March 21st, 2011
by Jeff Miller
Last Week's Data
To keep perspective, we should note that 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 fell slightly, to 130.4. The growth index reached yet another fresh peak, 7.1%, the highest since May, 2010.
- Risk as measured by the St. Louis Fed Stress Index, remains very low. 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 +.006, about the same as last week's +.002. These are completely normal readings. 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. The scale is in standard deviations, so anything short of 1.0 or so is neutral territory. I am doing more extensive research on this indicator.
- Initial jobless claims moved lower, to 385K, consistent with the gradual trend.
- The Philly Fed Index hit a multi-decade high of 43.4. I do not place a lot of emphasis on the regional indicators, but it is wise to note that every manufacturing measure has been very strong.
- Coordinated currency intervention was effective, as noted by Econbrowser. Many traders continue to underestimate the power of government.
- Equity markets outside of Japan held up pretty well, considering the challenges. As we noted last week, there are multiple support levels.
NB: The ECRI and SLFSI are actually readings from week-old data.
The bad news centered on housing and Japan.
- CoreLogic issued another negative report, this time on home prices, down 5.7% from a year ago.
- Building permits were down over 8% from January and over 20% from a year ago. I regard the permit series as a good leading indicator, but for those who prefer housing starts, the numbers were similar. As Steve Hansen wrote: New Housing Permits Offer Strange Data.
- The Japan tsunami aftermath and nuclear threat is a continuing story of human tragedy as well as economic loss. At the time of writing, the worst case outcome-- a complete core meltdown at one or more of the reactor sites-- seems to have been avoided, although information is not yet complete.
The Military Uncertainty
There is a tension in US foreign policy as it relates to revolts against dictators. On the one hand, we applaud the outbreak of democracy around the world. On the other, we note that this movement has the potential to topple both friends and foes. While I have my own opinions about foreign policy, my mission is to discern the investment implications.
I see an ad hoc policy, lacking a consistent guiding principle. How else can one explain intervention in Libya and a sideline stance in Bahrain?
The turmoil has created a premium in oil prices of $15/barrel or so. Depending upon events in the region, that premium might move either way, but the bias seems higher.
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 much more cautious. Several weeks ago we said it was a close call, and switched to neutral. Six weeks ago it was still close, but we shifted back to bullish in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. We remained marginally bullish last week, but we have now moved to a neutral posture. This is based on the near-zero ratings for the various index ETFs, which do not suggest a time for selling short. Here is what we see:
- Only 45% of our 56 ETF's have a positive rating, down from 70% last week, a continuing trend.
- 86% of our 56 sectors are in our "penalty box," up dramatically from 43% last week. This is an indication of very high short-term risk.
- Our universe has a median strength of -11, down from +9 last week, also a negative trend.
The overall picture deteriorated dramatically last week. We reduced positions in trading accounts to 40%, holding only the strongest sectors. 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 is little of importance on the economic data front. The routine numbers will be overwhelmed by news from Japan and the Middle East.
Interpreting this news will be a continuing challenge for traders.
Investors with a longer time frame should be far less interested in the specifics of the news flow. I'll stand by what I wrote last week:
The ongoing theme is how investors should deal with worries. In general, there is a tendency to overreact. World events are difficult to quantify. Translating worry about Europe into the effect on, for example, tech company earnings, is quite a challenge. Many people react to the story without stopping to gauge the specific effects.
During the week I explained exactly how to deal with a crisis: Plan ahead, follow your system, measure risk (as opposed to wild speculation), and analyze each holding. Following a quantitative risk measure like the SLFSI is an important advantage: You don't need to speculate about the importance of world events.
Meanwhile, most others follow the anecdotal approach. Many prefer this because it permits maximum spinning of events.
For the next several weeks we can expect everyone who wants to ignore the obvious economic improvement to claim that every new piece of economic data is irrelevant, since it does not reflect the incipient post-Japan weakness. Meanwhile, the economic evidence suggests that the Japanese impact on world and US GDP will be minimal and might even be positive. An alternative view has discussed how Japanese reconstruction might disrupt U.S. Treasury markets.
The nuclear fear also requires context, especially when projecting world-wide effects. Except for those in the immediate vicinity of the site, the radiation levels should be compared to those from a variety of other sources. I strongly recommend the careful analysis cited at The Big Picture, a valuable tool for interpreting news about radiation exposure. Here is another good piece from Scientific American with a brief and accurate summary. Steve Hansen, who has engineering experience with the reactor type affected in Japan, has a very reasoned discussion of the specific nuclear issues and possible economic implications.
For long-term investors we followed the cautious buying strategy at mid-week, and we will be more aggressive if support levels are holding. Monday morning has U.S. stock markets looking very promising.
The Week Ahead: Time to Head for the Exit? by Jeff Miller
Investing with a System by Jeff Miller
New Housing Permits Offer Strange Data by Steven Hansen
Japanese Meltdown Will Inhibit Recovery by Steven Hansen
Chicago Fed National Activity Up Via Backward Revision by Steven Hansen
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.