April 22nd, 2012
by Jeff Miller
Get ready for a week of renewed focus on the Fed. No one expects a policy change, but there is plenty of room for disappointment.
In the new era of Fed communications there will be plenty to analyze, including the following:
- The FOMC statement, which can be carefully parsed for small wording changes and evidence of disagreement or dissent;
- The updated economic outlook;
- Updated projections from each FOMC member, with a report showing ranges and central tendencies;
- A press conference where Bernanke will try to explain it all.
In the old days, when no one expected a policy change, there would be no reason for fixation on the Fed. There is now much more to analyze.
I'll offer my ideas on what to expect in the conclusion. First, let us do our regular review of last week's news and data.
Background on "Weighing the Week Ahead"
There are many good sources for a comprehensive weekly review. I single out what will be most important in the coming week. My theme is an expert guess about 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
Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:
- The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
- It is better than expectations.
The general economic data continues to be a little soft, while earnings have been very good.
- Building permits show solid growth. In my experience this is the best leading indicator. Steven Hansen does a nice job on this indicator, which the ECRI should probably consider including instead of housing measures obfuscated by foreclosures.
- Earnings reports are very good so far, via Bespoke Investment Group. As you look at this, please keep in mind that many claimed that earnings estimates were too high and should be moved lower.
- Earnings and revenues. One of my pet peeves is a general lack of accountability on earnings expectations. Remember when the earnings rebound started? Here is Dr. Ed Yardeni's account:
"When the bull market first started in 2009, the bears growled that the rebound in earnings was all attributable to cost cutting. So it wasn’t sustainable, in their opinion. They didn’t believe, and couldn’t imagine, that revenues might actually have a normal recovery too. I track three measures of business revenues, which are all at record highs now."
- Rail traffic was solid if you ignore coal. Steven Hansen at GEI has been doing a great job with this series. This table tells the story -- solid except for coal.
- Too much focus on the trees -- and neglecting the forest. We should all keep in mind the overall picture coming from creativity and innovation --- via Abnormal Returns and Barry Ritholtz.
The economic news was disappointing, with everything a touch worse than expected. If the list is not enough for you, check out a source that even sees employment growth as bad (via Todd Sullivan).
- Initial jobless claims moved higher, to 387K and revisions were also higher. The times include the final week for the April employment report. While many observers opine that this will be better when the unusual seasonal factors are resolved, I continue to be concerned about the jobs numbers in two weeks.
- The Philly Fed was a bit light at 8.5 versus expectations in the 10 range and 12.5 last month.
- Assorted political salvos. I hardly know where to start. Each party is proposing legislation that has no chance of passage. The GOP has a choke point in the House and also preventing 60 votes (required to block a filibuster) in the Senate. The President can veto any bill and the GOP has no chance of a 2/3 vote to override. I have a long list of links from last week, but I think it is better handled as a separate article. Let us just say that political debate is descending to the lowest common denominator (see here for examples). Jeb Bush warns to expect the most negative campaign ever.
- Vehicle traffic has moved lower, especially with an adjustment for population. This is an interesting and creative indicator from Doug Short.
- European debt continues to be worrisome. While the scheduled auctions met sales targets, the rates are high, so I am putting this in the "bad news" category. The Spanish 10-year note was trading at the 6% level and the Italian equivalent at about 5.5%. I monitor these daily. While I still believe in a broad compromise settlement involving many parties, there is obviously an attack in the CDS market. I encourage readers to check out Cam Hui's commentary. I invite other recommendations for good sources in the comments.
This week's Ugly award goes to the stock-picking robot -- ready to help you find instant gains in penny stocks. The economic and investment losses have created a new level of desperation. There is a dramatic increase in both perpetrators and victims.
The robot team had a business model that profited in all of the key ways:
- Selling bogus software to clients. The software developers were told that the program needed to appear to be analyzing data, but actually taking direction from the scammers.
- Selling pump-and-dump services to companies. Results guaranteed.
- Front-running the suckers.
This is a constant battle. I want to give credit to the SEC, but it is frustrating. I have reported a number of obvious scams. The SEC does not let you know what happened. They do not even acknowledge your contribution. Two groups that I reported were the subject of later action, but some are still at large.
The Indicator Snapshot
It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:
- The St. Louis Financial Stress Index.
- The key measures from our "Felix" ETF model.
- An updated analysis of recession probability.
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.
The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread." I'll explain more about the C-Score soon. Bob also has a group of coincident indicators. Like most of the top recession forecasters, he uses these to confirm the long-term prediction. These indicators are not close to a recession signal. For his subscribers, he offers the following conclusion:
"I now find myself in statistical opposition to all those who are calling for a cycle peak in 2012. I use the “statistical” qualifier in that sentence because after doing this for more years than I care to admit, one has to be cognizant of the fact that strange things can happen. So it is possible, but highly improbable, that the conditions associated with a cycle peak could present themselves before we “turn the page” on 2012."
Bob has his usual exhaustive analysis with many charts. His analysis is erudite, comprehensive, entertaining, and witty. Here is a single chart summary, but you should understand that all show the same thing.
I am a big fan of Dwaine van Vuuren, whose excellent statistical work is giving us better insight into a wide range of recession forecasting methods. The data point that I cite each week (the four-month recession outlook) is only one aspect of a comprehensive report. The SuperIndex includes nine different methods, including the ECRI. The analysis has a very strong, practical market application which has paid off richly for subscribers over the last few months. How? Mostly by putting the ECRI recession forecast into better perspective. I am publishing the one-month delayed Leading SuperIndex estimate of recession probability in the near future -- three or four months. This is plenty of time to have value for public followers of their reports.
Two weeks ago they added another interesting recession indicator, finding states that show economic changes in advance of the nation. You will be surprised at which states are the "canaries in the coal mine."
Last week Dwaine teamed with Georg Vrba to analyze the unemployment rate as a recession indicator. It turns out that this single measure has terrific results. It currently suggests, "One can therefore reasonably conclude, based on the historic evidence of these unemployment-based indicators, that there will be no recession in the near future and that ECRI’s recession call may have been premature."
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. This week we shifted from bearish back to neutral. The last several weeks have been pretty close calls. The ratings have improved a bit. The inverse ETFs are no longer at the top of the list, so I would not be surprised to see a little buying next 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. For daily ETF commentary from Felix, you can sign up for Wall Street All-Stars, where I still have a few discounted memberships available. You can also write personally to me with questions or comments, and I'll do my best to answer.]
The Week Ahead
While I expect the Fed to be the main story this week, there will be plenty of other action.
Before the trading week even starts, we will have the first round of the French elections. Normally this would not be a major consideration for US stocks, but this time is different. A loss by incumbent Sarkozy could lead to dramatically changed policies for France, with other countries in line. This could affect the euro, the European economy, and also US stocks. ThisWashington Post summary lays it out nicely. That will be Monday's story.
I am interested in Consumer Confidence (Tuesday) and Initial jobless claims (Thursday) as important coincident reads on the economy. Q1 GDP -- the first reading -- will be reported on Friday, presumably confirming that the economy weakened a bit but was not close to a recession.
This is the big week for housing data, including Case-Shiller prices, FHFA prices, new home sales, and pending home sales. Housing is important, of course, and some see signs of improvement. I am not expecting much from these reports.
It is also a big week for earnings reports. It could well be an exciting week.
And finally -- Tuesday will give us the BLS Business Dynamics Report. This is the one that shows whether the employment estimates from 8 months ago were accurate. Everyone should be watching this, but I will probably be the only one reporting!
Trading Time Frame
We were out of the market last week in trading accounts, after a long period when Felix caught the rally pretty well.
The current market has been confusing to many top professionals, as I reported last week in this article featuring commentary from Art Cashin.
Investor Time Frame
For investment accounts I have been buying on dips in stocks that we like. I tried to explain the most important concept for individual investors in this article about the Wall of Worry. I have had many emails from people who had a personal breakthrough in their investing when they understood this concept. If you missed it, I urge you to take a look.
Investors should not be trying to guess the next market move. Instead, take what the market is giving you. I have been offering this advice for months, and it led to a great quarter for anyone taking heed.
If you are an investor who has been frustrated by a market that ground relentlessly higher, providing no opportunity for entry ---- well--- what are you waiting for now?
I want to emphasize that being an investor does not mean "buy-and-hold" or a "forever" portfolio. I believe in active management of investment accounts, adjusting for changed circumstances. We need to look beyond the headlines, political commentary, and those profiting from the climate of fear.
There is an important difference between short-term market timing and active management of your holdings.
I look at the following:
- Recession risk -- now very low.
- Earnings growth -- excellent and undervalued.
- Financial stress -- high on the headlines, but modest on the data, falling rapidly.
If you are really worried, you can imitate our enhanced yield program. Buy good dividend stocks and sell short-term calls. I am targeting 8-9% returns on this approach, and achieving it no matter what the market is doing. You can, too.
Final Thoughts on the Fed
When I put on my trader hat, focusing on the attitudes of those on the front lines, I know what is important.
Traders want more of that QE!
The trading perspective is that the economy is weak and the Fed does not get it. Traders -- and therefore the "market" in the short term -- want to see the Fed doing more. At the most fundamental level there is no need for a deep explanation. The last two years show a pattern which (to a very forgiving eye) seems to show a market that rises when the Fed is active and declines when it is not.
While I disagree with this interpretation, success in trading means understanding the perspective of everyone else. The Fed policy has had much less impact than traders believe. Here is a helpful chart from Doug Short.
For investors, more twisting is not a big deal. For traders, it is.
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.