accept the reality of the obvious course of policy and ignore the pundits. The Fed has always succeeded in creating inflation – eventually. It will happen again, but given the overall economic weakness it is taking longer. My current guess is late in 2016 or so. Meanwhile, there are some profitable investments to enjoy.

Monitor data, not pundits.

Weighing the Week Ahead: What does the Iraq conflict mean for markets?

Into the economic news vacuum, summer doldrums, and sports stories, there was finally some real news – the renewed conflict in Iraq. This had all of the features that make for good financial television and web punditry – action, plenty of people with opinions and accusations, and the potential for a dark outcome.

Whether or not this is a big story, there was clearly a media drive to make it one. My guess is that it will continue to lead for the early part of the week ahead.

Prior Theme Recap
Last week I expected a focus on a rebound in volatility, with potential for an upside breakout for stocks. I suggested that we should all “be prepared.” Sure enough, the quiet upside started the week, but lasted only two days. I did not guess that the House Majority leader would lose his primary race, sparking a round of instant-punditry on the future of many policies. The expanding Iraq conflict also demonstrated what can happen to markets in a low-volatility backdrop. Investment strategist John Canally, cited in Barron’s opined that the shock to energy markets would have had a big effect thirty or forty years ago. It is less important for a service economy. The same article notes that many market participants confessed to watching the beautiful game during working hours. Quelle surprise!

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

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

This Week’s Theme

The market discussion will start with a recap of events in Iraq, with media sources milking the story as much as possible. By mid-week the attention will probably shift to the Fed meeting and the housing data.

I have covered the latter two topics quite thoroughly in recent weeks, so I want to take a deeper look at the Iraq issue.

Here are some interesting perspectives.

  • The breathless coverage from CNBC. I love the updates from Art Cashin, which accurately reflect what floor traders are thinking. Here is the sequence:
  • Jim Cramer, with television in both morning and evening has plenty of air time to fill. The general theme of the Cramer warnings it that everyone remembers the stock declines associated with prior Iraq conflicts.
    • On Tuesday Cramer was warning about declines while also saying that most declines since 2009 have been buying opportunities.
    • On Thursday night Cramer advocated caution, profit-taking, and sitting on cash.
    • Jim Cramer, who has a lot of air time to fill, opined on Friday morning that oil would move to $120/barrel in a straight line.
  • The 24/7 coverage from your favorite conspiracy and doomer site. If you are determined to focus on what could possibly go wrong and get some confirmation for your opinions, you know where to go! The “analysis” there makes the CNBC stories seem wildly optimistic.
  • Focus on expansion of the conflict. Whether you watch CNN or read the New York Times, The Washington Post, Politico, or The Hill (all favorite sources here) you will understand that this is not another round of major U.S. involvement. A key question is whether Sunni tribal leaders will support this particular insurgency.
  • Potential effects on energy prices – maybe $15-20 per barrel at the max. This is enough for a serious economic effect. Most of the fighting (in the North) does not currently threaten reserves or exports. (Good overall analysis at MarketWatch).
  • Many factors limit the impact on oil prices, including production slack. (Helpful story at Yahoo Finance).
  • Stocks are not likely to suffer a major decline from the Iraq crisis. The chief investment officer of the Gabelli Funds thinks that the story will be with us for some time, but expects another 7.7% upside this year for stocks.

Which of these viewpoints is correct? I track them all as part of the job, but you need not. As usual, I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

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

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

The Good

There was some encouraging news.

  • Short interest is higher and that usually leads to market gains. (Callie Bost at Bloomberg).
  • Job openings increased by almost 10% to 4.45 million. This was the positive aspect of the JOLTS report. (See below for the negative on quit rates).
  • Small business optimism is surging. I do not usually emphasize the NFIB results. As a small businessman and board member for two other small companies, I understand the frustration with regulation and policies that seem to stall growth. The NFIB statements express this viewpoint, and attitudes plunged with Obama’s election. It is interesting to note the improvement (via the WSJ). Bespoke also has a great chart and a table of business concerns.

BN-DD840_NFIB06_G_20140609164403

  • PPI declined by 0.2%. Ostensibly this is good, but some take any decline as a sign of economic weakness. The market had little reaction.
  • Rail shipments surge. Simon Constable notes the correlation with industrial production, including this helpful chart:

MW-CH658_rail_s_20140610080050_MG

 

The Bad

The economic news was slightly negative for the week.

  • The “quit rate” from the JOLTS report showed no change. Job openings are a bit higher. Most people would be surprised to learn that almost 2.5 million people voluntarily quit their jobs last month, but it is not an improvement.
  • The World Bank cut the growth forecast for 2014 to 2.8% from the prior 3.2%. In a sense this is old news, since it is reflecting Q1, but it is still discouraging. (Reuters).
  • Retail sales growth disappointed – only 0.3% after some good private data. The ex-auto results were also soft. See Calculated Risk for analysis and charts, including this one:

RetailMay2014

  • Oil prices spiked. Gasoline prices have been stable, but will probably soon follow the oil price increase. New Deal Democrat has the story on this, along with his regular collection of high-frequency indicators. While the gas prices are a negative, he is looking for strength in Q2 GDP.
  • Bullish sentiment is spiking. Normally we treat this as a contrarian negative. Bespoke has this story as well as the chart (below). The AAII has their own study. It is a bit long for most readers, but it is worth the time for those who like to follow sentiment. The gist is that most studies incorrectly include some hindsight in the analysis of past data. If you use only data available at the time, the contrarian interpretation is not very persuasive. High neutral readings are actually encouraging for stocks and bullish readings not much of a negative.

AAII Bullish Sentiment 061214

  • Michigan sentiment remains discouraging, missing expectations at 81.2.

The Ugly

There is plenty of ugly news in the world, but I wanted to enjoy Father’s Day without dwelling on the negative. I miss my Dad. I wrote about him six years ago in this signature family story about a young sailor. It has plenty of insight for investors, which I tried to explain. I hope to enjoy tomorrow with my son, and I am sure that we’ll remember his grandfathers as well.

The Big Question for This Week

The Fed has not managed to satisfy markets when it comes to communication. Fed Chair Yellen was the communications guru before assuming the lead. The problem is that traders want a clear, unambiguous message. They frequently respond as if each Fed speaker was on a mission to add nuance to the latest official statement.

Unlike those of us who have worked in non-business organizations, the market types are uncomfortable with debate, dissent, and nuance. The decision is not Yellen’s, although she has special influence from her leadership. It is the vote of a committee. There are also non-voting members. Even when the vote is unanimous, the opinions vary. In an effort to improve communications, the Fed is sharing the projections of each participant. Markets seem to be focusing on this rather than the result of the voting process. Thomas Simons of Jefferies (cited at MarketWatch) has taken the public statements of Fed members and constructed chart for those who want to score at home:

MW-CH869_fed_do_20140611183907_NS

If there is a deviation between the “dot plot” and the official summary, we can expect a repeat of the “taper is tightening” market fuss from a year ago.

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 Bill McBride of Calculated Risk. There is a lot of debate about labor force participation and also many misconceptions. My friend and fellow Michigan man Dean Baker is an expert economist on labor markets, and has written that the decline in prime-age workers shows weakness in labor markets.

Bill responds by looking at the trend for this age group, noting that a researcher in 2000 might well have predicted today’s participation rate. This implies reasons other than economic weakness, including stay-at-home dads. I will be interested in whether Dean has a response.

LFP4044May2014

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.

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

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (2 ½ years after their recession call), you should be reading this carefully. Doug includes the most recent ECRI discussion, which has been consistently bearish, including the blown call on the recession. He compares their “consistent” forecast with the spread of conclusions from mainstream economists in the most recent WSJ survey. I always encourage reading this summary, but I find this one surprising for three reasons:

  1. It seems rather obvious that a group report will have a wider range than that of a single source;
  2. Doug produces no evidence that any single member of the panel has been inconsistent; and
  3. Inaccurate consistency is not a virtue.

Doug does not mention whether he expects GDP for Q2 GDP to follow the ECRI prediction of that of about 35 of the economics panel who are looking for something between 3 and 4%. Here is the chart in question:

dshort wsj forecasts

Doug also has the best continuing update of the most important factors to the NBER when they analyze recessions.

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.

Jan Hatzius made important news. The inimitable “Stalwart” Joe Weisenthal says it is the Call We’ve Been Waiting 5 Years to Hear. Hatzius believes that growth will now be back above trend. Joel quotes him as follows:

Despite the 1% drop in real GDP in the first quarter, we believe that the US economy is now growing at an above-trend pace. The best way to see this is via our current activity indicator (CAI), which grew at an annualized rate of 3.4% in May, similar to the average of the prior two months. Although an estimated ½ percentage point of this sequential growth is due to a bounceback from the weather distortions of the first quarter, even the year-on-year CAI now stands at 2.7%, the fastest pace of the expansion so far and above our estimate of potential growth of 2%-2½%. In our view, the CAI is a far more reliable indicator of economic activity than real GDP because it is more timely, more broadly based, less noisy, and less subject to revision.


Hatzius also cites housing as one of the key drivers of growth.

Readers should also note that he was cited by Nate Silver as the economist who got the Great Recession called right, and for the right reason. This is important to keep in mind as we learn more news about how bad things were in Q1. I am seeing revisions taking Q1 GDP down as low as -2.0%.

Binyamin Applebaum of the NYT presents an alternative viewpoint, featuring George Mason economist Tyler Cowen. His research, supported by a growing group of economists, suggests that a lower long-term growth rate is in prospect. There are many sources in the comprehensive article – well worth reading. The darkest viewpoint comes from two Brown economists who are concerned about a “permanent recession.”

The Week Ahead

We have an active week for economic news and data.

The “A List” includes the following:

  • FOMC rate decision (W). Taper by the expected $10 B or a little more? Continuing debate over how to interpret the group message.
  • Initial jobless claims (Th). Best concurrent read on employment.
  • Leading indicators (Th). Remains a popular method.
  • Housing starts and building permits (T). Any sign of a spring rebound. Watch single-family permits for a leading indicator.

The “B List” includes the following:

  • Industrial production (M). A read on Q2 GDP after some seasonal fluctuation.
  • CPI (T). Eventually this will be interesting, but currently remaining in a narrow range.

FedSpeak will be limited to the official variety because of the FOMC meeting. The regional Fed surveys are not very important unless there is a very large move. Iraq and related news will dominate, unless there are clear signs of stability.

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 sees even more opportunities — fresh buys in the ETF universe, as more sectors emerge from the penalty box. A high penalty box level implies less than normal confidence in the ratings. This week we were fully invested in three of the top sectors for our trading accounts.

The overall call has become more bullish, after a few weeks of near-neutral readings.

Insight for Investors

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

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

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

10 Lessons Learned from Peter Lynch is a great reminder story at Novel Investor. Jon pulls together items from two of Lynch’s books. I am picking the lesson that most closely fits today’s theme, but all of them are great.

Every day brings something different to worry about – inflation, recession, depression, natural disaster, war, market crash, and that bus when you cross the street. In the last 100 years, the market has seen it all and recovered. You can wait for the sky to fall or you can invest knowing it will happen, you’ll get through it, and the market will too.

The post reminded me of a story from ten years ago, at the North American Bridge Championship in Reno. One of my friends, a retired investment professional, was walking along a corridor leading to the game. A man walking next to her asked if she knew where to find the partnership desk. (This is a place where people without a partner or team can find someone with similar experience). She replied that she did, but that she had no game herself. She said that she would be delighted to play that afternoon. And that is how my friend got to play bridge with Peter Lynch. It is amazing that he was moving through the maze of clueless highly-focused bridge players in relative anonymity. Bridge players are focused on winning. It was at this tournament where my team beat Bill Gates in a short match….but I am getting too far off course!

Beware of using the Dow ETF for long-term investments. With only thirty stocks and based upon price weighting, it does not capture an economy that has more service and technology. Do you think that your “general market investment” should be 8% in Visa (V)?

Stock prices are consistent with economic fundamentals. Ed Yardeni provides an update on his Fundamental Stock Market Indicator, which seems to work better than many others!

Yardeni Fundamentals

Investors have a low exposure to stocks, the lowest since 1959. (See Howard Gold at MarketWatch).

Another source (cited in the NYT) confirms the conclusion. One observer notes that fear is the reason.

If it wasn’t fear, there’d be a much different variation by age,” Ms. Duncan said. “Certain cohorts need more liquidity than others. When you find consensus across age cohorts, you realize it’s not for liquidity needs but lack of trust across all age and wealth levels

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. Check out our recent recommendations in our new investor resource page — a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love and use feedback).

Final Thought

The resurgence of conflict in Iraq is a story with many angles.

Most importantly, it raises questions about the prospects for stability in a country torn by religious and ethnic divisions.

For the U.S., there are questions about foreign policy. Is it wise to intervene in foreign civil wars? Does it matter if regional stability is threatened? What if terrorist groups are involved? If action is taken, should it mean providing arms (which seem to find their way into the wrong hands)? Is there a special responsibility in Iraq, given the history of U.S. involvement? These are all difficult questions. While the answers will seem obvious to many, the problem is that there really is no consensus.

The issue provides political ammunition just as the mid-term elections are gearing up and the Presidential election (already) getting plenty of play. Reputations and past decisions can and will be re-examined.

These issues are important to us as citizens and the election angle is fun for political junkies.

This is the wrong attitude for investors! These are the times when people are most tempted to confuse their opinions about foreign policy and politics with the cool, unemotional decisions about their investments.

Investors should focus on two things:

  1. The chance for an expansion of conflict beyond Iraq. So far this seems pretty limited.
  2. The impact on energy prices. This could be a threat to global economic growth, so it bears watching.

Weighing the Week Ahead: Time for a Market Breakout?

In sharp contrast to last week, the punditry has less to chew on. This leaves the media agenda wide open. Discussion will range freely on the potential for the economy as well as the markets. Expect to see stories about China, Europe, low volume, low volatility, and the implications therefrom.

Everyone is expecting the quiet time to end, with a break in one direction or another. Will it be this week? Or are we in for a continuing quiet time?

Prior Theme Recap
Last week I expected a plenty of discussion about the economic data, finally providing some clarity about the direction of the economy. This was indeed the main subject for discussion, but the data changed few minds. The overall effect was positive, as you can see from Doug Short’s weekly market summary – a good discussion featuring this chart:

DShort Market Week

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

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

This Week’s Theme

I suggest: Be prepared! It is quiet, too quiet.

Nearly everyone expects a rebound in volatility.

Here are some perspectives.

  • Josh Brown wonders if we will experience “the annual letdown” that we have seen in the last few years.
  • Barron’s notes the improvement from the “strong manufacturing and jobs data.”
  • James R. Hagerty, writing for the WSJ, has a balanced discussion about the potential for a U.S. manufacturing rebound – both sides examined carefully.
  • Dan Greenhaus at BTIG provides (via the WSJ) a list of 26 current investor worries.

As always, the conclusion may depend upon your time frame.

We always use our planning to be prepared, but the current market is a special test. Charles Kirk sets a great example for traders. His invaluable weekly chart show cites both the bullish underpinnings and also the possibility of an early-week test of recent trading gaps. He explains what to watch. (The Kirk Report has a small membership fee, which you will recover almost instantly in your personal trading. The weekly magazine is an entertaining and instructive mix of ideas that I always review in my preparation).

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

Last Week’s Data

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

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

The Good

There was plenty of encouraging news.

  • Hurricane season is less likely to push up natural gas prices. Why? The shale gas revolution. (See Tim Puko at MoneyBeat).
  • Light vehicle sales were strong. The annualized rate of 16.7 million was the best since early in 2007. There was clearly some rebound from bad weather, so the question will be whether the strength can be maintained. (See Scott Grannis for analysis and charts).
  • ISM reports were positive. The manufacturing report had a reporting glitch, creating great fun for conspiracy buffs. The original report was a miss, followed by an estimate that was positive, and a final verdict that was in line. A sharp economist at the prestigious Stone and McCarthy firm noted that the underlying data were not consistent with the conclusion, given the pre-announced seasonal adjustment factors. A quick tweet sent the ISM folks back to the spreadsheets. The ISM services report beat expectations. The combination seems consistent with economic growth of 4 % or so. Bespoke has an interesting chart that I have not seen elsewhere – putting the two reports together. The result is the sixth highest level of the current expansion.

060414 ISM SVCS Main

yardeni dow theory

  • ECB actions satisfied markets – negative rates, asset purchases and a promise of more. Much of the punditry objected to the policies, but the market treated the decision as a mild positive, as you can see from the chart in the introduction. Brian Blackstone of the WSJ has a good account.
  • Rail traffic remains strong. See GEI for data, charts and analysis.
  • Underwater mortgages have declined sharply—half the level of 2009. (CoreLogic via MarketWatch)

MW-CG712_Core06_MG_20140604141549

  • Employment showed continuing strength. The market reaction was positive, but analyst opinion was mixed.
    • Headline payroll job growth met expectations at 217K. Labor force participation increased, but the unemployment rate remained constant. The headline for most sources was that this was an all-time high in employment. Calculated Risk has this story and also announces the retirement of the “scariest jobs chart ever.”
    • Dean Baker warns that 41-year-olds are leaving the labor force – not just the older workers. Meanwhile, some older workers want to work longer.
    • Job quality is the biggest criticism. (See Eric Morath at the WSJ).
    • The real story is mixed. The most helpful source on job changes since the recession is the New York Times interactive chart. It is 255 charts in one, showing employment trends and wages in many industries. The trends in job creation are not easy to capture, and this wonderful resource defies illustration. You will enjoy spending a little time with it. Another good chart pack (only ten, but good ones) comes from Fivethirtyeight. Noteworthy is the drag from the public sector throughout the recovery.

    Sources of all political stripes contrasted the all-time high in jobs with the reality of continuing high unemployment. No serious analyst questions this. The economic recovery may be enough to retire Bill McBride’s scariest chart, but it is certainly not “mission accomplished.” Bob Dieli says it well:

    As welcome as this news is, you should keep in mind that it is the economic equivalent of winning the first game of the World Series. Namely, a good place to start, but hardly enough to get you a champagne shower in the locker room.

The Bad

There was also a fair share of bad news last week.

  • Investors Intelligence shows bulls at 62.2, the 2nd highest rating on record. This is a favorite sentiment indicator of celebrated deep value investor Robert Marcin, my frequent opponent in friendly discussions at Scutify. I applaud Bob’s value approach, but we often disagree on specific indicators. It is even better and more fun when readers join in.
  • Immigration is off the House calendar for June. (The Hill).
  • Trade deficit was higher – more than $6 billion above expectations. The April data is a negative for Q2 GDP, which adjusts for the trade imbalance.
  • Ford truck sales disappointed. I have highlighted the “F150 indicator” and this month it dropped 4.3%. These sales reflect sales to construction companies and small businesses. Bespoke has the story and an update of their regular chart:

F150 Truck Sales YTD May 2014

The Ugly

The VA hospital scandal. The causes of delayed care will eventually be revealed. We can and must do better for veterans. The Senate will hold hearings. In the House, the “other Jeff Miller (R-Fla.)” is on the job. (The Hill).

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. Nominations are always welcome.

Quant Corner

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

Indicator Snapshot 060714

Recent Expert Commentary on Recession Odds and Market Trends

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

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

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

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.


Doug Short uses data from initial and continuing unemployment claims to analyze the probability of recession. Quant types will appreciate his data-driven analysis and fine charts. Some of the themes are similar to those we draw upon from Bob Dieli, and the conclusion is also familiar:

If history is a guide, the current percent ratios of weekly claims to the labor force contradict the minority view that the US is currently in recession (e.g., ECRI and a few bearish bloggers). Instead, the ratios suggests that even a near-term recession would be months in the future.

 

 

The Week Ahead

We have a light week for economic data.

The “A List” includes the following:

  • Michigan sentiment (F). Good concurrent read on spending and employment.
  • Retail sales (Th). We know that car sales were good. The rest of the story?
  • Initial jobless claims (Th). Best concurrent read on employment.

The “B List” includes the following:

  • Business inventories (Th). April data. More important because inventories were the key factor in Q1 GDP weakness.
  • Wholesale inventories (T). April data. See above.
  • JOLTS (T). This report is gradually getting more respect and attention. Look at the quit rate for a sense of overall labor market strength.

There will be more FedSpeak as well as news from China on inflation and retail sales.

 

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 sees more opportunities — fresh buys in the ETF universe, as more sectors emerge from the penalty box. A high penalty box level implies less than normal confidence in the ratings. This week we were fully invested in the top three sectors for our trading accounts.

The overall call remains very close between bullish and neutral. Even in a neutral market there are often good sectors to buy. This week Felix is even more bullish for our three-week time horizon.

Insight for Investors

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

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

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

David Tepper has been reassured. Tepper famously made a “Fed has your back” comment that started a rally in late 2010. The idea was that economic strength did not matter since the Fed would act if necessary. Stocks rallied that very day. While the idea was not unique, it carried credibility when coming from a top hedge fund manager. At the recent SALT conference Tepper said he was nervous about the market, apparently sparking 40-50 bps of pull back. This week he professed some satisfaction with the ECB action, although he sees them as still “behind the curve.” While I think that too much is made of this, it is worth reviewing.

The bull market has plenty of time to run according to Ed Yardeni – at least another year. He shows the relationship with Arthur Okun’s misery index and illustrates with a helpful chart:

yardeni misery index

Eddy Elfenbein explains that the rotation to value stocks is “still on.” Check out his ETF-based chart.

I provided some advice for young investors. My hope is to make this an ongoing resource on my site. Please take a look and offer some comments. Some readers wrote that they passed the information along to young people in their lives. I hope that many find it helpful and it stimulates more ideas and sharing.

Want to be like Warren? Here is an interesting analysis of how he succeeds. “It may be possible to build, in essence, a Buffett-bot portfolio. No Oracle required.”

There are still plenty of interesting ideas for cheap stocks. Here is an interesting list from MarketWatch.

MW-CG610_10stoc_20140603141845_MG

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. Check out our recent recommendations in our new investor resource page — a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love and use feedback).

Final Thought

The last few weeks have reflected a continuing improvement in economic data. While I do not like to use a “weather” excuse, I also insist on recognizing reality. Some of the economic activity in Q1 was lost forever. Some was pushed forward creating an artificial boost. It may take a few months to see the actual trend.

Housing is not reacting as positively as auto sales. Employment is a little better, but not great. Corporate profits are encouraging.

Scott Grannis pulls this all together, explaining that 2% job growth implies, boring as it may seem, implies higher P/E multiples and rising interest rates. The key? No recession in sight. That has been my theme since I noted the weakness in the ECRI method and replaced them in my forecasts, many months before their erroneous recession prediction.

I agree with Josh Brown that full year GDP forecasts will be lower, but only because the upbeat year-end data must blend the known negative data from Q1. The list of 26 worries is an essential part of the trek to Dow 20K, my forecast from four years ago.

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

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

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

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

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

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

This Week’s Theme

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

Here are three perspectives, from three different markets:

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

The market message is confused and inconsistent!

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

Last Week’s Data

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

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

The Good

There was plenty of encouraging news.

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

Yardeni capital spending

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

91184213ztemp

The Bad

There was a fair share of bad news last week.

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

AAII Bullish 053014

 

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

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

    real GDP per capita

     

 

The Ugly

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

There are no easy solutions.

The Silver Bullet

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

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

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

This is something to watch for on Friday.

 

Quant Corner

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

indicator snapshot 053114

Recent Expert Commentary on Recession Odds and Market Trends

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

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

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

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

dshort big four

 

The Week Ahead

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

The “A List” includes the following:

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

The “B List” includes the following:

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

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

 

How to Use the Weekly Data Updates

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

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

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

Insight for Traders

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

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

Insight for Investors

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

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

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

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

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

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

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

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

Regular readers might want to guess before reading!

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

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

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

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

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

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

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

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

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

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

Trade data via Guggenheim

 

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

Final Thought

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

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

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

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

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

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

Weighing the Week Ahead: Will a Sluggish Housing Sector Derail the Economy?

In a holiday-shortened week, there is plenty of data. The Case-Shiller home-price index will set the tone on Tuesday morning. After last week’s soft housing reports, many will be asking, Will housing weakness undermine economic growth? Prior Theme Recap Last week I expected a focus on bonds versus stocks. It was a light week for data and the bond market rally was an ongoing mystery. That theme was as good as any, but nothing really stood out. The appetite for content created many “fluff” pieces and trading was very quiet. As long as you did not take small moves seriously, there was an opportunity to do some buying at mid-week. Forecasting the theme is an exercise in planning and being prepared. Readers are invited to play along with the “theme forecast.” I spend a lot of time on it each week. It helps to prepare your game plan for the week ahead, and it is not as easy as you might think. Naturally we would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. This Week’s Theme Has the housing recovery stalled out? If so, what does it mean for the economy? Here are some perspectives:
  • Housing is a leading component. It is not responding to interest rates as expected, and those good times may be ending. (New Deal Democrat).
  • Nearly ten million Americans have underwater mortgages. These are concentrated in low-priced homes (30%). Some of the least expensive homes were purchased by investors and are now rental properties. This leads to poor prospects for entry-level buyers and also interferes with those wanting to “move up.” Many others lack real equity that allows them to trade up or trade to move to a new job. (Various accounts of the Zillow story. See Erin Carlyle of Forbes).
  • Home affordability is challenging, especially given sluggish income growth. (MarketWatch).
  • Big investors are betting against housing. Bill Miller disagrees. (MarketWatch).
  • Expect sideways movement and gradual progress. (Calculated Risk).

It all seems pretty negative. As usual, I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information. Last Week’s Data Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:

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

The Good There was little news, but it was mostly good.

  • Car sales are looking strong, up seven percent according to private research firms in a strong spring selling season.
  • Forward earnings estimates rose for the sixth consecutive week. (Via Brian Gilmartin).
  • Leading economic indicators rose 0.4%, beating expectations. Doug Short has a complete analysis. This chart (typical of his skill in bringing data to life) tells the story:

dshort LEI

Mortgage rates

  • New home sales beat expectations, but this is a noisy series. I am scoring this as “good” on the monthly improvement and the market reaction, but it is a close call. Calculated Risk notes that the first four months of 2014 are down 2.6% from last year. John Lounsbury and Steven Hansen reach a similar conclusion, after viewing the data in various ways.

The Bad There was a little bad news as well.

  • Immigration reform is stalled again. Nearly all of the economic studies show the benefit of more immigration and also reassure that immigrant labor is a complement to native-born workers. This explanation is from a liberal source, but many conservative leaders (former Speaker Dennis Hastert, for example) take a similar position. This is one of many economic issues that has become politicized.
  • Jobless claims increased by 28K, worse than expectations.
  • Existing home sales missed growth expectations.
  • Tensions between Russia and Ukraine remain high. Mark Mobius of Franklin Templeton Investments discusses the sanctions and the economic effects.

The Ugly Penny stocks, a market that is once again seeing a lot of action. (Via WSJ). The SEC is acting against the worst frauds. Cody Willard often warns investors at Scutify.com about these dangers (especially in pot stocks), harkening back to his excellent 2011 article. The Humorous If you missed the video interviews with NYU grads about Janet Yellen’s commencement speech, take a minute for a few chuckles. While some have a general idea of who she is, others were wondering and would have preferred a different choice. (Tina Fey?)   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 there was no award. This week I have two great candidates. I’ll save one for our next installment. This week’s award goes to Barry Ritholtz for The Truth About Auto Sales and also Jalopnik on the same theme. When things get a little slow on the bad news front, some sources are happy to recycle old stories as if they were current. I wonder how many readers looked carefully at the pictures of the cars. 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 Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg’s BCI index also shows no recession in sight. For those interested in hedging their large-cap exposure, Georg has unveiled a new system. RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. 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. 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. Blaine Rollins at 361 Capital always has some interesting ideas, with good charts and data. This week he cites an analysis from JP Morgan comparing current conditions to past market peaks – quite different! 08-Bull_Market_Peaks_625px The Week Ahead We have a lot of data stuffed into a short week. Here is what to watch for. The “A List” includes the following:

  • Initial jobless claims (Th). Best concurrent read on employment.
  • Michigan sentiment (F). Information on spending and employment that you cannot get elsewhere.
  • Personal income and spending (F). April data. Important read on the consumer and the economy.
  • Durable goods (T). April data, but a component for GDP.

The “B List” includes the following:

  • PCE prices (F). This is the inflation indicator the Fed watches. Whether or not you agree with this choice, you should pay attention.
  • Pending home sales (Th). All things housing are of great interest.
  • Chicago PMI (F). I do not place much emphasis on regional results, but this one is a good predictor of the national ISM index – a major indicator. I am especially interested when a weekend separates the two releases.
  • GDP second estimate. Everyone knows this will be very weak, possibly a decline of 0.5%. As usual with GDP releases, we are so far into the next quarter that interest will be modest. It does provide the baseline, showing how weak things were at the start of the year.
  • Case-Shiller home prices (T). This index has the brand name value, but is actually a bit slower to pick up changes. Expect the Professor to do some interviews with a worried look and a cautious take!

Ukraine remains a wild card. There will be a little FedSpeak but also possible hints about ECB policy from a European conference. Negative rates in store? I don’t care much about the regional Fed surveys. 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 lost enthusiasm for the market. Few choices in our ETF universe qualified as fresh buys. (We use a rating of 20 or higher and exclude sectors in the penalty box). The broad market ETFs look a little worse than last week. The overall picture is neutral – with the Q’s (QQQ) slightly positive and the Russell 2000 (IWM) slightly negative. We are still fully invested for Felix trading accounts, but the ratings are marginal holds. We will probably have reduced positions and might even be completely out by next week unless there is some improvement. Those who want to follow Felix more closely can check us out at Scutify, where he makes a daily appearance to join in vigorous discussions about trading. 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. We had enough volatility to do some additional buying, replacing some enhanced yield positions lost at options expiration. Those trying out our Enhanced Yield approach should have enjoyed yet another good week in a sideways market. Bespoke illustrates this in the current market: SP 500 052214 The time decay in last week’s slow trading was dramatic but rather predictable. It is always satisfying to make money when nothing is happening. To do so it is important and helpful to own value stocks that pay dividends and add some hedging via short calls. I have written several times about examples that you can try on your own. It reduces your risk. Start small and get the sense of how to do it. This week on Scutify I responded to a reader question about IBM. I explained that I traded it versus the JUN 190 calls. This has been a rinse, lather, repeat position for us. The stock does not seem explosive to the upside. We have collected dividends and call premiums and played the trading range. Today the stock moved a little higher while the calls actually declined in anticipation of the long weekend. You won’t read that in any book about option deltas! Here are some key themes and the best investment posts we saw last week: Summer melt-up? I am not necessarily predicting this, but we all need some balance in our reading. It seems like the pundits and the media are very negative. The emphasis on top-calling makes the risk/reward seem out of balance. The source expects a final surge and then does the obligatory crash prediction. Sheesh! (BAML via Business Insider). Time to avoid small caps? The noisy sources emphasize the dire implications of the small cap weakness. Our programs hold these stocks only in our “Aggressive Program” and even then in small allocations. The entire Russell 2000 is equal to about six stocks in the S&P 500. There is big reward, but also big risk. If you are worried about risk, choose larger stocks. Here is a nice analysis showing the distinction between small and mid-caps. small-mid Be careful with ETF choices and trading. Many investors treat ETFs as a cheap substitute for mutual funds with the advantage of more liquidity. There are some problems with that liquidity. Sometimes the ETF holds illiquid holdings, preventing a fair settlement price. On other occasions there are too many sellers hitting the exits at the same time. I regularly trade in ETFs and I am not warning against the entire asset class. You just need to use caution in your choices and trade timing. Tracy Alloway at the FT has a good post on the subject. Watch out for slick salesmen selling yield. Josh Brown already warned you about brokers and incentives in his excellent book, which I reviewed here). Josh knows the pitch and shares it with the authenticity of an insider. This time he flips it with a conversation you will NEVER hear. I cannot do justice to this with a quote, so you need to read the entire post. Conclusion: Someone selling you an amazing yield is probably exaggerating and collecting a big fee. Maybe you suspected that… Want to know the most popular stocks owned by big hedge funds? They must reveal the holdings and you can see the list in this article by Steven Russolillo of the WSJ. Pretend that you are playing Family Feud and try to guess stocks from the top 5. Answer at the end of the post. Barry Ritholtz seems to have a new great theme each week in his BloombergView column. This time he discusses risk, using odds of death to provide an out-of-the box challenge to investors. We all over-estimate the odds of dying from terrorism rather than mundane causes like heart disease. The same story is true for investors who exaggerate the odds of market crashes. Read the entire post. Leon Cooperman, Chairman and CEO of Omega Advisors spoke at Columbia Business School. His chart-packed presentation illustrated the improved financial situation for both households and businesses, as well as catalysts for near-term action. Here is one of the many good charts, leading to his conclusion that “treasuries and corporate bonds are uninteresting and unattractive.” corp-america-is-very-liquid-0514 If you are obsessed about possible market declines, you have plenty of company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. Check out our recent recommendations in our new investor resource page — a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love and use feedback). Final Thought I was surprised at the traction from the Zillow story about underwater mortgages. Everyone’s focus was on the 18.8% rate with little comment that this is much better than the 31.4% rate from only two years ago. The stories also characterize the market in terms of simple stereotypes. This makes for a compelling story, but it is not good economic analysis. Markets actually reflect a distribution of participants with different price points and motives, A real economic study would take note of a few factors:

  • If 30% of low-cost homes are underwater, then 70% are not. It reduces the supply, but does not end it.
  • Many homes are still purchased without 20% down via mortgage insurance.
  • If low-cost existing homes are in short supply, builders can provide new ones. (And they are).
  • If there is real demand for low-cost homes, those purchased for investments can be offered for sale.

To summarize, if you view housing as a market instead of a few stereotypes it is easier to see how some progress could be possible, progress that includes new construction. Economic growth would be better if we simply had some relief from the housing “drag” of the last several years. Top Hedge Fund Stocks Top five include Google (GOOG), Apple (AAPL), General Motors (GM), American International Group (AIG), and Time Warner Cable (TWC). How many did you guess? How many do you own?