June 4th, 2012
by Jeff Miller
Last week's employment report has dominated the business, financial, and political news over the weekend. With no action expected from Congress, attention will focus on the Fed. Since Chairman Bernanke will testify before the Congressional Joint Economic Committee on Thursday, we will soon have an update on Fed thinking.
Mark Thoma raises the policy question and provides helpful context.
Background on "Weighing the Week Ahead"
There are many good sources for a list of upcoming events. With foreign markets setting the tone for US trading on many days, I especially like the comprehensive calendar from Forexpros. There is also helpful descriptive and historical information on each item.
In contrast, I highlight a smaller group of events. 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.
This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting 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 US economic data last week was mostly negative, especially on the most important theme -- jobs. There was a little good news.
- Rail traffic points to continued growth (via Cullen Roche).
- ISM Manufacturing remains solid. I know that the report was slightly below expectations, but the internal elements were good (via Bespoke) and the overall reading (according to ISM) is consistent with a GDP growth of 3.7%. Some readers have questioned this. I am simply quoting the ISM report, but I note that my friend Michael Lewis is quoted in Barron's saying that it corresponds to growth of 2.5%, which seems more plausible. I am investigating further. Either way, this is a small ray of sunshine in an otherwise negative week. There is good overall analysis and this chart from Calculated Risk:
- Gas prices are lower, which will help consumer spending. See Doug Short for analysis and chart.
- Labor force participation increased, as did new jobs as measured by the household survey. This complexity is part of the pundit's paradise for spinning. Bob McTeer puts it well:
"In the household survey, which contains such statistics, the number of employed people increased by 422,000, far above the highly-advertised 69,000 in the establishment survey and quite a good number. The civilian labor force, however, actually increased by 642, 000, causing the increase in the unemployment rate from 8.1 percent to 8.2 percent. We’ve been qualifying recent drops in the unemployment rate as being aided by a declining labor force. To be fair we should acknowledge that the reversal of that is actually good news and masked a substantial increase in employment as measured by the household survey."
There was plenty of bad news on the economic data front, especially the most important news.
- The chance for "technical" selling. The S&P 500 crossed below the 200-day moving average, a popular market-timing method. Mark Hulbert thinks that there might be an avalanche of sell orders on Monday. As I write this on Sunday night, futures trading shows a decline of about .75% at the opening. See Josh Brown's analysis of the pros and cons, along with a great chart.
- Consumer confidence shows a big decline. This is the Conference Board version, which is usually in step with the Michigan version, but not this month. Doug Short has a typically great chart that shows how far below trend (and how close to recession levels) the current reading is.
- Q1 GDP was revised lower. I am scoring this as a negative, since that was the market reaction. It was a superficial look, since the most important elements were actually better. The topic is too complicated for the weekly article, so I will put it on the agenda. Start here for the basic idea, but this is just a start.
- No news from Europe. In this case, no news is bad news. While there are continuing stories on the themes I have mentioned in past articles (Eurozone deposit insurance, more powers for the ESM) the hardball negotiations with Germany continue. Germany wants serious concessions of sovereignty over finances in exchange for more guarantees. The story continues, and the participants are not marching to the beat of the market drummer!
- Net job creation slowed dramatically in the official government report. The gain was only 69,000 jobs and prior months were revised lower. Current losses are sometimes offset by gains in hours worked, but that measure also ticked lower. The official report was even worse than the alternative measures I cited in my regular monthly employment report preview. This is now a three-month trend.
Politicizing the employment data gets this week's "ugly" award. This is a story that should be about the economy and the people who need jobs and cannot get them. It is also a story for investors, since we are all interested in economic developments.
Most people are more interested in the effect on the Presidential race. It is not just stories like Jobs report upends 2012 race, from The Hill, but similar coverage in daily papers and the Sunday morning talk shows. The general level of discussion from these sources, even the best of them, gives only superficial attention to the complexity of the data.
Investors should get used to this, since it will be the pattern until the election.
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. We identified a reading of 1.1 or higher as a place to consider reducing positions.
The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events. It uses data, mostly from credit markets, to reach an objective risk assessment. The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.
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. We are working on a modification that will make this method even more sensitive. None of the methods are worrisome. 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 also not close to a recession signal.
There is a lot of discussion on the recession forecasting front. There is a great team of researchers who have reverse-engineered the ECRI approach and improved on the recession forecasting power. Since they have not gotten the mainstream recognition they deserve, our readers can still enjoy the advantage from their methods and consider subscribing for more detailed reports.
Here is a nice summary graphic of how RecessionAlert pulls together many sophisticated approaches:
You can take a look at how this all plays out and see a sample report at their site. Here is a sample chart:
This is so much better than what we typically see in the mass media.
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 continued as "bearish" and were 1/3 short via DOG in trading accounts during the week. The ratings have improved, so I would expect to be neutral again soon, with the possibility of new long positions by the end of the 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
Last week brought plenty of data, but there will be some interesting items this week as well.
The most important items will be ISM services on Tuesday, initial jobless claims on Thursday, and the April trade balance figures on Friday.
Central bankers will be in the spotlight. Dallas Fed President and FOMC member Richard Fisher and Chicago Fed President Charles Evans both speak on Tuesday. The Beige Book to be used in the next FOMC meeting will also be released on Wednesday. Fed Chair Bernanke testifies on Thursday.
The ECB will also have its monthly press conference on Wednesday.
Trading Time Frame
We have been partially invested in trading accounts, in a bearish position with 1/3 of our position profitably in bond ETFs and another 1/3 in an inverse (short) ETF, as I predicted last week. Felix has now sent the bond position to the penalty box, so we have a cautious short position.
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. You can contrast this with the many pundits who claim miracles of market timing.
The single most difficult thing for me to explain is that investors should often embrace opportunity just as traders are trying to do some fancy footwork. Investors should not be trying to guess the next market move. Instead, take what the market is giving you. You should not be a "buy and hold" investor, but instead engage in active management. Think about risk control rather than market timing.
To highlight the continuing discrepancy between headlines and the economic fundamentals, let us look to Doug Kass. Doug is known for being comfortable with a short market position and also for calling the 2009 market bottom with great accuracy. He has ten good reasons for liking American stocks.
Long-term investors who are really worried 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 over the course of a market cycle. You can, too. With the increase in volatility, there are many good opportunities.
Final Thoughts on the Fed
Most of the hot money remains in complete disagreement with Bernanke and the bulk of the economic establishment. The trader viewpoint is that the economy is near collapse, if not already in a recession, and that the Fed just can't see it. Many also believe that the Fed has no ammunition left because interest rates are already so low. Nonetheless, there is continuing attention to the prospect for more quantitative easing since that was associated with higher commodity and stock prices in the past.
My guess is that Bernanke will acknowledge the higher economic risks, perhaps hinting at the willingness to take further action if needed. Open-minded observers should remember that the Fed Chair is on record that the employment growth early this year was greater than we should have expected given the other economic data. I doubt that the weaker numbers are that surprising from his perspective.
There will also be some political lines of questioning during this hearing. I do not think that the Fed will be dissuaded from acting further if the FOMC members see the need, regardless of the election season.
To summarize: No new policy announcement, but maybe a few hints.
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.