The Bad
There was plenty of bad news last week.
- New Home sales were soft, down 1.9% month-over-month, but up 24% year-over year. See John Lounsbury and Steven Hansen’s discussion.
- Earnings forecasts moved lower. Reacting to second-quarter reports and outlook, analysts have reduced forecasts. Brian Gilmartin tracks this carefully, showing the actual changes by sector as well as some thoughtful commentary. One-year forward earnings have not moved that much. Bespoke wonders whether the bar is now low enough for Q3. Here is their typically helpful chart:
- Durable goods orders declined by 13.6%. Even excluding the transportation segment with the high volatility airline orders, the decline was 1.6%, much worse than expected. See Steven Hansen’s discussion and helpful charts. Here is one example:
- Chicago PMI broke below 50. The 49.7 reading indicates marginal contraction in manufacturing for the Chicago region. Normally this report gets less attention, but it moved the market on a Friday morning. Many view this as an indicator of the national ISM report which will be released on Monday.
- Business investment is weak reflecting lower confidence. Scott Grannis discusses and provides this chart:
The Ugly
Iran’s progress toward nuclear weapons. Just as importantly, Israeli perceptions of Iran’s progress. See Israeli Prime Minister Netanyahu’s UN General Assembly Speech.
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.“
Bob and I recently did some videos explaining the recession history. I am working on a post that will show how to use this method. As I have written for many months, there is no imminent recession concern. I recently showed the significance of by explaining the relationship to the business cycle.
The ECRI recession call is now over a year old. Many have forgotten that at the time of the original prediction, the ECRI claimed that the recession was already underway by September of 2011. See New Deal Democrat’s carefully documented discussion, including the original video, at the Bonddad Blog.
Readers might also want to review 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. This week’s article describes the complete history, the critics, and how it has played out. We are now seeing modest declines in two of the major indicators. Here is the key chart:
The Doug Short updates are mandatory weekly reads for those who are still worried about a new recession.
[We did not get our regular data for the RecessionAlert forecast, but hope to update this next week.]
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 after a brief stint at “neutral.” These are one-month forecasts for the poll, but Felix has a three-week horizon. The ratings have moved a little higher, and the confidence has improved from last week. It has been a close call over the last few weeks.
[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 not so many items on this week’s calendar, but it is a crucial week. As noted above, my grading of the reports relates to what I see as important.
The “A List” includes the following:
- The Employment Situation Report (F). Right or wrong, this will be viewed as the official indicator of where the US economy stands.
- Initial claims (Th) which continue to provide the most up-to-date read on jobs and the economy.
- The ISM manufacturing report (M) is expected to be weak, but remains a wild card. This has implications for Friday’s employment report.
The “B List” includes several reports:
- ADP jobs estimate (W) may actually be as good as the official report, but does not enjoy the same status.
- The ISM services index (W) does not have the long history of the manufacturing index, but now represents a more important part of the economy.
- The FOMC minutes (W) may seem like old news, but provide some color.
The Presidential debate will be big news, but challenging to interpret. Pundits will speculate both on who won and also the implications for the economy.
There is a lot to cover this week, but I’ll try to do something on debate night.
Trading Time Frame
Felix has moved back into a neutral posture after a few weeks as marginally bullish. It has been a close call for several weeks. In practice, the official forecast has mattered little to our trading positions. Felix became more aggressive in a timely fashion, near the start of the summer rally. Since we only require three buyable sectors, the trading accounts look for the “bull market somewhere” even when the overall picture is neutral. The ratings have moved lower this week, and I would not be surprised to see a reduction in trading positions this week.
Investor Time Frame
Last week I reported on research showing that many long-term investors have simply lost touch with reality. I see confirmation in data showing that investors have abandoned stocks.
Even the PBS Newshour program, exceptionally aimed at balance and information on topics like this, winds up with a pairing of two people celebrated by those of the bearish persuasion — Harvard’s Econ and Public Policy Prof Kenneth Rogoff and PIMCO’s Mohamed El-Erian. Neither seemed especially bearish in this interview, perhaps because of the setting.
Rogoff, whose recent book as frequently cited as proof positive that the end is near for the US economy, responded as follows:
“I do think next year might look a little better. But I don’t think we’re going to be having fast growth for a very long time. The uncertainty around the world, in Europe, in the United States, in China is one thing.
The huge debt legacy from the financial crisis is another and the growing government debt.
That said, I mean, I wouldn’t underestimate the upside, with the U.S. being such a creative economy. For example, energy prices have fallen a lot. And there are some other things you can point to on the upside.
But, so far, businesses have been very reluctant to invest heavily, very reluctant to hire heavily.”
El-Erian had the following comment:
“I tell the politicians, please remove the fiscal cliff, because if the fiscal cliff occurs, and we get 4 percent of GDP disorderly cuts in spending and then across-the-board increase in taxes, the U.S. will go into recession.
So, the first thing is, do no harm.
Second is, if we can get over that, I see an economy gradually picking up momentum. It’s not going to be great. We’re going to — we’re going to create jobs, not enough to really lower the unemployment issue. And, hopefully, we’re going to start dealing with these longer-term issues.
So, like Ken, the thing I find most frustrating, Judy, is this is not a complicated issue. We can handle this. We can unleash the innovation, the entrepreneurship, the cash that is on the sideline. But it requires a political will and political coordination.”
I watched the show and decided to do a one-person focus interview — not a poll – with one of the smartest people I know. He is a regular Newshour viewer and had just watched the interview. He understood the background and biases of the participants. He has personally beaten the markets and the pundits by choosing and maintaining some high-quality investments and discounting the headline worries. Since he is a Poli Sci PhD he is not scared witless (TM euphemism OldProf) by news from Europe. He is accustomed to progress through incremental processes.
While I am delighted that my friend is doing so well, I suspect that most investors do not share his savvy. Here is the full interview for your consideration:
Watch Consumer Confidence Is Higher Than Before on PBS. See more from PBS NewsHour.