October 4th, 2011
by Jeff Miller
Few would question the importance of improving employment prospects, especially given the fragile state of the recovery.
Employment is also important on the political front, but for those facing election, the extra dimension of claiming credit intrudes. The result? Little has happened since last month's employment report.
The housing and employment gloom has been a multi-year negative backdrop. There is a huge disparity between perceptions and actual data. The average person does not care about official recession definitions, hates the political leadership from both parties, and is perfectly willing to accept confirming information, whatever the source.
There is a disparity between perceptions and reality. Daniel Indiviglio's nice article in The Atlantic does a careful job of reviewing the improved economic data, mostly ignored by the public and pundits alike. Here at "A Dash" we have documented a continuing picture of sluggish growth which still continues to generate strong corporate earnings.
The U.S. may not be in a double dip yet, but Americans sure think it is. Although August was another extremely weak month for the recovery, the big drop in consumer and business sentiment didn't match the economy's essentially sideways movement during the month. While the picture looked pretty gloomy in August, it still appeared better than in June.
I'll return to this theme below, but first let us do our regular review of last week's data and 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 reversal from last week, the stock market was terrible in spite of news that was pretty good.
Good news was apparent on several significant fronts.
- Progress in Europe. It is there, but mostly unrecognized. Because traders and the market punditry know little about public policymaking they make beginner blunders. They expect instant solutions and magic bullets. Perhaps because they make trading decisions in a few seconds, they do not understand the painful process of negotiation and compromise. As I accurately predicted, the most recent European suggestions would be ripped apart by those who have no ability to recognize a solution. The final European plan will be a combination of many factors, which I describe. Reality check: Remember all of the worry about Finland? Cross that off. German Parliament? Solid vote. Inadequate resources? A work in progress....There are a lot of instant experts who cannot find these countries on a map. Beware and be focused.
- Initial jobless claims moved sharply lower. The BLS warned that there were some problems with seasonal adjustment. The result looks very good, even on the unadjusted data. We'll know more next week, of course. For an excellent discussion of this series and the seasonal factors, check out Doug Short, who explains why seasonal adjustments are necessary, but also offers an alternative approach.
- The Chicago PMI was quite strong -- over 60. The other regional indicators have also been better than expected but the Chicago PMI has the best correlation with the national ISM.
- No government shutdown -- as I assured you last week. We now have a week or so until the next threat. Sheesh!
- New home sales look better -- via Steven Hansen. Eschewing the questionable seasonal adjustments in this noisy series, he sees some small but promising developments. Here is the interesting chart:
This is one of the few bright signs in housing.
There were also some negative events.
- The ECRI announced that a recession is now inevitable. In addition, it will be really bad, leading to larger budget deficits. There is nothing that can be done to stop it. While ECRI has been warning of slower growth, this was a dramatic announcement, featuring a media blitz. This comes in spite of little change in the public series and last week's revisions of past data. This was a big story, although clients obviously knew earlier in the week. Abnormal Returns has good coverage, Doug Short has the customary great charts, and I had my own story later in the day.
- China's PMI was better than expected but still contractionary. Credit default swaps traded higher. The CDS market in everything has been getting plenty of attention, despite many questions about volume and liquidity. Lisa Pollack at the FT has an excellent articleon the basics of the Chinese CDS market, something that is being used as an all-purpose hedge. You need to know about this.
- M2 growth has stalled, although it is still up big on a year-over-year basis. This stimulus in the pipeline should not be ignored.
- Action on the Jobs Bill is stalled in the Senate. Is it the Tea Party versus Obama? No. Senate Majority Leader Harry Reid, a fellow Democrat, is holding the bill hostage until the Senate can pound on the Chinese for currency manipulation, a bill that Obama does not support. Democrats know that the general public loves anti-China rhetoric, and they want to vote on this one. Meanwhile, the jobs plan does not have the needed votes in the Senate - yet.
- Consumer confidence remains terrible. I view this as a combination of the employment picture, housing, gas prices, and general reaction to Washington. It is the indicator that I think is most worrisome. You can see why from this excellent chart from Doug Short, clearly showing the economic relationship and recession risk. We could certainly use some inspirational leadership.
Are you looking for an example of extreme market sentiment? Something like one of those magazine covers that provide wonderful contrarian indicators?
How about the BBC's embrace of some minor, unknown trader, who explained how the smart money knows all, Goldman Sachs is in charge, and it will all end in disaster. Here is John Dvoark's take:
It’s not as if Rastani’s necessarily wrong, but whether these actually are his ideas, who knows? He has no known standing, no books, no background. Oh wait: He does have a blog.
I guess that is good enough for the BBC.
I’m not actually sure how the network found him, but let me say that booking TV shows is a bitch. People cannot make it at the exact time; people are busy with a real job. There is no nearby studio for a satellite feed. There’s always something, so you take what you can get.
So I was thinking about this guy and realized what is missing from the pundit scene. I’d like to see what TV network will bite the bullet and employ a guy with a bag on his head: The Unknown Analyst!
Felix Salmon explores whether the whole thing was a hoax, along with the psychology that makes everyone susceptible to these stories.
This story got a lot of undeserved attention, including from the non-financial media. The theme resonates. Quite frankly, the stories on the more cerebral shows are not that different. Last weekend's "This Week" on ABC featured a stacked and gloomy group discussing Europe and "what it means to your 401K." One panelist, a featured mainstream writer, was talking about a 40% decline in the European economy. It was irresponsible, but I do not think it was intentional.
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 is edging higher, closer to my pre-determined risk alarm. This is partly the result of the VIX. Another rising element is LIBOR. The increase here (according to one of my expert sources) may be an unanticipated consequence of the Fed's Operation Twist. The SLFSI is still not signalling the major calamity that many deem a foregone conclusion, but it is moving higher.
There will soon be at least one new indicator, and the current choices are under review. Meanwhile, the ECRI has a "long leading" series that is available only to subscribers, which they refer to in media appearances.
The Week Ahead
It is a big week for economic data.
The most important news will by Friday's employment report. I am not expecting a strong result. This week's improvement in initial claims occurred after the survey period for the jobs report. The ADP private employment report on Wednesday will be an early indicator for this.
Initial jobless claims will help to clarify whether last week's improvement was mostly the seasonal adjustment or a real improvement.
The ISM index on Monday will be closely watched, and provides an early signal on employment. ISM services on Wednesday is also of interest.
While the Europe story will have more events next week, we can expect continuing news and opinion.
The Bonddad Blog, highlights auto sales as especially important in light of the ECRI conclusion (where they also have some reservations).
Trading Time Frame
In trading accounts we were 20% short all week with a similar position in gold stocks via GDX.We still have a bearish vote on the market with a three-week time horizon. Nearly all of our ETF positions are in the Penalty Box, meaning that confidence in forecasts is low for us. It should be for you as well!
As part of our technical take we always check out Charles Kirk's weekly chart show. It is usually posted on Sunday, but it is already up for this week. (There is a small annual subscription fee -- well worth it). Whether you are trading or adjusting positions, it is helpful to understand the current market dynamics and what you should be watching.
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. It is conservative, but has no short positions at this time.
Long-term investors should buy and maintain core holdings of an appropriate size. This does not mean "buy and hold." I recommend an actively managed portfolio, adjusted with conditions, but one that includes stocks. The mid-year selling has tested the resolve of many investors. It is one thing to state a risk tolerance and another matter to watch it in action. Investors who are staying the course have "right-sized" their positions and maintained confidence in their methods. There are many stocks that are attractive on an earnings or dividend basis, despite all of the fear.
In this article, I offered some suggestions on how the long term investor can take advantage of volatility.
Some Thoughts on Recession Forecasts
When I did last week's commentary I did not know that the ECRI was about to announce a new recession. Keeping that in mind, my growing concern about their data was pretty well timed. Here is what I wrote:
I am still doing a careful analysis of recession forecasting methods. What if we had a method that had multi-decade accuracy in real time? Not something that someone conjured up later, but a method that was in the public domain and actually used.
The fascination with the ECRI data series is interesting. Big-time economists make forecasts based on this series with no knowledge of the composition --- even when warned that the "better series" is not published.
Suppose that we had access to a method that was just as good or better as the ECRI on past data, but we also knew the components.
The advantage would be transparency. That is also the disadvantage, since whichever spinmeisters did not like the outcome could criticize the indicators, something that no one can do with the ECRI.
Friday's events highlighted my concerns. We have all been monitoring the WLI series. It has been weak, but not as bad as last year. Now we learn that it really has no bearing on the recession forecast.
I really do not see the point in tracking a black-box indicator that has no meaningful interpretation by its consumers. Last week I invited readers to nominate other economic cycle indicators. I may choose to include more than one. Here are three current leading candidates:
- Robert F. Dieli's Mr. Model. I have been tracking this for months. You can see the key chart and my analysis here or download the most recent report here.
- Mike Dueker's Business Cycle Index. Thanks to reader RB (and some others) for suggesting this.
- Steven Hansen and the Econinteresect Economic Index (EEI). This approach emphasizes recent data as part of a "new normal" hypothesis. I am watching this closely, and you should, too.
The nominations are still open! Check out this article to understand how and why you should make choices on indicators like this.
The Week Ahead: Is a Recession Likely? by Jeff Miller
New Home Sales Continue Improvement in August 2011 by Steven Hansen
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.