February 21st, 2011
by Jeff Miller
Most major economic indicators remain in positive territory. There is growing recognition that the economic rally now has a self-sustaining character.
- Economic growth is still improving. The ECRI Weekly Leading Index pulled back slightly while the growth index reached a fresh peak, the highest since May, 2010. This is a signal of solid growth for as far ahead as they are willing to forecast.
- Risk as measured by the St. Louis Fed Stress Index, moved to the lowest level since before the financial crisis. This measure tracks a lot of market data in the eighteen inputs. It is not a poll, nor opinions, nor a collection of anecdotes. We should all pay attention to some real data. The value moved to -.022, even lower than the .024 from last week. For more interpretation, the St. Louis Fed published a short paper with a very nice chart that helps to interpret this index. The chart does not reflect the recent continued decline in stress, but it identifies the dates for important recent events. The paper also has a longer version of the chart, illustrating past stress periods. I am not going to run the chart each week, but I strongly recommend that readers look at the paper. In the 2008 decline there was plenty of warning from this index -- no sign right now. Mark Perry at the Carpe Diem blog, one of our featured sites, highlighted this indicator. Mark gets a lot of well-deserved exposure so perhaps the 'secret risk measure' that readers of "A Dash" have profited from will now be more in the public eye.
- The Philly Fed. I said last week that this was not important unless there was a big move. There was -- 35.9 versus 21 expected. This provides support for the various measures of manufacturing improvement.
- Rail Traffic. The data came in great as noted at GEI. Bonddad adds that this series seems to be a good lead for industrial production.
- Inflation Data. The Fed has an announced policy on inflation, making it easy to profit from following the lead. They want a higher core inflation rate. I explained what investors really need to know, and debunked the extremist "money-printing" crowd. Prof. Hamilton says the same, with force and authority.
There was some important bad news for the economy. The story is rarely one-sided. There is a continuing problem on several fronts, a widely known "wall of worry" that is already reflected in current market prices.
- Housing Sales Overstated. The most important bad news of the week came from the CoreLogic Year-end Summary of Trends. I read their reports, and so should you. Calculated Risk has a nice summary, showing that the existing home sales from the National Association of Realtors may be overstated by 15%. Consistent and aggressive critic (another of our featured sources) Barry Ritholtz has this take.
- Retail Sales. This was a big disappointment.
- Initial Jobless Claims. The highly volatile series moved higher, but the trend continues lower. It is not good enough to improve the employment picture.
The "Not Bad"
Each week there are important numbers that are not decisively good nor decisively bad. If the information is important we cannot and should not ignore it, especially if expectations were different from the reports.
This week's candidate is sentiment. Many think that sentiment is excessively bullish. These observers have (incorrectly) been calling market tops for months. Traders Narrative (Yet another hat tip to Abnormal Returns) has the most comprehensive summary of sentiment indicators I have seen. The readings are high, but not off of the charts. Personally, I do not like polls of those with little marginal money to invest. I prefer looking to big money players who could make a significant difference with a small change in asset allocation, as I wrote here.
The Big Worry: Energy Prices
The rally rests on economic growth, profit growth, a good supply of well-known worries, and attractive valuations. What might threaten this picture?
Two of our favorite sources, Bonddad and Econbrowser, are highlighting rising fuel prices and the possible threat to the economy. This bears watching.
Our Own Forecast
We base our "official" weekly posture on ratings from our TCA-ETF "Felix" model. After a mostly bullish posture for several months, Felix has turned more cautious. Three weeks ago we said it was a close call, and switched to neutral. Two weeks ago it was still close, but we shifted back to bullish in the weekly Ticker Sense Blogger Sentiment Poll. We remained bullish this week. Here is what we see:
- 77% of our 56 ETF's have a positive rating, up from 68% last week.
- 55% of our 56 sectors are in our "penalty box," down sharply from 73% last week. This is an indication of significant, but reduced short-term risk.
- Our universe has a median strength of +19, about the same as +18 last week.
The overall picture is slightly bullish. We remained fully invested in trading accounts since there are several strong sectors, but we are watching the indicators quite carefully. This has been a very close call for several weeks.
[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]
The Week Ahead
There are a number of reports this week, but here is what I will be watching.
- Case-Shiller data. The market cares, so I must watch also. Bad news is already reflected in the market. If Diana Olick ever says anything positive, we will see a huge market rally.
- Interest rates. Watch the ongoing interplay with currencies and inflation expectations.
- Energy prices! Enough said.
- The ongoing protests in Wisconsin and the Middle East -- what a juxtaposition! I don't see a big link to stock prices right now, but I am watching.
- The chances for a federal government shutdown. It seems stupid, but who knows?
Nearly everyone has been under-invested at some point during the extended rally. Even those of us who have been bullish throughout are under-invested for new accounts. Trying to time the market correction has been a big mistake. A good alternative is to watch the fundamentals and risk factors I highlight each week.
Jeff Miller has been a partner in New Arc Investments since 1997, managing investment partnerships and individual accounts. He has worked for market makers at the Chicago Board Options Exchange, where found anomalies in the standard option pricing models and developed new forecasting techniques. Jeff is a Public Policy analyst and formerly taught advanced research methods at the University of Wisconsin. He analyzed many issues related to state tax policy and provided quantitative modeling which helped inform state and local officials in Wisconsin for more than a decade. Jeff writes at his blog, A Dash of Insight.