July 16th, 2012
by Jeff Miller
It is summertime and the trading is usually slow. It is also options expiration week. Sometimes it takes little to spark a big move.
This week we have a three-ring circus:
- More corporate earnings
- The economy featuring housing data this week
- Fed Chair Bernanke back before Congressional committees
There are a number of cross-currents affecting each of the three, allowing plenty of room for action. I'll offer my own expectations in the conclusion, but first let us do our regular review of last week's news.
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.
It was, as expected, a light week for data.
- Initial jobless claims were much better than expected. This is being discounted because auto companies have been so busy that the traditional summer shutdowns were abbreviated.
- The FOMC minutes showed more support for aggressive Fed action, according to the FT (among others).
- There was progress on the Spanish bailout plan, reflected in lower yields on Spanish and Italian debt.
There was not much negative news, and some of it was subject to interpretation.
- The FOMC minutes showed little support for aggressive Fed action, according to MarketWatch (among others). This was the tempting conclusion since stocks sold off after the announcement.
- Other data a bit worse than expected, including consumer confidence, CPI, and trade data. (see the Bonddad Blog for details, and other high-frequency indicators).
- Earnings reports were disappointing, especially the Cummins pre-announcement of flat revenues for the year. Bespoke has the story of the earnings week, including how the stocks reacted.
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 recession 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 activity from the recession forecasters. The basic summary is that those with the best records still see little chance of a recession in the next six months or so. The people that get featured in the press and on TV are sticking by their guns, even though the evidence is mounting against them.
We are now at the end of the nine-month forecast window that the ECRI adjusted to after their September, 2011 call (recession imminent, maybe already here, and unavoidable) seemed to prove wrong. Since then they have been adjusting indicators and trying to extend the window, which supposedly ends right now -- mid-year 2012. Instead of agreeing to this, the ECRI has now raised the notion that there is already a recession, but it has not yet been recognized. This week there were a number of refutations of this claim. If I decide to work another evening during my vacation this week, I might summarize the key stories. Meanwhile, I recommend last week's article where I did a rather comprehensive list leading up to last week and also my new Recession Resource Page, which explains many of the concepts people get wrong.
The single best resource for the ECRI call and the ongoing debate is Doug Short, who has a complete and balanced story with frequent updates.
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 "bullish." These are 30-day forecasts.
[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
This will be a busy week for economic data, with many releases. I do not expect any excitement from the CPI. The Empire State and Philly Fed indexes are important only because they have recently been so negative. Retail sales and industrial production are important indicators, especially if they were to turn negative (an essential precursor for a recession). The release of the Beige Book is usually interesting information, but will be less so this week because of the Bernanke testimony.
Thursday will be the big day, with initial jobless claims, leading economic indicators, and existing home sales. The other big items are Wednesday's housing starts and building permits.
Trading Time Frame
Our trading positions continued in fully invested mode last week. Felix is not a range trader, but is excellent at getting on the right side for big moves. The recent aggressive move is still showing a profit, and Felix is pretty aggressive.
Investor Time Frame
The successful investment strategy differs markedly from trading. It is especially important to establish good, long-term positions when prices are favorable. Most individual investors seriously underperform long-term results by selling low and buying high. Most successful professionals, of course, do the opposite.
This is easier said than done. With everyone on TV explaining with great confidence what just happened (please check out my article on the "message of the markets") it is easy for the average person to think he is out of step.
There is no magic moment. Resolving market worries is a process, not an event.
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 market action last week was an excellent illustration of market moves based on little change in the underlying information.
The best strategy through the various gyrations has been buying dividend stocks and selling calls for enhanced yield. Anyone unhappy with bonds should be doing this for a yield of 8-10% with greater safety than pure stock ownership. Take what the market is offering!
Final Thoughts on the "Circus"
Here's something to watch in each of the three rings:
- The corporate earnings estimates have come down quite a bit for the current quarter, but held up pretty well for the 12 month period (see Brian Gilmartin's full update). I expect results to be fine on actual earnings, but there is no reason for executives to make bullish statements about future visibility. This is widely understood.
- Housing has been a recent bright spot for the economy. Building permits are especially important and ignored by the "stall speed" recessionistas (who did not read the full article) and also by the ECRI.
- Bernanke is not going to announce a policy shift, but I expect that he will acknowledge weaker economic growth since the last Fed meeting. I expect him to be clear that the Fed will act if necessary, regardless of the upcoming election.
James Hamilton is a pragmatic and balanced economic analyst. He has a great article focusing on the significance of housing to the economic rebound. There are many charts and tables, and an effective discussion of the Calculated Risk call of the housing bottom.
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.