September 5th, 2011
by Jeff Miller
Last week was all about data. Next week will be about government, in the US and around the world. Get ready for an avalanche of speeches -- from assorted Fed members, the debate of the GOP candidates, and the President.
Follow up:I'll suggest what this means for investors in the conclusion, but first let's take our regular look at last week's events.
Background on "Weighing the Week Ahead"
There are many good sources for a comprehensive weekly review. My mission is different. I single out what will be most important in the coming week. 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.
Unlike my other articles at "A Dash" I am not trying to develop a focused, logical argument with supporting data on a single theme. I am sharing conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am trying to put the news in context.
Readers often disagree with my conclusions. (A commenter recently suggested that was proof that I was wrong -- an amazing interpretation!) Do not be bashful. Join in and comment about what we should expect. 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 feel free to disagree. That is what makes a market!
Last Week's Data
In a big week for data, the sluggish growth story still prevails. Calculated Risk has an interesting take on the data, suggesting that the early August numbers were worse than those reported later. It is something to think about.
There were a few bright spots. In each case there is a spin campaign to explain why the data are different "this time." As regular readers of "A Dash" know, I prefer taking the data at face value. If you are going to question a current data point, you need to go back over the entire series and ask the same question. If you are unwilling to do that work, you are just torturing the data, as I explained here.
- Personal consumption was up 0.8%, handily beating expectations. Some observers noted that the increase was less without transfer payments. D'oh? Is this news? Transfer payments are part of the social safety net. Nothing new there. One of the most inaccurate forecasts of the punditry has been the collapse of consumer spending. Another widely ignored factor is the underground economy. Personally, I see a lot of cash business, sometimes involving those who may also be collecting benefits. As taxpayers we do not like this, but our mission here is to think as investors.
- Initial jobless claims declined a bit, still in the 400K range. This is still not what we need, but it is better than recent levels and much better than many were forecasting a few weeks ago. It is neither a recessionary level, nor a sign of robust growth.
- The money supply rebound continues. This is a major forward-looking indicator that is widely ignored. It is a leading indicator, giving it extra significance. I have been writing about this for several weeks. There is finally some commentary, centering on the idea that M2 growth reflects panic and a desire for cash. Putting aside the complete lack of correlation between M2 growth and any measure of panic, you might expect panic to show up in brokerage accounts (MZM), bond purchases, or gold purchases rather than M2. This is another example of where some are willing to throw out the entire body of Milton Friedman's work because they think that "this time is different." Do such pundits really believe that there were no other "panics" in the history of the M2 series? My advice is to ignore cheaters who spin current data without reviewing the entire series. Anyone who wants to look seriously at the question might start with this piece from Bryan Caplan (one of our featured authors).
- Bank lending is higher -- although excess reserves are still very high (HT featured source Scott Grannis).
- Projected auto sales are on target according to GM -- sticking to the overall annual US sales forecast of 13 to 13.5 million. This helps to explain PCE and also why the midwest manufacturing readings are better than those from the East coast.
- Home prices show some stability. The Case-Shiller data are not exciting, and no one really expects an imminent housing rebound. Having said this, we should be alive to the possibility that some stability is possible. The Bonddad blog notes such stability in the last five months from this series.
- Dividends are soaring. The increase is projected to be up 18% over last year.
There was some important negative news.
- Greek debt yields spiked as new payment fears arose. How about nearly 50% on a two-year obligation?
- Consumer Confidence plunged. This in line with the Michigan survey, and an important factor for future spending.
- The ECRI growth index dropped further into negative territory. The ECRI warns against over-reacting without a persistent change in this indicator, but we are watching with interest. They have not yet suggested an official recession forecast, sticking with the story of the lower global growth that they first talked about in May.
- The ISM index continued the decline. The report was actually a bit better than expected and consistent with the rest of the slow-growth data, but the decline is still worrisome. Check out Steven Hansen's look inside the numbers.
Everyone knows that jobs are the most important feature of economic recovery. The zero net growth from Friday's employment situation report puts an exclamation point on our economic problems. Everyone knows this is a crucial problem, and must be a focus for economic policymakers.
Steven Hansen does a nice job with the employment data, highlighting the relevance of job growth in determining recession benchmarks.
I am especially disturbed by the massive unemployment rate among blacks. This is 16.7%, double the rate for whites.
The Indicator Snapshot
It is important to keep the weekly news in perspective. My weekly indicator snapshot includes important summary indicators:
- The ECRI Weekly Leading Index and the derivative Growth Index
- The St. Louis Fed Stress Index
- The key measures from our "Felix" ETF model.
As I have often noted in the past, the ECRI and the SLFSI report with a one-week lag. This means that the reported values do not include last week's market action. In my research, I take account of this lag. In my daily monitoring of the market I look at the underlying elements in the SLFSI. I cannot do this with reliability for the ECRI since the indicators are secret. The SLFSI will increase next week, but not to the level that would trigger the "risk alarm."
There will soon be at least one new indicator, and the current choices are under review. In particular, I am considering replacing the ECRI method with the equally effective and more transparent approach from Bob Dieli. The ECRI has a "long leading" series that is available only to subscribers, which they refer to in media appearances.
The indicators show continuing sluggish economic growth, but the rate of growth continues to get weaker. Three weeks ago there was an increase in the SLFSI, generated by a slight increase in LIBOR rates and a big jump in the VIX. The SLFSI increased a bit this week. I have been doing extensive research on this indicator. It was not designed to predict the stock market. It is a reflection of financial risk, based upon what happened in past crises. I believe that it will prove valuable as a tool for investors who prefer data to story telling. This article helps to explain how to interpret the values and also provides historical context.
Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. We have a long public record for these positions.
While we voted "neutral" this week, Felix now recommends some buying.
[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
Tuesday brings the ISM non-manufacturing index, which will get attention. Everyone will watch Thursday's initial jobless claims to see if there is movement from the 400K level of recent weeks. Wednesday's beige book release will give a glimpse at the regional evidence the FOMC will consider at the September meeting, but everyone already expects them to focus on jobs.
The real news will be a parade of speeches from multiple Fed heads, the Republican candidate debate, and President Obama (who is doing the Packer pre-game this week). I expect the Fed speeches to reflect concern about jobs and the GOP debate to do the same. The problem is that the two will be from polar opposites!
President Obama will offer a collection of "obvious" programs to continue, some targeted employment ideas, and a few tax cuts that will tempt a little GOP support. Meanwhile, the GOP candidates are competing for the nomination, causing them to appeal to the conservative elements of the party -- those who vote in primary elections, especially Iowa and New Hampshire. The speech is a work in progress. I'll watch the Sunday news shows for hints tomorrow, and we will start the week with reactions to the stream of trial balloons. Whatever you think of Obama, we should expect a tough audience for this speech. It is a highly-charged, partisan environment. In the absence of an agreed common enemy, leadership is difficult. Unemployment as a common enemy would be a good theme for the speech.
Mark Gongloff at the WSJ has his customary helpful preview of the coming week, showing all of the speeches as well as economic releases and earnings.
Vincent Cignarella of the WSJ highlights the European news, which he expects to be negative. You can see the entire calendar for various European parliaments, the one-day general strike in Italy, the German Constitutional Court, and the ECB.
Trading Time Frame
In trading accounts we got back into the market last week. Our Felix model is not calling a market bottom, but (to my surprise) is now finding a few ETFs to buy. The trading position is changing very frequently. Meanwhile, the official posture is "neutral."
Investor Time Frame
In our ETF-based Dynamic Asset Allocation program, the portfolio remains very conservative. This cautionary posture includes bonds, gold ETFs, and utilities. The DAA now also includes one inverse ETF, and might add more if adverse conditions persist.
For long-term investors little has changed. The market is pricing in a high level of systemic risk and recession potential, even though these outcomes are not suggested by quantitative indicators. I am thinking about this from three different perspectives. (I remind readers that I cannot write a Master's thesis on each topic. These are my conclusions, usually supported by prior articles and data).
Recession Potential. I spent a lot of time this week writing on the topic of basic investor education. If an investor really wants to make good decisions, he/she needs to be able to interpret data. I strongly recommend that you take advantage of my mini-course on analyzing data. If it seems confusing, you have learned something important. You will have a good BS meter for bogus claims!! Right now you can find recession forecasts ranging from 100% to 0%. Bob Dieli's work has been accurate for decades. He has graciously agreed to provide a free link to his most recent report, where he writes as follows:
As I said last month, we are going to have another recession, but not today.
To clarify this point, here is what he said last month after the payroll report:
Those of you looking for evidence of the onset of a new recession should start by looking at this chart. As you can see the signature move of recessions is steady declines in private payroll employment. Which are not happening now. Unless, of course, you want to change the definition of a recession.
Look at Chart 8 on the link.
His overall model also does not signal an imminent recession. My own conclusion, from many sources, is that we remain in a period of sluggish growth with increased recession risk if there is an external shock.
2008 Potential. Investors constantly ask if this can be another 2008. I ask the question each day, and it is the reason for studying the SLFSI. At the moment I see few similarities. The crucial point is whether European banks will fail and the counter-party risk for US institutions. Readers have asked me to elaborate, and I will try to do so. Meanwhile, you might start with this nice take from a new blogger, Crackerjack Finance, who lists six good reasons why 2011 is not 2008. I am enjoying my reading of this anonymous young blogger, who impresses me as having useful knowledge. I hope he keeps writing. For those who prefer a veteran observer, I note that Ron Baron's comments are aligned with Crackerjack.
Valuation. Count me among those who believe that the market has already priced in a healthy recession, even before it has happened.
I am not trying to predicted stock prices in the next few weeks, but I like the prospects for the next year.
Investing Blog articles by Jeff Miller
About the Author
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 he 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.