April 25th, 2011
by Jeff Miller
We have not yet reached the peak of earnings season, but that story may take second chair this week. There is a fixation on the Fed, QE II, and prospects for a policy change. In this environment there is yet another experiment, a press conference by Fed Chair Ben Bernanke.
I few weeks ago I went on record saying that information is good and more is better. As a consumer of data and an economic blogger, I'll stick with that position. I love to have fresh information. Follow up:
But is this wise?
So much of Fed policy is open to debate. My own conclusion is that the direct effects of QE II are small and therefore the end of QE II will also have little effect. But....
As a political scientist, I am trained to think about perceptions as well as the first-order impacts. If much of the QE II effect has come from increased confidence (conspiracy or otherwise) then what will come from the end?
I also wonder how the Fed Chair will do in answering questions from reporters. It is not the same as the Congressional testimony that goes with the job, or the controlled environment of 60 Minutes or a CNBC interview. This will be a new challenge.
This might be difficult to understand. What is the difficulty in answering a few media questions?
People would learn while being entertained from the excellent TV series, The West Wing. The program was very accurate on many elements of internal dynamics in Presidential administrations. This is partly due to the influence of Dee Dee Myers, a Clinton Press Secretary. One of the best features of the show was the difficulty in communicating the message. There were several episodes illustrating this issue, and the show got this story right. If you had to pick a single example, my colleague on these episodes (my son, now at U of I) recommends this one.
This leaves me wondering how Bernanke will do. Put in West Wing terms, the skills involved in knowing the policy, deciding the policy, and explaining the policy resided in different characters and different jobs.
The Bernanke performance will be widely followed. Even if he does well, it might set a bad precedent.
I would rather have a Fed Chair that was good on decisions rather than one who was good on media relations. How about you?
I'll return to the investment theme, but first let us do our regular weekly review of events.
Background on "Weighing the Week Ahead"
There are many good services that do a complete list of every event for the upcoming week, so that is not my mission. Instead, I try to single out what will be most important in the coming week. If I am correct, my theme for the week is what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.
In most of my articles I build a careful case for each point. My purpose here is different. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but some will disagree. That is what makes a market!
Last Week's Data
The news was basically good, including earnings, the economy, and risk. The negative points are still with us, but not fresh news.
Most major economic indicators show that the US economy has returned to its normal state, self-sustaining growth. Many seem to have forgotten that economic growth is normal, including the use of slack resources to expand and to build new businesses.
- Economic growth forecasts improved. The ECRI Weekly Leading Index increased slightly, to 131.6. The growth index moved higher to 7.7%. These continue to be good readings. Everyone is watching the indicator closely, mostly with the idea of bailing out at the first downtick. There is no empirical basis for that interpretation. We are doing our own research on the indicator.
- 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 -0.139, a bit lower than last week's -0.088 (adjusted). These are completely normal readings for a scale measured in standard deviations from the norm. 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.
- Earnings have beaten expectations. Eddy Elfenbein, in a nice review of the week, writes as follows:
To give you an example of how well this earnings season is going, General Electric ($GE) not only beat earnings but the company raised its dividend for the third time since July. The overall numbers are still early but this is shaping up to be the ninth-straight earnings season in which results have topped expectations. So far, 137 companies in the S&P 500 have reported and earnings are up 18.2%. Three out of every four reports have exceeded analysts’ expectations.
- Building permits were stronger. March came in at 594K (seasonally adjusted annual rate). This is up over 10% from February but down more than 10% from last year. Regular readers know that I like the building permit series as a forward indicator.
NB: The ECRI and SLFSI are actually readings from week-old data.
The biggest negative was the continuing spike in energy prices.
- Energy prices move higher. Gasoline prices were up five cents in a week. There is continuing stress in the MENA region, with a very uncertain outcome. The price increases directly affect other discrectionary spending.
- Initial jobless claims continued to be elevated. We are back to the 4-handle. This series is only one part of the employment story, but everyone agrees on the significance. It is a real-time data series from a good source. I follow it closely, and the story has not been good.
- Housing, by any measure, remains very poor. Even a flat housing market would end the drag of more than 1% on GDP. A real turnaround would be better. I am not expecting any immediate good news. The New York Times wrote about negative sentiment among home builders, featuring interviews from my area. Calculated Risk explains how this is related to distressed sales. For an excellent comprehensive overview of the housing situation, I strongly recommend John Lounsbury's We Could be Near a Housing Bottom. My own conclusion from the data presented was that the bottom still seems elusive, but please read and draw own conclusions.
The US debt story gets this week's "ugly" award. The S&P decided to announce a negative outlook for US debt. This led to a curious divergence in the reactions of various markets. The ugly reaction came from stocks. I covered this pretty thoroughly, so read my earlier piece if you missed it.
The debt story will continue with the political focus on the debt limit and whether it will be raised.
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. We shifted from our neutral posture to bullish last week, and we continue that posture in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. This is based on improved ratings in the various index ETFs, as well as the general trend. Here is what we see:
- 61% of our 56 ETF's have a positive rating, down significantly from 86% last week. This is a big break in the recent trend.
- Only 46% of our 56 sectors are in our "penalty box," down from 61% last week. This is an indication of moderate short-term risk, and the picture is improving.
- Our universe has a median strength of only +6, down significantly from +30 last week.
The overall picture weakened last week. We are still 100% invested in trading accounts, since there are many attractive sectors.
[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 ETF 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 will be housing data, but no one is expecting much there. The earnings news will be important, with a continuing skeptical look at each company. Please see here for the checklist of concerns you should watch.
One feature of the Bernanke press conference will be a discussion of the official forecast. To prepare, you might want a scorecard of how the forecast has changed over time. I was going to do one, but I see that Calculated Risk has already done the work, so go there and print the article:)
I look at the Big Four when taking a long view:
- Expected earnings from stocks versus alternative investments: Highly Positive
- Economic Trends: Highly positive
- Risk: Moderate to low
- Worries: Elevated and widely publicized
For each of these I try to use objective measures, avoiding emotion. Having said this, I do not see a rush to go "all in." For new long-term accounts I am buying 50% right away in the names we love and waiting for dips for additional buys.
The time frame and your own needs are most important in your investment decisions.
The Week Ahead: Hype About the End of QE2 in Overblown by Jeff Miller
We Could be Near a Housing Bottom by John Lounsbury (Seeking Alpha)
Gundlach: Treasuries will Rally When QE2 Ends by Robert Huebscher
Why Mid-Caps? by Ridgeworth Investments