December 26th, 2011
by Jeff Miller
As noted last week I plan to focus on year-end matters, as well as enjoying time with family and friends. This is a somewhat abbreviated version of the regular weekly update. I want to provide continuity on the indicator updates, as well as capture important events in real time.
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. Do not be bashful. Join in and comment about what we should expect in the days ahead. 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
The economic data was mixed, but the most important were positive. Initial jobless claims continued the downward trend, covering the period that will be part of the monthly employment survey. GDP was revised lower, but the third quarter now seems like ancient history. Personal income and spending were weaker than the recent trend.
There was great coverage of these stories from my favorite sources, and I'll get back to highlighting that in two weeks.
Europe remains the big story, dominating everything else. This is the single most important thing to understand, for both traders and investors. It might start to be a case of the "dog not barking" for those who know their Sherlock Holmes. In the absence of fresh bad news, the market seems to have an upward tilt.
There was a developing story this week that is still given short shrift by many observers: the recognition that the European "solution" will be incremental in nature. Regular readers know that I have been a lonely advocate for this position for many months (as noted in this new summary of articles). I forecast that there will be no magic bullet and no single meeting with a comprehensive plan. I anticipate that we will observe a gradual process of compromise and negotiation. Eventually this will include many programs and participants. The result will be messy and will not please everyone. My time frame for general recognition that this is "working" is mid-2o12. I put "working" in quotes because the underlying problems will linger for years after the situation is no longer viewed as a crisis.
This type of policymaking is viewed disparagingly by the current market punditry. It is actually a classic and respected approach, dating back toCharles Lindblom's 1959 article, The Science of Muddling Through.
This week there were several new members in what I am going to call the "Lindblom Club."
- Mark Mobius says that the Euro crisis could be over by June and that it is easier because the UK will not be involved. There were widely publicized articles quoting Mobius as predicting a disaster from derivatives. Joe Kernen does a nice job, going right to the heart of the story with his questions. The entire video is worth watching.
- Joe Weisenthal asks whether the crisis might not already be over?
- Doug Kass, also giving credit to Steve Liesman, writes as follows:
Despite the anxiety in the markets and the downside risk to the world's economic growth entwined in the European debt crisis, I remain of the view that a credible plan to stem the debt crisis in Europe has just begun and that European and global leaders and central bankers will all come to their senses and intervene in a massive way.
I expect more members in the Lindblom Club as the weeks go by. There may never be a magic moment, but the story will gradually shift.
The Indicator Snapshot
It is important to keep the weekly news in perspective. My weekly indicator snapshot includes important summary indicators:
- An Economic/Recession Indicator. I am evaluating several candidates. None confirm the ECRI forecast of an inevitable and imminent recession. These are sources that have a similar track record, greater transparency, but less PR. I realize that I am (long) overdue for making the choice for a new indicator. It has been a careful research process, and I expect the explanation to require multiple articles. Meanwhile, if something really bad were taking place, I would make it clear in the weekly updates. From the strongest candidates, I see the recession odds over the next nine months as being less than 25%.
- The St. Louis Financial Stress Index.
- The key measures from our "Felix" ETF model.
The SLFSI reports with a one-week lag. This means that the reported values do not include last week's market action. The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect. Weidentified a reading of 1.1 or higher as a place to consider reducing positions.
Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. We voted "Bullish" this week.
[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 are few important reports this week. I am mostly interested in initial jobless claims and the Chicago purchasing managers index (as a hint about the ISM report). For anyone who is interested in real-time commentary on these reports you can check out my new "investment diary" at the Wall Street All-Stars site. Some readers informed me that there was some kind of hacker attack leading to a virus warning. The team there has cleaned up the problem, so please check it out again.
Trading Time Frame
Our trading accounts were fully invested last week, starting with a partial position on Monday afternoon. Before that Felix had high ratings, but also high uncertainty which relegated everything to the penalty box. As I predicted in last week's update, this led to new trading positions and we were fully invested by Wednesday. This program has a three-week time horizon for initial purchases, but we run the model every day and change positions when indicated.
Investor Time Frame
Long-term investors should continue to watch the SLFSI. Even for those of us who see many attractive stocks, it is important to pay attention to risk. In early October we reduced position sizes because of the elevated SLFSI. The index has now pulled back out of our "trigger range," but it is still high. For investors desiring this risk management approach we raised cash when the trigger hit the range. We have also been cautious with new accounts. We still do not have an "all clear" signal, but I expect the SLFSI to decline next week.
Our Dynamic Asset Allocation model maintains a very conservative posture, featuring bonds and other defensive holdings.
To summarize, we have a very conservative approach in most of our programs, recognizing the uncertainty and volatility. For new accounts we are establishing partial positions, using volatility to buy favored names and selling calls for those in our Enhanced Yield program.
Take what the market is giving you.
[Interested readers can get information which you can use for your own investing and/or consider us for some help -- our approach to limiting risk, coaxing out more yield, and exploiting the current opportunities. This includes a description of how to do a year-end tuneup. Write to main at newarc dot com -- no charge, no obligation, and respect for your email privacy.]
Repeating my prediction from last week:
- Trading volume will be lower
- There will be less political activity and speech-making
The reduced volume sometimes exacerbates big moves, so I make no guesses about volatility.
A Final Investment Thought
When I talk with individual investors, most of them are struggling with headline risk. They also are bombarded with stories about how the market is overvalued, earnings estimates are wrong, and the world is in a permanent state of disarray, led by poor leadership everywhere.
As someone who lived through Nixon, Vietnam, a cold war where nuclear destruction was a daily possibility, interest rates in the high double-digits, and many other challenges, I am shaking my head in disbelief.
By my standards, the world is a better and safer place. Opportunities are greater in both work and entertainment. The potential for personal productivity is huge. The comical Washington scene is no worse than it has ever been. Hasn't anyone ever heard of Will Rogers?
"A fool and his money are soon elected."
....and too many others to count. This is nothing new.
What has changed is the way we observe and parse news, and the link between that and our investment decisions. If you want to read one thing during the holidays, check out this article by Chuck Carnevale, who shares my relentless focus on fundamentals. While the article provides a nice uplifting message, it also includes a shopping list of 100 cheap stocks -- a nice Christmas gift from Chuck.
Here are the first ten (alphabetical) stocks on the list, just to illustrate the valuable information in the table.
I own two of these names for different programs (ABT and AFL) and many others from the rest of the list.
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.