Weighing the Week Ahead: Should We Expect September Mourning?

The abbreviated week’s calendar has little important data. The economic news last week leaves open the timing of the next interest rate increase. As vacationing market participants yawn their way back to their desks and trading floors, what will be the focus? A look at the calendar and the end of summer will have them asking: Should we expect September mourning?

I borrowed the title from Alan Steel’s excellent post on this subject. More from him in the conclusion.

Last Week

There was a lot of important economic news. The picture was mixed, but mostly promising. The Fed can move in September or delay until December.

Theme Recap

In my last WTWA, I predicted another weeklong focus on the Fed. I expected every economic data point to get special attention, parsed through the perceived eyes of the Fed. This was the story all week – even on the quiet Friday afternoon. I asked whether the Fed would get a signal to hike rates. At the end of the week, most were answering “no.” I have had a good streak going on guessing the theme, but the week ahead is really a challenge.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. The overall range, once again, is very narrow. Doug’s take is that the market liked the slightly weaker than expected report, observing as follows:

The “bad news is good news” syndrome once again reaffirms the market’s primary dependence on Fed pampering via low rates. The index hit its 0.65% intraday high about 30 minutes into the session. Profit taking sent the index to its 0.13% intraday low in the early afternoon. But the buying returned, and the 500 ended the session with a 0.42% gain.

Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

Please Watch…

…for some upcoming events that might be interesting to WTWA readers.

  1. It is Labor Day weekend. Like you, I am enjoying some family time. Because the employment report is so important to markets, I will publish a little quiz to test your Jobs IQ. It will not be easy. You may keep your results secret or else boast about your knowledge!
  2. I am joining an outstanding group of fellow advisors in a webinar this week. It will be on Wednesday, September 7th at noon EDT. (Sign up here). We meet regularly for our own benefit. This time our leader, Rob Martorana, felt that other might learn from the interchange. The subject is how to interpret financial news. The material is great, and I am looking forward to participating. Please join us if you can. If you miss it, check out the original article. If investors find this to be useful, we will do more.

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. My working definition of “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The Good

  • Initial jobless claims remained very low at 263K and beat expectations. (Bespoke)

  • Hotel occupancy remains at near record levels. (Calculated Risk).
  • Withholding tax collections remain strong. (Barry Ritholtz).

    As the total dollar amount of Federal withholding taxes continues to increase, we should expect to see retail sales and sentiment continue their improvements. This has resonance for GDP as well as the Presidential Election.

  • Factory orders rebounded nicely. Up 1.9%, the biggest gain in nine months. Steven Hansen offers a sharp dissent to the headline figure.
  • Earnings revisions have improved. There is a regular pattern of decline in over-optimistic estimates. Few are experts in studying the pace of these changes and how it is likely to impact the market. That is why we read the work of earnings expert Brian Gilmartin, whose most recent post which explains about this difficult question.
  • Personal income rose 0.4% in addition to positive revisions. Consumer spending also increased 0.3%.
  • Consumer confidence reached an eleven-month high. See Doug Short’s analysis for background, comparisons, and the best charts on the subject.
  • Bullish sentiment remains low, a near-term positive for stocks. Bespoke provides this chart.

 

The Bad

  • Auto sales fell to an annualized rate of 17 million. This was not far from expectations for most companies, but a decline nonetheless.
  • Rail traffic continues to decline. Steven Hansen (GEI) does his typical comprehensive analysis.
  • ISM index moved into contraction, registering 49.4 compared to 52.6 last month. Steven Hansen (GEI) has a comprehensive analysis including comparisons to the Markit PMI measure. It helps to consider the “internals” of the index calculation.

  • Employment gains disappointed. I am listing this as “bad” even though most see the overall story as pretty neutral. (WSJ). I am listing the specifics, but all are within their normal sampling error bands. The bond market reaction was also neutral. Calculated Risk said a “decent” report, which captured mainstream sentiment.
    • The net increase in payroll jobs was 151K. While this still represents reasonable growth, it was significantly below the last two months and also below expectations of 180K
    • Private hours worked declined and hourly earnings increased less than expected.
    • Unemployment remained at 4.9% and labor force participation was stable.

  • ADP reported private sector employment gains of 177K – reasonable but also a bit below expectations.

The Ugly

EpiPens. Rex Nutting gets to the heart of it: Saving lives isn’t Mylan’s business; maximizing profits is. The story has widespread implications. We all want to save lives. To do this there must be an incentive for drug development. When does this cross into exploitation? Should U.S. prices subsidize foreign drugs? It is an important issue on many fronts.

 

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. This week’s award goes to Ben Carlson, who takes on the apparently compelling statistical link between the Fed and stock performance. Since 2008 more than half of the increase in the market comes on days of FOMC meetings. He notes that this argument was featured in the WSJ, but it shows up in various places.

What happens if you change the starting date of the analysis?

Ben points out that the relationship is mostly a result of 2008.

 

The Week Ahead

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. You can make your own predictions in the comments.

The Calendar

We have a light week for economic data. While personally I watch everything on the calendar, you do not need to! I highlight only the most important items in WTWA. Focus is essential.

The “A” List

  • ISM services (T). Continuing strength in the service sector?
  • Fed Beige book (W). Anecdotal evidence adds color to the data for the next FOMC meeting.
  • JOLTS report (W). The Fed uses this to analyze labor market structure. It is less useful for employment growth.
  • Initial claims (Th). The best concurrent indicator for employment trends, but less attention during “employment week.”

The “B” List

  • Wholesale inventories (F). July data but relevant for revision of Q2 GDP.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

There will be some FedSpeak. There may also be news from the G20 conference. See Treasury Secretary Lew’s presentation at Brookings for a preview.

Next Week’s Theme

Last week brought us more quiet trading with no clear message from the data. As people slowly return from vacation, it is a natural time to review events. We will see plenty of stories about how September is the worst month for stocks. Everyone will be asking: Will September bring a market correction?

Michael Brush, writing at MarketWatch, has a typical example, Get ready for a 5%-10% stock-market drop. Expect more such predictions and advice to do something or other to avoid this kind of decline. This week’s Barron’s cover was similar.

Most expect the record streak of low volatility to end. Here are the top worries:

  1. The calendar. This chart from Michael Batnick (who does not present this as a trade) makes the point.

  1. The Fed. Some are worried that rates will rise. Others are worried that the Fed will keep rates too low.
  2. Energy prices. Some worry about a sharp rebound. Others are concerned about another crash.
  3. China.
  4. Europe. The current focus is Italy. The last hot spots (Greece and Great Britain) are OK for now.
  5. The US election. You can worry about either candidate or just the uncertainty.
  6. Congress is back in session (see conclusion*). Note the shaded area of the VIX chart, marking the recent seven-week recess, perfectly coinciding with the record lows in volatility.

Feel free to add your own thoughts in the comments, including anything I have missed.

As always, I’ll have a few ideas of my own in the conclusion.

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Think risk first, reward second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 

The Featured Sources:

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he expresses more confidence about growth in earnings.

Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.

The recession odds (in nine months) have nudged closer to 10%.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has a number of interesting approaches to asset allocation.

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli’s enhanced aggregate spread, considering when it might first give a recession signal. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score. This week, as he always does after an employment report, Georg updated his unemployment-based recession indicator. No recession is indicated.

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. For most readers, they can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Holmes – the top artificial intelligence techniques in action.
  • Why 2016 could be the Year for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions or suggestions for new topics.)

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested, including several aggressive sectors. The more cautious Holmes also remains fully invested.

Top Trading Advice

Brett Steenbarger describes the three main causes of big drawdowns. See if you remember any of them from your own experience. Here is how to think about the diagnosis.

If you’re in drawdown mode, it’s important to ask if the problem is with your betting versus folding or if the problem is sitting at the wrong table or playing the wrong game altogether.

Dr. Brett has another lesson, showing how to milk information from data to find the best trades. Take a look at this chart and then read his analysis.

We have all had losing trades. The Trading Goddess discusses the best way to exit, including the thorny question of stops.

But as soon as you’ve entered the position, the price falls apart and forces you out of the trade when your protective stop is triggered.

Then, as soon as you’re out of the trade, the stock swiftly reverses back up.

After running 5% to 10% higher over the next few days, you’re left in the dust with no position and tear in your beer!

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Morgan Housel’s final column at The Motley Fool. He has been the best advice choice many times. His work is consistently helpful to investors. He promises that he will keep writing in his new gig, and I hope that is true. This week’s article reviews some of his key lessons. They are all worth careful study, buy I especially like this one:

Progress happens too slowly to notice; setbacks happen too quickly to ignore. The market quickly lost 38% in 2008, and it was huge deal. Books were written about it, and Congressional hearings were held. We’ll be talking about it for decades. The market then slowly tripled from 2009 to 2015, and barely anyone flinched. You had to sit down and show people the numbers to get them to believe you. This is common: Recessions take place over months; recoveries take place over years. It can take decades for companies to become valuable, but bankruptcies happen overnight. Pain hurts more than the same level of gain feels good, but the duration differences between progress and setbacks helps explain why there are so many pessimists amid a backdrop of things getting better over time.

And also this one….

There has never been a better time to be an investor. Ever, in history. More people have access to first-class services than ever before. It’s so important, and we don’t spend enough time realizing how good it is.

Stock Ideas

Chuck Carnevale continues his strong recent series with a look at the “Big Five” Canadian banks. He emphasizes the importance of finding a good entry price! This is a thorough analysis, and you should read it carefully before investing.

Morningstar updates the top buys and sells from their “ultimate stock pickers.” This group was a “net seller” but still holds some favorites. Check out the full article for other ideas.

Holmes will begin contributing an idea each week, a stock we bought for clients a few days ago. I will mention it here and Holmes will also post it each Friday at Scutify.com. While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas may be a starting point for your own research. Holmes may exit a position at any time, and I am not going to do a special post on each occasion. If you want more information about Holmes and exits, just sign up via holmes at newarc dot com and you will get email updates. This week’s Holmes made no portfolio changes. Danaher (DHR), which we bought last week, is still interesting and about the same price as our entry.

Energy

With a new trading range for oil prices there is renewed interest in energy stocks. Dan Dicker (Oil&Energy Insider – subscription required) recommends waiting until oil is closer to $40/bbl. He includes an interesting chart showing how some of the Bakken shale drilling sites developed. He writes as follows:

Oil wells cost money to drill and inevitably run dry. They need to be constantly replaced with fresh drilling to maintain output. Those drilling and maintenance costs sometimes overwhelm the returns of the oil being sold, as is the case this year and the previous two, and sometimes the returns greatly outpace the costs, as was the case before the bust in 2014.  We know that most of the independent U.S. oil companies operating in shale have bypassed this current cash burn problem in the short term by raising efficiencies – which lowers costs – and by slashing capex, which sacrifices the ability of potential future replacement.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are several great choices worth reading, but my favorite is this advice from Jonathan Clements. He explains that people are living longer and must take that into account in setting an investment horizon. He notes as follows:

…your time horizon may extend beyond your own life expectancy. Suppose you are age 80 and you have money you plan to bequeath to your 20-year-old granddaughter, who will then use the inheritance to pay for her own retirement. The investment time horizon for this money might be 50 years, over which the stock market will likely clock dazzling gains.

[Jeff] I agree with this analysis, but I always start by securing enough of a portfolio to assure against life-changing market results. One good place to start is with another source from Tadas, Tim Maurer. He warns against taking too much risk.

Market Outlook

Eddy Elfenbein, continuing to impress on his CNBC segments, explains 5 Signs that Stocks have Room to Run. We turn off the mute and TIVO back when Eddy is on, our highest indication of respect!

Strategy

Michael Batnick (MarketWatch) has a helpful article about what investors could learn from horse bettors. There is a list of ten great ideas, especially for value investors. I especially liked this one:

There is always the temptation to abandon your strategy when it’s out of favor.

“If you begin espousing this approach, you are sure to suffer abuse from your fellow horseplayers. When one of them asks you who you like in a race and you say, ‘I think the 4 is a bigger price than he should be,’ the likely response is, ‘So what? Who do you like?’ Your cronies are apt to tell you that you should be betting on horses, not on prices, and after an inevitable stretch of watching some of their underlays win, you will begin to doubt yourself.”

 

I wrote on a similar theme last week. You might enjoy Why Smart Investors Struggle to Beat the Market.

Ben Carlson explains the importance of rebalancing. If you do not regularly review and execute this strategy, you are missing out on a natural way of selling high and buying low. You are also taking too much risk!

Final Thoughts

Volatility will eventually increase, but there is no reason to expect it right away. Most of the reasons have been recycled all year. Let me comment on the new ones.

  • The calendar. One pundit stated that the reason for weak Septembers was that people were worried about October! Alan Steel covers this topic in a witty fashion. He deals with “the hordes of deviant scribblers…who have made single variable correlations into a media business.” His brief post has plenty of good advice, and you definitely won’t stop reading after the first line about the prune juice and Viagra diet. Take some time to read his other helpful and entertaining posts.
  • Rate increases. James Hamilton has a nice analysis of the concurrent moves of other economic indicators during rate increase periods.

    These 4 episodes have several things in common. First the inflation rate rose during each of these episodes and was on average above the Fed’s 2% target, a key reason the Fed moved as it did. Second, the unemployment rate declined during each of these episodes and ended below the Congressional Budget Office estimate of the natural rate of unemployment, again consistent with an economy that was starting to overheat. Third, the nominal interest rate on a 10-year Treasury security rose during each of these episodes, consistent with an expanding economy and rising aggregate demand.

  • Congress back in session. While the information is accurate, this point is a joke. Mrs. OldProf said that I should footnote and include this line so that everyone would know to laugh. I told her that readers of WTWA know a silly bivariate chart when they see one!

Fundamental factors are more important than the small seasonal effects. The latter often include a couple of large moves that skew the result. The chance of a correction is no higher than it was last month, or the month before.

Weighing the Week Ahead: Is the Brexit Vote a Turning Point for Stocks?

This week’s economic calendar has plenty of data during a week where many will want to anticipate the long weekend. Despite these factors, most are still trying to digest the Brexit decision. There will be stories on politics, polling, history, and human interest. The economic and financial market consequences will get the most play from financial media.

Is the Brexit Decision a Market Turning Point?

Last Week

There was some significant economic news, but attention focused on Europe and the United Kingdom.

Theme Recap

In my last WTWA, I predicted that the week would be all about Brexit. Despite Yellen’s Congressional testimony, the Brexit theme was a wire-to-wire winner.

Last week’s “Final Thoughts” section was also on target, suggesting a plausible range for the week’s trading.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. You can clearly see the early strength, based mostly on the Brexit polls, followed by Friday’s collapse. Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

SPX-five-day

 

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. My working definition of “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

 

The Good

  • Hotel occupancy continues at a near-record pace. (Calculated Risk).
  • Fed stress tests were solid. Banks can $526 billion in losses under the “adverse scenario.” (MarketWatch). Bloomberg’s editors have a contrarian viewpoint.
  • Existing home sales were strong. Bill McBride explains that it would have been even better if inventory were not so low. It is a complex story because baby boomers are “aging in place” and some single-family homes were converted to rentals. The numbers do not always reveal the underlying strength. And BTW, mortgage rates are near record lows. The good news was reflected in the Lennar earnings release.
  • Chemical activity is up 3% in the last three months. (Scott Grannis).

CAB 1960-

  • Initial jobless claims dropped to 259K, a great reading. It is important to monitor job creation as well as job losses, so this good news is not the whole story.

The Bad

  • Durable goods orders declined by 2.2%, missing expectations. Steven Hansen examines year-over-year changes in the adjusted data and arrives at a slightly better conclusion.
  • Social Security financing projections got worse, exhausting the funds two years earlier than expected. D-Day is now 2028. Political leaders need to get a compromise solution in place very quickly. The longer the delay, the more difficult the solution becomes.
  • Leading indicators declined 0.2% when a gain of 0.2% was expected.
  • Rail Traffic continues to decline, although the rolling average is a little better. We have been following Steven Hansen’s coverage of this topic (GEI), partly because of the exhaustive analysis of past data. At some point we might see the effects of reduced coal consumption to show up.
  • Michigan sentiment slightly missed expectations with a reading of 93.5. Doug Short has the best representation of the history of the series and the link between sentiment and the economy.

Michigan-consumer-sentiment-index

  • New home sales at an annual seasonally adjusted rate of 551K missed expectations of 560K and decreased from the prior month. Calculated Risk provides a chart of the long-term results.

NHSMay2016

 

The Ugly

Non-working, prime-age men. With varying motives, there is a very misleading and oft-repeated “94 million people can’t find jobs.” While this is technically true, it includes grandma, teenagers, and people who prefer to study or take care of families – among others. A much better group to study is men between the ages of 25 and 54. The White House Council of Economic Advisors released a report examining the long term decline in labor force participation in this group, a trend they call “worrisome.” Various sources have provided summaries of the 50-page report and added commentary. Alan Berube (Brookings) does this nicely, including this chart of areas where the problem is greatest.

prime age employment map

 

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. No award this week. Nominations are always welcome.

Noteworthy

I enjoy Pandora’s music service, often listening as I write WTWA. I have never owned the stock, but when their CEO appeared on CNBC last week I turned off the mute and TIVO’d back to watch the interview. Among other things, he discussed the potential for targeted political advertising. He stated that they could predict votes with 90% confidence using only two variables: Zip code and Pandora playlists.

The Week Ahead

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. You can make your own predictions in the comments.

The Calendar

We have a big week for economic data, with many participants edging out the door by noon on Friday. I always highlight only the most important items, helping us all to focus.

The “A” List

  • The ISM Index (F). Important for those on recession watch.
  • Consumer Confidence (T). Good read on employment and spending.
  • Personal Income and Spending (W). Key data on consumer health.
  • Auto Sales (F). Continuing strength in this private data series?
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Pending Home Sales (W). Less direct impact than new home sales, but a good read on the housing market.
  • Construction Spending (F). A noisy series, but an important sector.
  • Q1 GDP (T). This is the final estimate – at least until benchmark revisions. Old news, but it is what goes in the books.
  • More Fed Stress Test Results (W). Which banks can increase dividends and buy back shares?
  • Chicago PMI (Th). Market will watch for a hint about the ISM report.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

Fed Chair Yellen is meeting with ECB President Draghi at a European forum on central banking. That should be interesting! We’ll get some additional FedSpeak later in the week.

Next Week’s Theme

With the momentous Brexit results known, it is time for the pundits to explain what it all means. Despite the daily flow of economic reports, Friday’s stage-setting selloff guarantees that attention will once again focus on Brexit. It is certainly historic, and might provide a tipping point for the UK or Europe.

While the financial media theme for the week ahead will be broader, the key point will be:

Is the Brexit result a turning point for equity markets?

As was the case last week, I read many articles on this topic, watched webinars from experts, and listened to the punditry. (As I write this, I am reminded of the best football preview program. Mrs. OldProf, who grew up in Green Bay is an enthusiastic and knowledgeable fan. She loves the show, and so do I. You have to record it in the middle of the night and watch it on Sunday morning. One of the hosts, Merril Hoge, usually says that he did “70 hours of tape study” in the prior week! The plays he selects to analyze provide some credibility for this claim).

Since I read quickly, I did not spend 70 hours on Brexit. I did read a lot more than you probably want to. In this week’s WTWA I want to cover a range of key perspectives. Read some of these links, the best and most responsible samples of each type, and draw your own conclusions. Then check out mine at the end of this post.

  • Every market was rocked, or hammered – but maybe not a Lehman moment. CNBC kept running the “Markets in Chaos” subhead. The WSJ coverage was more moderate than most, but it will still worry most.
  • Expect more volatility. Beware! (Oppenheimer)
  • Brexit is bad for U.S. companies and corporate profits. (Barron’s)
  • Expect a decline in UK GDP. Econbrowser summaries key studies.
  • Expect weakness in the global economy. (The Atlantic).
  • The process will lead to more uncertainty and pain. (Hale Stewart at Bonddad. Also here and here. Further thoughts from his colleague, New Deal Democrat).
  • Cameron has sent the UK into a “potential investability vacuum.” (Reuters BreakingViews)
  • The voting “disaster” will lead to the breakup of the UK. (Reuters BreakingViews)
  • The result may affect U.S. consumer confidence and the 2016 Presidential election. (Benn Steil via GEI)
  • Voter remorse from Brits who did not understand? Google searches raise the question.

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

Indicator Snapshot 062516

 

The Featured Sources:

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he expresses more confidence about growth in earnings.

Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.

This week the recession odds (in nine months) have nudged closer to 10%. This does not completely reflect Brexit effects, so we may get a further revision.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. His latest update describes the elements of the indicator we cite every week.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has a number of interesting approaches to asset allocation. Dwaine’s most recent update, U.S Economy most vulnerable to any shock since 2008, shows the recent deterioration in conditions. Read the full post, but the two charts below show the decline of the long-term leading indicators despite continuing low odds of an imminent recession.

2016-06-24_1315

2016-06-24_1334

 

 

As we review the weekly indicators it is important to maintain perspective. A 20% chance of a recession would be average. It is not a reason for fear, since it says that a recession is very unlikely. There will be a time to exercise more caution, but we are not yet close to that point.

I know that some readers have wondered whether the needle was “stuck” on these indicators. There is a temptation to tap on the gauge to see if it moves! We are seeing a little movement this week after a very quiet stretch.

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. For most readers, they can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 could be the Year for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions or suggestions for new topics.)

 

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue our neutral market forecast. Felix is fully invested in fairly aggressive choices. This was good for most of the week, but bad on Friday. The more cautious Holmes is still fully invested, but fared better in Friday trading. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now. It is not a resounding endorsement of the overall market, but a vote for opportunistic trading.

Top Trading Advice

Brett Steenbarger once again challenges traders. What can you learn from this?

Bergen poster

 

His crisp analysis shows why it is important to be unique, and also how to do it successfully.

Dr. Brett’s Brexit advice emphasizes the difference between novice and expert traders.

Josh Brown explains how to use the VIX in your trading. There are very good results from watching VIX spikes during an uptrend. (See also Dana Lyons). Many investors take the opposite viewpoint about the “fear gauge.” Maybe that is why it works so well. Maybe it is related to what Dr. Brett is saying!

Why do traders blow out? One reason is “revenge trading.”

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read, it would be this analysis from “Davidson” via Todd Sullivan. This is extremely important and worth reading carefully. Twice if you need to. He takes on the basic issue of why most analyses of value and momentum methods are wrong, introducing what he calls the 1% solution.

A key point is that value investors have great influence on markets:

The long-term perspective reveals that SP500 Index has grown ~6.1% in line with long-term earnings. Value Investors perform contextual analysis to determine at what price they find long-term value in markets. The period 1965-1982 was a period of SP500 underperformance relative to earnings. Rising inflation caused Value Investors to contract P/E levels.

Screen-Shot-2016-06-21-at-12.33.27-PM-768x492

 

From the SP500 EPS & P/E’s 1871-May 2016 chart, it appears we may be near a market top, but Value Investors today indicate this is not the case in their experience. Explaining why Value Investors are likely to be right requires contextual analysis which many do mentally. Warren Buffett’s now famous saying, “My brain is a computer” explains why this is so.

He provides a lot of additional explanation and detail, concluding:

Be patient. Several years of economic expansion appear to be ahead of us. I expect investors to shake off the current pessimism and shift equity markets higher. Investment success relies in having realistic expectations and being grounded to fundamentals.

(At some point several years from now, the economic data should indicate that an economic correction is likely. I will then recommend an appropriate shift in strategy. But, not today!!)

[Jeff] This is very strong and exactly right for investors.

Stock Ideas

Airlines benefiting from Brexit? Raymond James provides some ideas. (via Barron’s)

Ben Levisohn asks, Biotech: Buy the Brexit Blowup? His sources suggest that the selling greatly exaggerates the actual impact on many stocks. Check it out for specific ideas.

How about diversifying by strategy rather than by allocation? Michael Batnick explains how this can both improve returns while reducing risk. (Holmes is vigorously wagging his tail in agreement).

Tesla. Really? Every big firm hates the deal to buy Solar City and has downgraded the stock. One contrarian source likes the underlying numbers and notes the potential that the deal would be withdrawn. That was our thinking when we initiated a small option position. This is the kind of situation that can provide a great risk/reward ratio, but not by just buying the stock.

The Hardest Question: When to Sell

Chuck Carnevale wisely notes:

The most common complaint that I have heard from investors over my 40+ years in the financial services industry is as follows: “Everyone wants to tell me what to buy and when, but no one ever tells me when to sell.”

Hint #1: Do not sell just because the price drops.

Hint #2: Keep the stock’s fair value in mind.

Read the full post for plenty of helpful analysis and examples.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading, but my favorite this week is Morgan Housel with (yet another) great piece. It is aimed at new grads (although nearly everyone could benefit). He asks various sources for their best advice in five words. There are plenty of good ideas here, even though he allows four more words of advice than Dustin Hoffman got.

What would I say? How about: Don’t spend all at once. Well that was what my son calls “dad humor.”

My own father had great advice, and it did not take five words: Always think of tomorrow.

Runner up? This analysis of the 30-year mortgage, which might cost buyers an extra $100,000 or so, just so they can reach for more than they can afford.

Doing your own work?

If you are a serious individual investor making your own decisions, you should monitor your stocks via Seeking Alpha’s excellent transcript service. You can also get a lot of information from Avondale Asset Management’s weekly summary.

Final Thoughts

 

There is an important distinction among various Brexit effects: politics, history, economics, and markets. If we were sitting down for a cup of coffee or a beer, I would discuss any of them. As investors we should be mainly concerned with the last, and perhaps a bit with the economic effects.

That will be my focus.

The Path Mattered

The five-day path to the final decision was very important. The range of the week’s trading was within the +/- 2% we cited last week. The week started with a rally when markets mistakenly thought that the “remain” vote would prevail. When the opposite occurred, the market gave that gain back and declined another 1.3% or so. Everything was within the range that we expected.

  • If you kept this in mind, the big selling on Friday was not a surprise.
  • The path set up a big news event – markets in chaos, stocks slammed, Brexit threatens world economy, etc. Suppose that the vote had been on Monday, before the run-up. A decline of 1.3% would have been a relatively normal reaction to some negative news – not a catastrophe.
  • The psychology is in place. The weekend news coverage will frighten individual investors, probably leading to a weak day on Monday.

Most Fears Are Speculative

The measurable effects are all modest.

The biggest negative impacts all relate to speculation about the effect of uncertainty.

Investment Implications

As is often the case, the best risk/reward for investors is contrarian.

  • Allow markets to digest the Brexit information and don’t panic; (Morgan Housel and also MarketWatch)
  • Ignore those pitching a personal, political, or product agenda;
  • Emphasize quantitative fundamentals. Earnings impacts may be exaggerated; (Brian Gilmartin)
  • Choose value stocks;
  • Do not overreact to headlines calculated to sell advertising; (Chuck Jaffe, MarketWatch) and finally
  • As I noted last week, this may not be the final chapter. (Bloomberg)

Read these sources carefully and contrast with the more speculative fears.

The most difficult thing for most investors is to “stay the course” in the face of frightening news and incessant recession predictions. It is also the most rewarding.

Weighing the Week Ahead: What Does the Brexit Vote Mean for Financial Markets?

This week’s economic calendar is a little light on data, but it packs plenty of important news. Last week I suggested that the Brexit build-up would become the dominant theme. Nothing has changed. Expect daily stories on three Brexit themes:

  1. What UK voters should do;
  2. Predictions about the result; and
  3. Consequences for financial markets.

While financial media will cover all, my attention will be on the third. What Will the Brexit Result Mean for Financial Markets?

Last Week

There was little economic news. The biggest change was the reaction to the FOMC meeting.

Theme Recap

In my last WTWA, I predicted a week divided between two themes—first the Fed, and then Brexit. It was indeed a two-story week, with an overlap in the middle. The Fed decision was greeted positively for a few minutes, and then the tide shifted.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. You can clearly see the slightly delayed reaction to the Fed announcement. Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

SPX-five-day

 

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. My working definition of “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

 

The Good

  • Sea container counts are showing some rebound from the recent soft patch, but we remain well off the highs. (Steven Hansen at GEI).
  • Earnings estimates are strengthening. Check out Brian Gilmartin’s analysis for a detailed look at which sectors and by how much.
  • Fund manager asset allocations to equities remain near an eight-year low. On a contrarian basis, this is bullish for stocks. (Urban Camel).

fund-managers-asset-allocations-percent-cash-june_baml

  • Retail Sales were strong, in both real terms and per capita (New Deal Democrat). More people are shopping online, which makes interpretation of sales more challenging. Doug Short has multiple charts and a “Big Four” update. Ed Yardeni has the online story.

Yardeni online shopping

  • Housing showed strength. The picture remains complicated and a bit mixed.
    • Housing starts met expectations, had revisions for prior months, and an increase of 9.5% over last year. (Calculated Risk)
    • Doug Short analyzes the secular trends in both building permits and housing starts.Housing-Permits-and-Starts-population-adjusted

     

    • NAHB builder confidence increased to 60, up from 58 and well above the expansion signal of 50. (Calculated Risk)

The Bad

  • Industrial production fell 0.4%. This remains the weak spot in the economic data.
  • Foreigners are selling U.S. equities. The pace is an all-time high according to Torsten Sløk, Ph.D., Deutsche Bank Securities via Barry Ritholtz. Check out the chart.
  • The rail contraction continues. Steven Hansen at GEI has his regular update on this story.
  • Jobless claims edged higher. But still reasonable at 277K.
  • Lowered Fed expectations recognize slower growth. Most market participants do not expect lower interest rates to solve this problem. Bloomberg has a good summary of the Yellen conference, including various viewpoints.

 

The Ugly

Continuing violence and terror. The mass shooting casualties have been getting worse.

 

massshoot_jun16a-1

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. No award this week. Nominations are always welcome.

The Week Ahead

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. You can make your own predictions in the comments.

The Calendar

We have a relatively light week for economic data, but a big one for news. I highlight only the most important items, helping us all to focus.

The “A” List

  • The Brexit vote (F). The vote is Thursday, but results will not be available until Friday trading.
  • New home sales (Th). Can recent strength continue?
  • Michigan sentiment (F). Good indicator for employment and spending – remains near highs.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Existing home sales (W). Less direct impact than new home sales, but a good read on the housing market.
  • Durable goods (Th). A decline is expected in this volatile series, but how big?
  • Bank stress test results (Th). Mostly important to a few banks, but also a measure of overall financial health.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

Chair Yellen will provide her semi-annual Congressional testimony to the Senate on Tuesday and the House on Wednesday. The question periods will be closely watched. You might think there is nothing left to learn after last week’s FOMC decision and press conference, but any fresh hints will get attention. We also have a resumption of appearances by other Fed participants.

 

Next Week’s Theme

 

Anyone whose breath can fog a mirror is being asked about his or her opinion of what the Brits should do. That is a lively topic, but not one for us.

The outcome of the vote is important, but the prospects seem to change daily. Again, not a good topic for us.

While the financial media theme for the week ahead will be broader, the key point will be:

What does the Brexit vote mean for financial markets?

I have read scores of articles on this topic, watched webinars from experts, and listened to (some of) the punditry. While it is part of my job, most investors do not want to do this. I will try to provide a few key points as background. Read some of these links, draw your own conclusions, and compare them with mine at the end of this post.

  1. How does Brexit compare to other perceived crises? Josh Brown notes the $140 billion of net equity outflows and compares the VIX level to prior incidents. Concerns are higher than for interest rate hikes or the Presidential election. (Bloomberg)
  2. Some suggest that we should expect chaos – and then damage control. (Bloomberg)

Bloomberg Damage Control

  1. The impact on U.S. markets should be modest. (CNBC and also David Merkel)
  2. Brexit would hurt trade, the global economy and stocks, and especially revenues from certain sectors.

FactSet UK Revenue Exposure by Sector

  1. Last but certainly not least, a chart-based background guide to Brexit (The Economist) Here is a sample:

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And a tabular summary of the issues:

20151024_WOC501_2

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 

The Featured Sources:

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he expresses more confidence about growth in earnings.

Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). Monthly reports including both an economic overview of the economy and employment.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting approaches to asset allocation.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. His latest update features his unemployment rate recession indicator. A recession is unlikely “any time soon.”

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interest can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. For most readers, they can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 could be the Year for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions or suggestions for new topics.)

 

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue our neutral market forecast. Felix is fully invested, but the sector balance has become more aggressive. Many sectors remain in the penalty box. The (usually) more cautious Holmes is once again fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now. It is not a resounding endorsement of the overall market, but a vote for opportunistic trading.

Top Trading Advice

Dr. Brett explains why your trading psychology is reflected in your daily life, and vice-versa. Learn how this can be important to achieving your trading goals. As an example he writes as follows:

I was recently driving on a highway and the road split into two sections, each going the same way.  The left fork was a single lane labeled express; the right fork was a double lane labeled local.  My trip was several hours in duration but I immediately took….

Which one would he choose, and why?

Adam H. Grimes provides insight on strategy vs. tactics. He defines the difference, but also provides some specific techniques.

In this case, we need to be very precise: tactics refer to how, where, (and maybe why) we execute at the specific prices we choose. Strategy, on the other hand is the big picture perspective. First, get the strategic view right.

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read, it would be “Davidson’s” take on Brexit (via Todd Sullivan). Here is the key point:

High fear of financial collapse! Major investors saying “Get out!”, ‘Brexit’ forecasts dire for European economy! In the US, top investors say Fed has lost control and the economy or something will spiral out of control. These are only a few of the current basket of concerns. And then there is our current Presidential election fare and the terrorist attack in Orlando.

In reality, this week’s concerns have not been much different than what we have seen since the current economic recovery began in 2009.

He then produces charts on a series of key economic measures: employment, real personal income, retail sales, job openings, and the housing rebound. Please check out the charts, supporting the thesis that data trumps sentiment.

The conclusion?

While the world frets and then frets some more, economic activity has continued to expand. Eventually, investors have never failed to turn more optimistic and remain so for several years. It is this period of optimism from which excess economic activity derives. It should be readily apparent that while economic activity continues to expand, optimism and economic excess is not part of the current equation. It could said that “Excess pessimism does not produce excess economic activity!” There is no economic correction on the horizon. This does not mean that we could not have a dip in market prices at any point in time for other reasons. Dips should not matter for long-term investors. I anticipate taking action only once economic fundamentals indicate a correction is likely.

 

Stock Ideas

David Fish updates the list of Dividend Challengers. There are many specific ideas, so check it out.

Chuck Carnevale emphasizes the importance of valuation on your entry point, even when buying a great dividend stock. He has a great example of how waiting for the right entry point (even though a dividend was missed) actually added to total dividends in the long run.

 

Energy Perspectives

We have some interesting themes this week. Figuring out the stock implications will require some more thought. I am working on it, and I welcome comments.

  • Peak Fossil Fuels for Electricity, by Tom Randall at Bloomberg. Watch out for both coal and natural gas. Eight key points, including the upcoming domination of solar.

-1x-1

  • Billions in proven shale oil reserves suddenly become “unproven.” (Bloomberg) Hint: Improved accounting rules.
  • Don’t count on nuclear power. (EIA) The first new reactor just came online after more than 40 years of planning and construction. It is the first new one in twenty years. This chart shows the typical length of time

chart2

 

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading, but my favorite this week is Andrew Comstock’s What is the most important financial advice you would pass to your children. The advice garnered from a number of experts is somewhat inconsistent, but thought-provoking. In general, young people need to balance passion and earnings, current consumption versus the future, and borrowing versus saving. My own thought? You need to look forward to your work if you expect to do well.

For both young and old: 51 Things You Shouldn’t Do from John Clements.

For millennials: You need more realistic expectations about future returns.

Watch out for….

Chasing last year’s winners via annual sector rotation. Josh Brown has a nice post showing the prevalence of this performance chasing. He emphasizes, “The data is unambiguous.” His analysis and charts show why this does not work. (Felix objects that sector rotation works, but a shorter time frame is needed).

Yield stocks, the crowded trade. William Smead covers this point, while also noting the declining significance of Fed Stress tests and the potential for banks and the housing market.

9a85d9ad1d9f032c9fe14cfc3e5e5e5fe7d12d1d

 

Final Thoughts

 

Brexit is not another “Y2K” as Barron’s suggested this week, but the uncertainty has had an exaggerated effect. Here are my own conclusions:

  1. The outcome is approximately a coin-flip, making any planning difficult. Either resolution will reduce volatility.
  2. The referendum is advisory, which will be emphasized more next week. Members of Parliament will be informed by voter frustration, but may not accede to the specific plan.
  3. A Brexit would take years of negotiation to accomplish, with many of the agreements most important to the European and world economies re-established.
  4. The actual stakes are smaller than most think. I get some information from confidential sources, and I respect their restrictions. A strong and popular (but unquotable) source did some polling of experts. Likely immediate S&P 500 range is 2 ½% downside and 2% upside. The extremes might be slightly larger. This range fits my own expectations. It is all guesswork, of course, but probably better than the vague notions about dominoes dropping and world trade ceasing.
  5. There may be a surprise outcome from a positive vote. British leaders may use it to negotiate some EU rule changes.

And finally, as you navigate the week ahead remember this:

The most newsworthy stories are frequently not the most important for your investments!