January 13th, 2013
by Jeff Miller, A Dash of Insight
Sometimes the market focus is firmly in the present, or even in the past. More frequently we expect markets to be forward-looking.
At the moment, "the present" includes earnings reports influenced by Sandy and fiscal cliff uncertainty. The same is true for many of the economic numbers.
"The future" raises key questions:
- Will business investment increase?
- Will consumers show more confidence about their jobs and their futures?
- Will companies provide stronger statements about their 2013 outlook?
- Will our political leaders avoid another debt ceiling "crisis"?
The past data will be rather negative. The future invites differing interpretations.
I have some thoughts on the forward look 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.
As we predicted in last week's preview, there was not much on the economic news front. It is also a bit early to be drawing major inferences from earnings reports.
- Money flows into equity funds -- $19 billion in the first week, the most since 2008.
- China's trade is improving. (Via Marketwatch).
- Real M2 is up 6.6% year over year. The increase in the money supply is the single best measure of whether the Fed is achieving its objectives. This is covered effectively at The Bonddad Blog, along with all of the other high frequency indicators that we should monitor.
- The deficit picture is improving. Scott Grannis writes as follows (and also provides the typically helpful chart):
"The federal budget outlook is still dismal, but—believe it or not—there has been substantial progress. Federal spending in the past three years has increased by a total of only 1.5%, while federal revenues have increased by a total of 22.7%, despite a 2-year payroll tax holiday and no increase in tax rates!"
The thin data week included a little bad news.
- The end of Guru Grades from CXO Advisory. This is a real loss for investors who are easily seduced by the market-timing claims that are never verified. At least the archives will be there. Doing this type of analysis was not easy. It required objectivity, strong methodological skills, and careful research. Someone should be willing to pay for that result, especially since it can save you so much money. Instead, people prefer to believe in miracles. It is also a difficult business model when you need to sell a collective good.
- Investor sentiment has turned bullish -- and that, naturally, is viewed as bearish for contrarians. Here is the helpful chart from Bespoke:
- Rail traffic is significantly lower. See the full analysis and several helpful charts from Steven Hansen at GEI.
- Defense stocks are already affected by the sequestration threat.
- Jobless claims were a bit worse than expected. The pattern is essentially flat for 2012 (at an unacceptable level) as you can see from the following chart from Doug Short (whose discussion cleverly notes the "Sandy Steeple").
As I predicted, there is a temptation to fill up dead air and column space with hype about the debt ceiling crisis. I'm not going to say too much about this subject until we have more information, but here is something to think about:
Debt ceiling positions are flexible!
Consider these strong statements:
"The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. Government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government’s reckless fiscal policies. … Increasing America’s debt weakens us domestically and internationally. Leadership means that “the buck stops here.” Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better.""...[cutting spending will] take a long-term effort to sell the public on the need for significant changes.... it [is not] something to be undertaken in routine spending and budget bills. To go in and start making cuts without first helping people understand the problem, the extent of the problem, and the fact that these programs are not sustainable for the long term is, I think, political suicide." (A statement in support of raising the debt ceiling).
The early posturing extends to the idea that President Obama might do an end run around Congress in one of two ways.
- The 14th Amendment, which seems to provide a loophole. Congressional leaders are urging the President to go for it.
- The trillion dollar coin, another legislative loophole. Some took this too seriously, not understanding the nature of the concept. The single best analysis, non-partisan and objective, is from Donald Marron (former CBO Director, Georgetown Prof, and now Director of the Brookings-Urban Institute Tax Policy Center). [Breaking News -- The Treasury will not pursue this approach -- more good analysis from Donald, including additional ideas.]
Obviously there will be more to come on this story.
Ticket scalpers for the Presidential Inauguration are charging thousands for standing room and a program. More complete packages cost more.
These are freebie tickets from Congressional offices that are being resold at a profit -- and some look like scams. Caveat emptor!
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 have now added a series of videos, where Dr. Dieli explains the rationale for his indicator and how it applied in each recession since the 50's. I have organized this so that you can pick a particular recession and see the discussion for that case. Those who are skeptics about the method should start by reviewing the video for that recession. Anyone who spends some time with this will learn a great deal about the history of recessions from a veteran observer.
I have promised another installment on how I use Bob's information to improve investing. I hope to have that soon. Anyone watching the videos will quickly learn that the aggregate spread (and the C Score) provide an early warning. Bob also has a collection of coincident indicators and is always questioning his own methods.
I also feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index. They offer a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy. RecessionAlert has developed a comprehensive package of economic forecasting and market indicators. I will try to do a more complete review soon.
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 comment refers to the "Imaginary Recession." I have been expecting the ECRI to declare that their forecasted recession is over, since the indicators have obviously improved.
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. About 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 significantly 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 remains elevated, so we have less confidence 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.
- Michigan Sentiment (F). More important than most people acknowledge. This will be an early read on whether the fiscal cliff dip is reversing.
- Retail Sales (T). Significant for the ongoing monitoring of a potential recession.
- Industrial Production (W). Also relevant for GDP.
- Building Permits (Th). The best of the housing indicators.
The "B List" includes the following:
- PPI inflation data (T). I am not expecting anything significant.
- CPI inflation (W). See above.
- Fed's Beige Book (W). This supplementary anecdotal information is interesting, but adds little to the Fed story at this time.
There are a number of Fed speeches on tap. The most important is Bernanke's appearance at the Rackham Auditorium at the University of Michigan on Monday afternoon. As a Rackham Scholar who spent many hours in that building, it has a special interest for me, and might actually provide a few clues.
There are some regional Fed releases. As regular readers know, I acknowledge the potential significance of these releases when there is a big move, but generally think they provide more noise than signal.
Earnings stories will be big, especially the upcoming financial and technology announcements.
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 did pretty well last 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."
Rather than do a weekly update for investors, let me refer readers to my 2013 preview for Seeking Alpha. This covers some key investor catalysts, as well as some specific stock and sector ideas.
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).
Expectations for growth in corporate earnings remain low, and have been moving lower. The result is that the "beat rate" will probably be in the 60%+ range -- once again.
Skeptics of forward earnings make two inconsistent claims: Analysts are too bullish and they set the bar too low.
The answer is that very early estimates -- those for more than a year in advance -- are often too optimistic. The estimates at the time of the report reflect reduced guidance.
For the umpteenth time, I emphasize that any logical observer would conclude that at some point, the earnings estimate must be pretty accurate. I explained that the one-year horizon was best in this article.
This week Dr. Ed Yardeni writes as follows:
That’s because the market discounts 12-month forward consensus expected earnings. A good proxy for this concept is forward earnings, i.e., the time-weighted average of consensus estimates for the current and coming years. It tends to be a good 12-month leading indicator for actual profits, with one important exception: Analysts don’t see recessions coming until we all do too.The bottom line is that the bottom line for S&P 500 companies on a 12-month (and on a 52-week) forward basis rose to a record high at the beginning of this year even though analysts have been lowering their estimates for 2012 and 2013.
Here is the chart he cites:
It looks like a confirmation of current forward earnings forecasts. (Just go back one year on each blue line). This would be a surprise to a skeptical market, so it bears watching.