January 6th, 2013
by Jeff Miller, A Dash of Insight
The quirks of the calendar have delivered a week that has little fresh economic data. Some will use the quiet period to continue the discussion of politics and the debt ceiling. Others will focus on predictions for the coming year.
Most are tired of "the cliff" and will be happy to turn to a new subject: It's time for earnings!
This earnings season will be especially important. Here are two key reasons:
- Forward earnings estimates are at an all-time high. The oft-repeated pundit opinion is that analyst estimates are excessive and must be reduced.
- The January earnings season often includes full-year guidance. This is always interesting, but perhaps even more so right now.
Both of these intriguing ideas come from my Chicago-based friend Brian Gilmartin, who is among the very best sources on corporate earnings. He sees the forest, since he has tracked the ThomsonReuters estimates for over a decade. He notes trends in these estimates as well as revisions by sector, most recently with this report at his blog. He also covers many individual stocks through his posts on Seeking Alpha. (see his Alcoa preview).
I have some thoughts on this earnings season, which I'll report in the conclusion. First, let us do our regular update of last week's news and data.
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 other events.
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 holiday-shortened week still had a lot of significant news, and it was mostly positive.
- The Fiscal Cliff decision. Those who object to this being scored as "good" should re-read the criteria, e.g., market friendly. They also need to separate their political opinions from economic reality. The decision avoided an immediate economic drag from the expiration of tax cuts and the sequester. This was good for the economy and good for stocks. Those who are complaining the loudest about the outcome are the same people who were completely mistaken in their forecasts. I recommend that real investors ignore these sources and read my review of the outcome. There are obviously important remaining issues. I'll get around to those when it is more timely --- which is not right now!
- The ISM index is back above 50. Bespoke has a good discussion of the trends in the sub components, including this chart:
- The ISM services index was even better. See Steven Hansen's comprehensive discussion, including the various components.
- Shadow home inventory is down 12% according to CoreLogic (via Calculated Risk).
- Commercial lending is higher, along with many other growth indicators. Scott Grannis is not happy with the election result or current tax policy, but he is open-minded in looking at indicators. See the full article for all ten of his charts. Here is one example:
- The technical picture is better with an upside-down head and shoulders playing out, among other patterns. The analysis is not that simple, and difficult to summarize. Charles Kirk's success reflects his willingness to change with the data. His site has a small charge which goes to charity after offsetting expenses, and it is well worth it. He provides this week's update while fighting the flu. Get well soon, Charles!
- Europe continues to improve. Remember the threat of rates over 7% Dominoes falling? You can either listen to the words of those singing the same song, or you can look at data. Dr. Ed notes that the mission is being accomplished even without actual sovereign debt buying by the ECB.
There was not much bad news last week. I invite readers to nominate items that I overlooked, but make sure that they are fresh -- not just stale and recycled opinions.
- The FOMC minutes. These are usually not controversial, but the new era of transparency from the Fed seems to be backfiring. Despite the meeting decision to increase the QE program, to some the minutes seemed to suggest that a policy change might be imminent. This is a good topic for more work, so it is high on my agenda. Meanwhile, I recommend the comprehensive discussion from Cardiff Garcia at FT Alphaville -- a careful look at various perspectives. I also like the account from Paul Vigna at MarketBeat.
"Investors aren’t looking at the fundamentals through their own eyes, but through what they think the Fed thinks, and trying to gauge when the Fed will send a signal to everybody else that it’s going to change course. Because if you’re really playing this game, you’re trying to catch that signal from the Fed before every other trader, speculator and investor does."
- Manufacturing new orders disappointed. See Steven Hansen's report for all details.
Employment. I do not do a neutral category very often. I want to mention the employment report, but I cannot bring myself to call it "good" in the current market context. It was certainly not "bad." The job growth is consistent with recent months, which means that it is positive, but far less than what is needed. The report avoided the customary complaints about seasonality, labor force participation, and manipulation of data.
We need businesses to start hiring more aggressively.
This week's ugly award goes to the "sold out bull." I tried to explain why those who missed the "fiscal cliff rally" should simply understand that it was not all about price --- it is a matter of risk and reward. If you choose to avoid the high-risk situation (and what turned out to be the best price), there is no shame in buying after the risk is lower. It can be quite smart, and more consistent with your objectives. Very few understand this concept.
Josh Brown is more expressive and colorful, and I recommend the full piece. As usual he absolutely nails the market psychology of those who have been left behind. We can all learn from this:
No, the sold-out bull is pure evil - ferociously outspoken or slyly suggestive, he is all the time engaged in a singular mission: Scaring others out of the investments that he would like to buy back himself at lower prices.
The sold-out bull is a sickly creature, a thrashing fish on the deck of a ship, out of its element and sucking at the air for one more breath. Every trick will be employed, from fiery sermons of impending doom to sarcastic asides about the dopiness of those who are still in.
The sold-out bull is desperate and his mind is twisted, every thought and expenditure of energy is employed toward the creation of a lower entry back into the markets. Only a cheaper buy-in will vindicate the earlier decision to sell that haunts him so.
Steer clear of the sold-out bull, for the ferocity of his bearishness comes from somewhere very dark and extremely cold. He will hurt you if he can, climb over your body to get back in.
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."
Doug Short has excellent continuing coverage of the ECRI recession prediction, now well 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. His latest verdict is that the ECRI has flunked Recession 101! I have been expecting the ECRI to declare that their forecasted recession is over. The secret long-leading indicators have been identified by some, and they have improved since the original forecast.
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.
Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.
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. A month ago we switched to a bullish position. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings stabilized at a low level and improved a bit over the last few weeks. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings. That measure is moving higher, so we are becoming less confident in short-term trading.
[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 little data and scheduled news, an artifact of the calendar and the holidays.
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.
The "B List" includes the following:
- Trade balance (F). Continuing implications for the GDP.
- The JOLTS report (Th). Mostly helps on the issues of structural unemployment and letting people see the gross job changes. Not much movement in recent months.
There are a number of Fed speeches on tap. Given last week's news, this may be more confusing than enlightening.
Most important is the start of earnings season.
Trading Time Frame
Felix has moved to a bullish posture, now fully reflected in trading accounts. 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, and getting out a couple of months ago. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. Our current trading holdings have a foreign tilt.
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.
Buying in times of fear is easy to say, but so difficult to implement. Almost everyone I talk with wants to out-guess the market. The problem? Value is more readily determined than price!Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out."
Even the pros get it wrong. Any of us who are constantly commenting on markets will have some bad calls, but last year was worse than usual. Bloomberg's Michael Patterson & Lu Wang write, Almost All of Wall Street Got 2012 Market Calls Wrong. Citing some of the most prominent forecasts, they write as follows:
All of them proved wrong last year and investors would have done better listening to Goldman Sachs Group Inc. (GS) Chief Executive Officer Lloyd C. Blankfein, who said the real risk was being too pessimistic.
The ill-timed advice shows that even the largest banks and most-successful investors failed to anticipate how government actions would influence markets. Unprecedented central bank stimulus in the U.S. and Europe sparked a 16 percent gain in the S&P 500 including dividends, led to a 23 percent drop in the Chicago Board Options Exchange Volatility Index, paid investors in Greek debt 78 percent and gave Treasuries a 2.2 percent return even after Warren Buffett called bonds “dangerous.”
“They paid too much attention to the fear du jour,” Jeffrey Saut, who helps oversee about $350 billion as the chief investment strategist at Raymond James & Associates in St. Petersburg, Florida, said by phone on Jan. 2. “They were worrying about a dysfunctional government in the U.S. They were worried about the euro quake and the implosion of Greece and Portugal. Instead of looking at what’s going on around them, they were letting these macro events cause fear to creep into the equation.”
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).
How can you go wrong by under-estimating Congress and other political leaders? Amazing!
But that is what happened. Even modest expectations for results was enough to keep you on the right side of the market.
For the upcoming earnings season I remain open-minded and I will be very attentive. Last quarter was a minefield for corporations. If the complete story -- earnings, revenue, outlook -- was not perfect, the stock price moved lower. I avoided earnings dates in our most aggressive trading programs, and I was nearly always right.
So what now? We all know that the economy remained sluggish in Q4, so earnings will not be great. Much of the uncertainty has been lifted. We know the election result and also tax policy for the near future. Will companies provide a little more guidance? What will it be?
I have more respect for the analyst updates than I do for the pontificating pundits with opinions but absolutely no record. I understand that analysts are too bullish in their multi-year forecasts -- basically following trends with no allowance for bad news. I also understand that by the time earnings are actually reported, the bar has been lowered so that more than 60% of companies beat expectations.
Most experts share these views, but I seem to be alone in drawing the logical conclusion:
If estimates are too bullish in the long run and too bearish at the time of the report, there must have been a "crossover date" when the forecasts were pretty good. My research shows that this occurs at about one year in advance.
To summarize: This earnings season will be important for estimate revisions as well as the current "beat rate."