May 5th, 2013
by Jeff Miller, A Dash of Insight
For several weeks I have been monitoring a developing change in the US equity markets. There is a growing perception that some of the "safe" assets may not be so safe. There is a corresponding realization that the "risky" choices might not be so risky.
Some see this as a sign of danger. Cam Hui, our "Humble Student of the Markets," notes the general market trend, concluding, "For traders, it may be premature to get overly bearish without some catalyst or trigger." He is concerned, however, that the defensive leadership is a sign of weakness.
Prestigious BCA Research sees it as a "changing of the guard" even if the market moves somewhat lower. They provide a table of sector results in corrections that do not include recessions.
Goldman Sachs sees it as an opportunity.
"Going into May, sectors best positioned from a growth and value perspective are financials, industrials, information technology, and materials, according to a Wednesday note from Goldman Sachs Group Inc.
From a value perspective those sectors are certainly underperforming. Tech and materials the biggest laggards on the S&P 500 Index SPX +1.05% with year-to-date gains of 3.5% and 4.6%, respectively. Industrials and financials are also in the bottom five performing sectors year-to-date with gains of 8.6% and 13.3%, respectively."
Josh Brown, who deserves special respect because he is on the side of the individual investor, underscores how far the trend has gone. Bond funds are now buying stocks – in record size.
I have some thoughts about leadership. I will stifle my comments on political leaders and stick to market leadership! Check out the conclusion for my take. 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 regularly follow is the weekly calendar from Investing.com. For best results you need to select the date range from the calendar displayed on the site. You will be rewarded with a comprehensive list of data and events from all over the world. It takes a little practice, but it is worth it.
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 economic data this week was a mixed bag, but expectations were pretty low.
- Bullish sentiment remains low. The team at Bespoke is surprised – especially given the new market highs.
- Initial jobless claims declined to 324K. This is the lowest since 2008. While it is definitely good news, job losses are only half of the story. We also need job creation.
- Home Prices are moving higher according to the Case-Shiller index. This is the slowest of the various measures, but it is coming along according to the Calculated Risk analysis. (Contra – Shiller himself remains skeptical. Investors must decide whether he is a leading or lagging indicator).
- The Jobs Report was Positive. I am scoring this as good news, partly because of the negative whisper expectations. The BLS estimate beat my own cautious forecast. It seemed to hit the sweet spot of moderate economic growth and continued Fed stimulus. Before we celebrate too much, there are a few cautions.
- Hours worked. This bothers me. I do not like it when there is a soft number on overall jobs but an increase in hours worked. We must be consistent. The 0.4% decrease in hours is like a loss of 500K jobs or so. There is something going on -- shift to lower-paying jobs, consulting, whatever.
- Structural Issues and Labor Force Participation. These are key topics. Mark Thoma highlights commentary from two leading sources (both of whom—and Mark -- were at the recent Kauffman Conference). I respect their commentary, and so should you. Dean Baker cautions on the composition of the changes. Tim Duy recommends following long-term trends.
The data this week included some significant bad news.
- Rail traffic is weak, up only 1.6% y-o-y (via Cullen Roche).
- ISM manufacturing increased to only 50.7. ISM research shows this to be consistent with real GDP growth of 2.7%, but many observers think this is a bit too high. It is on my summer research agenda. Meanwhile, here is a good chart from Calculated Risk, where you can also get more analysis:
- Personal income growth was only 0.2%, below expectations of 0.4%. This is an important economic indicator.
- Earnings reports show bottom line beats, while top-line misses. This leaves us wondering whether the current rate of earnings growth can be maintained.
The bogus tweet about White House bombings gets this week's "Ugly" award. There is a race encouraged by social media. The fastest way to find out about anything is Twitter. I use it, and so do you. There is an abundance of raw information, which is useful on many fronts. The problem comes when the high frequency traders pounce on "breaking information." Many individual investors unwisely believe that they can "protect" their investments with standing stops. It is not so easy, as I explained in this post.
If you are an individual investor and attempting to do active management of your portfolio, you really need to think about this issue. There will be special attention to this in the wake of the three-year anniversary of the "flash crash."
The Silver Bullet
I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. Think of The Lone Ranger.
This week's award goes to Doug Short for exposing the most recent ZeroHedge data deception. As usual, whoever was writing as "Tyler Durden" did not give a link to the alleged David Rosenberg comment, so we do not know if it is accurate. I get frequent questions from readers about ZH analyses and conclusions. The stories usually combine a smidgen of real data with severe distortion. This makes them difficult to refute, especially when the story appeals to the preconceptions of most readers.
The latest installment takes a single month of real income, distorted by anticipated tax changes, multiplies the result by 12 to "annualize" and make it seem bigger, and then go for the scare. Doug exposes this methodically and carefully. Most readers will not want to consider the full refutation – and that is what "Tyler" counts on.
Noah Smith in How Zero Hedge Makes Your Money Vanish makes a frontal assault.
Zero Hedge is a financial news website. The writers all write under the pseudonym of "Tyler Durden", Brad Pitt's character from Fight Club. Each post comes with a little black and white icon of Brad Pitt's head. On Zero Hedge you can read news, rumors, facts, figures, off-the-cuff analysis, and political screeds (usually anti-Obama, anti-government, and pro-hard money). On the sidebars, you can click on ads for online brokerages, gold collectibles, and The Economist.
The site is a big fat hoax. And if you read it for anything other than amusement, you're almost certainly a big fat sucker.
What Noah does not mention is the widespread following enjoyed by ZH – and mostly not "amusement" readers.
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) provides 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, well worth your consideration.
Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. 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 points out that the public data series has not been helpful or consistent with the announced ECRI posture. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating.
Doug reviews the latest (umpteenth) change in the ECRI methods, showing why there is nothing magical about nominal year-over-year growth in GDP of 3.7%. Short answer: low inflation.
The average investor has lost track of this long ago, and that is unfortunate. The original ECRI claim and the supporting public data was expensive for many. The reason that I track this weekly is that it is important for corporate earnings and for stock prices. It has been worth the effort for me, and for anyone reading each week.
Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.
The Week Ahead
I cannot remember a week that offers less fresh economic data. The pundits may try to make something out of nothing, but I will not – and neither should you.
The "A List" includes the following:
- Initial jobless claims (Th). This is the most responsive employment indicator. It is improving, and worth watching.
The "B List" includes the following:
We have passed the peak in the earnings story, but there is still plenty to come.
With the FOMC decision in the rear view mirror, the participants are free to talk – and they will! Expect plenty of Fed commentary and speeches and plenty of over-reaction by the punditry.
Trading Time Frame
Felix has switched back to a bullish posture, but the featured sectors are quite defensive. While the "official" call was neutral over the last few weeks that is based upon the overall ETF ratings. As long as there are three solid sectors to buy, we are fully invested in trading accounts. Felix has remained invested, but in the defensive choices. That means that the model has lagged market performance over the last few days, but at least we stayed invested – and despite plenty of skepticism.
Those who follow Felix have learned a key market lesson: Understand what is working, and follow it!
Investor Time Frame
Each week I write this separate section for long-term investors. Most want to out-guess the market. These are really smart people who are quite successful in their "day jobs." They spend some time online, reading carefully from the leading blogs.
They find themselves scared witless (TM OldProf euphemism). The result is that they rush to anything that has a defined yield, without considering the risk of losing principal.
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."
My general advice to investors differs sharply from that for traders. It also depends upon age and risk tolerance. And please remember that everyone is different!
Take what the market is giving you!
For the conservative investor, this means buying stocks with a reasonable yield, attractive valuation, and a strong balance sheet. You can then sell near-term calls against your position and target returns close to 10%, with risk far lower than a general stock portfolio.
For the investor with a longer time horizon, there are many fine opportunities. While some stocks and sectors are overvalued, there are many good choices.
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).
Can we expect new stock leadership?
In a word, "Yes."
We have experienced a multi-year period of economic skepticism. The US economy has succeeded anyway, and corporate profits have done even better. The Great Recession included a sharp decline, but a gradual rebound. We are still in the mid-innings of this recovery, with the end of the game not in sight.
It is an unusual opportunity to buy stocks that will benefit from an improving economy. Here is some good advice from Pat Ryan at FT Adviser: Buy Cyclical Equities.
Investor sentiment on equities appears to be improving, with inflows to equity mutual funds turning positive early in 2013 for the first time in years, but investors do not appear to have confidence in a true recovery in global economies.
Investors seem to have been forced into equities by the lack of return available in other asset classes and have thus far restricted their search to those equities they expect to show resilience in a potential market downturn.
However, this view has driven the valuations of more defensive stocks, particularly large, well-known companies, to unattractive valuations relative to the overall market.