The Week Ahead: Autumn, The Season of Fear?

October 7th, 2012
in contributors

by Jeff Miller

Sometimes the political and economic streams converge to determine the agenda.

Each turn of the calendar seems to bring a new warning for investors.  There are reasons offered for many specific months, but we never seem to hear the corollary about when to buy.  If you are a fan of "sell in May" an idea that got plenty of punditry buzz this year, then you should have a question in mind:

If I sold in May, when should I buy?

Just asking...

Abnormal Returns is the go-to source for anyone following the markets on a daily basis.  I love it when Tadas also finds the time to do a longer post, drawing together the threads from his daily observations.  This week he had an important idea for individual investors, writing as follows:

Follow up:

"In the meantime we have seen more signs of individual investors fleeing the market.  A recent survey shows that a majority of individual investors were unable to correctly identify the fact that the S&P 500 had been risen in calendar years 2009, 2010 and 2011. At Fidelity Investments a recent milestone shows that the firm now manages more in bond and money market funds than it does in equity funds.

Today in piece at the Wall Street Journal by E. S. Browning more evidence that individual investors who were so traumatized by the declines of 2008 are simply unwilling to recommit to equities as a cornerstone of their portfolios.  The signs of “disaffection are widespread” and include continued outflows from equity-related funds and ETFs, reductions in equity holdings in 401(k)s and simply more households holding fewer equities. Most of all investors seem traumatized from the seemingly existential declines markets experienced in 2008."

For most investors, this week, this month, this autumn, are a time of fear.  Major media sources refer to positive news as "hopium," something that you used to see only from perma-bear blogs.  No wonder the average investor is scared witless.

I'll offer my own take 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 lists of upcoming events.  One source I especially like is the weekly post from the WSJ's Market Beat blog.  There is a nice combination of data, speeches, and earnings reports.

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:

  1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
  2. It is better than expectations.

The Good

The news last week was mostly positive, including these highlights.

  • Advance earnings estimates are turning stronger.  There is intense skepticism about earnings.  The idea that estimates are too high has become an element of Wall Street Truthiness.  Meanwhile, the method with the best long-term record for earnings forecasts is turning more positive.  Brian Gilmartin, writing at his new blog Fundamentalis, is doing some of the best work on earnings.  He has a great report on the most recent revisions.  Here is his take on forward earnings:

"We continue to think that the 3rd quarter, 2012 earnings results will be the bottom or nadir of this cycle for the S&P 500. Expectations are very low coming into 3rd quarter numbers as – overall, for the S&P 50o in total – earnings are expected to decline -2.4% and revenues are expected to be flat year-over-year."

  • ISM manufacturing index is back in expansion territory at 51.5, consistent with solid growth.  It also reflected good internals.
  • The ISM services index was pretty good.  See Steven Hansen at GEI for a thorough account.
  • The Presidential Debate.  Obama supporters are encouraged to read the above definition of "good" which means market-friendly.  It was pretty obvious on Thursday that the market, right or wrong, wants to see a Romney win.  Felix Salmon has good analysis and a chart of the changing odds.


  • ECB leverage, possibly as high as two trillion euros.  I understand that the Mauldin followers whose approach has been an arithmetic calculation of Europe needs versus German capability will be shocked to learn this.  They will complain about "can kicking" and the inevitability of European collapse.  Meanwhile, all of the objective measures show that conditions improve.  Risk is lower, refinancing costs are lower, and cooperation is higher.  (Contra -- Hugo Dixon sees jitters).
  • Employment is better.  Maybe only a little better, but improvement is good.  The payroll job increase was pretty much in line with expectations, allowing for the upward revisions to the prior months. Hours worked moved higher, adding to the overall increase.  The hourly wage upticked.  And of course, there was the controversial decline in unemployment.  Anyone who follows my advice of monitoring many sources over many months would understand the need to take the monthly report in context.  Check out my preview for this month, featuring my bean-counter contest example, and you will see.

The Bad

There was some bad news last week, but most significantly from abroad.

  • European unemployment remains high.  There are many ways of evaluating the European economy, but the job situation is important.  Rebecca Wilder (an engaging and sunny person who has a dark professional view on Europe) brings her economic acumen to bear in generating this chart:


  • Congress is struggling with the challenges of a temporary, lame duck solution to the fiscal cliff.  The problem is that tax changes need to be for the full year (see The Hill).  The good news is that they are working on this now.  I still expect a solution, dependent on the election results, but this bears watching.  It is already hurting growth as noted by Cardiff Garcia at FT Alphaville.
  • Household employment gains reflected a surge in part-time employment, about 2/3 of the newly employed.  This is better than unemployment, but less than ideal.
  • Household income remains poor.  Doug Short has a comprehensive analysis. Here is a key summary chart which hints at the whole article:


  • Manufacturing orders were a disaster according to Steven Hansen. While subject to some interpretation for the most volatile components, it was pretty bad.  Here is the key chart, emphasizing losses in transportation:


The Ugly

The US Postal Service.

We moved our office to larger and more suitable quarters on 9/27.  Here is the checklist:

  • Buildout and move-in prep.  Done.  Great job by our new building management.
  • Physical move of furniture, files, and material.  Done.  Great job by Larry (a fellow Michigan man) and his team from Praeger.  No disturbances, nothing broken, fast and efficient, and helpful at all times.
  • Easy transition of phones (two of three lines working as we adjust internal wiring), Internet (all but one computer), and TV (financial stations on mute, with Tivo).  Thanks Comcast -- up and going within two hours.  We'll tweak the rest, but continuity was preserved.
  • Forwarding of mail. No. After eight days, and despite plenty of advance notice, we are not getting mail.  We only moved four miles away.....

Fortunately, the modern investment office does not depend on snail mail for vital communications.  I doubt that any of our clients even noticed an interruption, since we had back up in place for phones and trading for the two-hour transition.

The only hitch is the mail.  It is not the fault of the postal employees, but there is something wrong with this system.

Meanwhile, after eleven good years in our former office, we have attractive and peaceful new surroundings.  My commute has increased to 4.7 miles from 1.2 miles.

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

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.

The ECRI keeps moving the goal posts on this prediction, suggesting that we will only know about a recession after many months because the data will be revised lower.  For the few die-hards who are still taking this seriously, you should read the careful, thoughtful, and data-driven work from Dwaine Van Vuuren.  He is taking up the key elements in determining recessions and looking at whether revisions affected the timing of past recessions.  He does this by comparing the difference between the original observations and the final revised version.

Please note that Dwaine has actually done this research, while the ECRI has not supported its claims.

Here is a key chart on employment:


Dwaine's observations:

"The first is that the real-time data results in several false positives (false alarms) as indicated by the “1″ markings. The second observation is that for the most part, the signalling of the start of recessions is near-identical between the real-time and revised versions of the growth rate. The only exceptions are 2008 (tagged “2″), 1957 and 1959 where the revised data signalled recession earlier (meaning the real-time observer would have been late in his/her assessment that a recession was indeed underway) and point “3″ where the real-time data was actually earlier in signalling recession.

On the whole, the revised data provided earlier signalling 2 more times than the real-time data, giving it a slight edge. Whilst revised data results in a 3-month smoothed growth rate that can differ to that of the real-time growth rate, that difference seems to be isolated to the expansions and contractions, but not so much around the turning points themselves."

Bob Dieli's clients also get a special report on each payroll employment Friday.  This information is a hidden treasure, if only because the mainstream media is so clubby.  This is an advantage for me, and for readers of "A Dash."  I met Bob partly as a result of my nationwide search for the best recession forecasters, and partly because we were both participants in a great investment roundtable.  His analysis has been a big plus for my clients.  (He has a membership system, but trials and discounts are possible.  Write me if interested.)

His reports are chock-full of strong analysis and wry humor.  Here is a brief take from yesterday's report:

Dieli on Employment

His subscribers have known better than to be paralyzed by fear of a recession that might affect corporate earnings.

Scott Grannis also reviews an array of indicators and charts concluding that there is "still no sign of recession."

Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.

Indicator snapshot 100512

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 our neutral forecast. These are one-month forecasts for the poll, but Felix has a three-week horizon.  Felix's ratings have continued to drift lower.  The penalty box measures our confidence in the forecast, and that is also moving lower. It has been a close call over the last few weeks, as the ratings moved out of bullish territory.

[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 is a light week for economic data, but there is still plenty to watch.

The "A List" includes the following:

  • Initial claims (Th) which continue to provide the most up-to-date read on jobs and the economy.
  • The Vice-Presidential debate (Th evening) which has assumed extra significance after the first Presidential debate.
  • Earnings Kickoff with Alcoa (AA) on Tuesday and JP Morgan (JPM) on Friday.  Earnings will be even bigger next week, but these reports will set the tone.

The "B List" includes several reports:

  • Michigan sentiment (F) is an important concurrent indicator of job creation, spending, and the economy.
  • The Beige Book (W) where we will see the anecdotal evidence in front of the Fed for the next meeting.
  • Trade balance (Th) which will affect GDP.

The JOLTS report on labor turnover, the PPI, Merkel's visit to Greece, and assorted IPOs all might be newsworthy, but probably not.

Trading Time Frame

Felix has continued the 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 we have reduced to two trading positions in commodity gold (GLD) and health care (XLV).  We might reduce to one position during next week.  Felix is cautious.

Investor Time Frame

Each week I think about the market from the perspective of different participants.  The right move often depends upon your time frame and risk tolerance.  Here is the biggest mistake I see among individual investors:

Waiting.  Waiting to see the election result, what happens in Europe, whether there is a recession, and what happens with the fiscal cliff.

And thinking that they need to be "all in" or "all out."

The key challenge for investors is still the barrage of confusing headlines, often with a political motivation. Two weeks ago I reported on research showing that many long-term investors have simply lost touch with reality.  Many have been out of the market and worry that they have missed the rally.  A few months ago there were too many worries for them to invest.  There is a new stock of well-documented worries, and some of the others are gone.  Meanwhile, these investors rush into bond funds without realizing the chance that they may experience absolute losses from these holdings.

The traders (including Felix) are getting more cautious for a variety of reasons.  Some are trying to lock in profits to earn their bonuses.  Investors face different questions, as I try to point out each week.

The Risk/Reward Question. How much risk should you take?  The right answer is different for everyone, but too many people choose "zero."  These investors do not follow the Buffett advice of buying when others are fearful.  Then, when the market rallies, they are afraid that they are "too late."  I wrote a recent article, Stock Prices and the Fundamentals: Don't be Fooled, showing how to avoid this trap.  The answer is not going "all in" since most of us have to pay more attention to short-term risk than does Mr. Buffett!

If you have been following our regular advice, you have done the following:

  1. Replaced your bond mutual funds with individual bonds (bond funds are very risky!);
  2. Sold some calls against your modest dividend stocks to enhance yield to the 10% range; and
  3. Added some octane with a reasonable allocation of good stocks.

There is nothing more satisfying than getting yield and call premiums, even if stocks move sideways.

If you have not done so, it is certainly not too late.  We have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love feedback.)

Final Thoughts on October Fear

We would all do best to consider data rather than to be paralyzed by emotion.

Most of the October fears come from a few incidents.  We noted the 2008 events in the introduction, but we will soon see articles on the 25th anniversary of the 1987 crash.  Meanwhile, the overall October record is better than the average month (via Bespoke).

There is also the added influence of politics.  This week demonstrated an extreme of people allowing their political opinions to influence the interpretation of data and their investment judgment.  Regular readers will already know my viewpoint on conspiracies and data manipulation -- a  position that I have held no matter which party has been in power.

By putting politics aside, the investor has an instant advantage.  The employment data merely reflected what we see from all other sources:  modest growth -- not a recession but far less than what is needed for a robust recovery.  You can use that conclusion any way you want in the voting booth, but for investors the news has been mildly encouraging.  You can see the entire story in one chart from Invictus, whom I follow on Twitter.  I found the source with full explanations here.

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About the Author

Jeff MillerJeff 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.

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