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. Bob and I met last week, planning an update soon after the election. 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.
RecessionAlert uses a variety of different methods, including the ECRI, in developing a Super Index. They also offer a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy.
Doug Short has excellent continuing coverage of the ECRI recession prediction, now over a year old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. The most recent news from the ECRI states that they are “Assessing the Current Optimism.” This is apparently available only to paid subscribers, the ones who had early access to the 2011 forecast.
Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong. Newly added to the list of errors this week was the popular but bogus 100% recession chart.
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 bearish position. 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 percentage measures our confidence in the forecast. That indicator has moved to the very top of the range. This means that there is so much conflict in the indicators that we do not have a lot of confidence in the current bearish rating. 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
This week brings more economic data, but not the most important reports.
The “A List” includes the following:
- Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator. Possible Sandy effects.
- Industrial production (F). This has continuing significance for GDP.
The “B” List” includes these entries:
- PPI (W) and CPI (Th). Someday these reports will matter more.
- FOMC minutes (W). Perhaps a little more color on the QE3 thinking.
- Retail sales (W). Difficult to interpret because of Superstorm Sandy.
There will be more news about Greece and progress toward the next funding gap. The regional Fed surveys might surprise.
There will be continuing non-stop speculation, attempting to parse the words of anyone who will discuss the fiscal cliff.
Trading Time Frame
Felix has continued in a marginally bearish posture. It has been a close call for several weeks. Felix has done very well this year, becoming 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 again this week. We are 1/3 invested in an inverse ETF for trading accounts, and another 1/3 would not be surprising.
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. Individual investors too frequently try to imitate traders, guessing whether to be “all in” or “all out.”
Investors often let the calendar tell them when to review, but sometimes events provide a better guide. There is a lot of opportunity right now. Here is what to think about:
- Risk. If you are like the average investor you have it all wrong. You have been piling into bonds, gold, and dividend funds. All of these categories are now over-valued, the result of this stampede.
- A portfolio anchor. You need stability. If you are trying to do it with bond funds, you need to understand the risks. I prefer owning specific bonds.
- Stretching yield. My approach is to find some reasonable dividend stocks and sell near-term calls against the positions. If you did this skillfully, you could hit double-digit annual returns with significantly less risk than simply owning dividend stocks.
- A little octane. Many investors do not think carefully about asset allocation. There is always volatility, so the key is to “right-size” your position. Instead of trying to time the market, try to be a player in the right sectors, the right stocks, and the right size. There are plenty of stocks selling cheaply in terms of their historic P/E multiples.
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. We have a good discussion going on bonds versus funds, and I plan a separate article that will provide a further forum.)
Final Thoughts on Cliff Diving
I can state this pretty simply: A dive over the fiscal cliff will not happen. There are specific and personal tax and budget consequences for nearly everyone — especially major GOP constituencies like those who will get hit with the Alternative Minimum Tax and business leaders who need to plan. Most people seem not to realize how close the two parties are to a reasonable compromise. I first expect a temporary plan that will address some problems and buy time, but I would not be surprised to see specifics sooner than most expect.
The simplistic comparisons to 2011 have many flaws, and the comparisons to TARP in 2008 are even worse. I have been planning to write more about the probable outcome of the tax and budget negotiations. This is best done when the topic is relevant and we have a little more useful information.
Meanwhile, what we have right now is a little bit of preliminary posturing. Imagine that you were about to represent your team of investors (or workers or business leaders) in important negotiations. Would you start the process with a public declaration of your best and final offer?
There is no information in this posturing, but you can expect to hear all sorts of wild statements. These provide a negotiating position and set the stage for compromise. Meanwhile, the stock market rallies on one sentence from the President or the Speaker, and then sells off on the next. Most of the predictions you see come from those who no experience or track record in forecasting public policy outcomes. They also seem to have forgotten that the election is over, providing a window of opportunity for joint action before the battle resumes.
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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.