August 11th, 2013
by Jeff Miller, A Dash of Insight
In last week's article I predicted a snooze fest, and that was pretty accurate. I also wrote,
"Because column inches and air time must be filled whether there is real news or not, I expect a week laden with speculation about tapering, who will become the new Fed chair, and whether economic data warn of a new recession."
That was also on target, especially with several Fed speakers and the reports from the Kotok "shadow Fed" meeting, where there was plenty of Fed leadership discussion. The disaster scenario, apparently, is a Summers appointment with Yellen and others resigning. Meanwhile, President Obama's press conference seemed to back away from the idea that these are the only two choices.
Last week did raise a theme that I did not forecast: The testing of 1700 in the S&P 500 index. I expect this to get more play in the week ahead. There are plenty of talking heads suggesting that the year is over, and it is time to ring the cash register! Ka-ching! But should it be Ka-ching?
Here are the basic viewpoints:
- Look out below! It is easy to find the single most popular "investment" website, which has been expensive for any reader who took it seriously since its start in January, 2009. I am regularly sent links to this site from big-name brokers and fund managers, who uncritically accept appears to be data confirming their positions. You can also easily find the regular predictions of Cara, Comstock, Shilling, Mauldin, Fleckenstein, and Prechter. Save yourself some money by checking out the "guru grades" at CXO Advisory.
- Look out for biased advice! Cullen Roche (in a theme that will be familiar to my readers) says it very well:
'But you have to be really careful with these kinds of sites. They aren't actually out to serve your best interests. They really just want you to keep coming back every day so they can feed on your emotions like a leach. After all, that's how they survive. If they didn't keep you coming back they'd go out of business and the authors would have to go out and find real jobs doing something that doesn't involve scaring the (ahem, edited to "wits" TM OldProf euphemism) out of people professionally."
Please read his entire short and sincere post on scary websites….
- Look out for general financial news! Daniel Solin at USNews (HT Chris Roush) shows just how bad the general advice can be. Did you know that the Motley Fool funds are all performance laggards? Or that Jim Cramer had a "sell" on the four best market performers? (negative odds of 13 billion to 1, but I did not check the exact calculation).
- Targets have been reached. Many Street analysts who were bullish at the start of the year have seen their original targets met. In some sense, they are already winners. Why push it?
- Move targets with changing evidence. Thomas Lee of JPMorgan thinks that the S&P could get to 1800 or even 1900 in the next twelve months. That is 12%, and he is the most bullish on the Street….
So there you have it, and you will see more in the next few weeks. Worries about the Fed and the fact that the market has already had a big year.
As usual, I have some thoughts on the rest of the year and "ringing the cash register." 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. Each week I consider the upcoming calendar and the current market, predicting the main theme we should expect. This step is an important part of my trading preparation and planning. It takes more hours than you can imagine.
My record is pretty good. If you review the list of titles it looks like a history of market concerns. Wrong! The thing to note is that I highlighted each topicthe week before it grabbed the attention. I find it useful to reflect on the key theme for the week ahead, and I hope you will as well.
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.
This was a light week for data, but the news was mostly good.
- All of the "high frequency" indicators (except interest rates) were positive. I always check out NDD's weekly post at The Bonddad blog for a good update on money supply, gas prices, rail traffic, and lots of other items.
- Home prices are up 11.9% according to CoreLogic June data. Calculated Risk calls the report "very strong" noting that it is the best increase since 2006.
- The ISM services index was very strong. Steven Hansen at GEI looks deeply into the report and concludes,
"The July 2013 ISM non-manufacturing (aka services) index continues its growth cycle, improving from 52.2 to 56.0 (above 50 signals expansion) – and the internals were even stronger."
- Jobless claims beat expectations. Doug Short notes that the widely followed four-week moving average is at a post-recession low. Check out the full article, but here is a great chart. (If Doug wanted to dabble a little more during his alleged retirement, he could teach a class on the visual display of information).
- Global PMI's improved – a lot. This is very good for corporate revenues and (eventually) earnings. See Ed Yardeni's discussion and charts.
There was very little bad news. Feel free to add in the comments anything you think I missed!
- The BLS JOLTS report showed little increase in available jobs. It is not getting worse, but we really need some improvement.
- The China threat looms. Ed Yardeni pulls together a number of indicators, for a 2014 China warning.
The Indicator Snapshot
It is important to keep the current news in perspective. I am always searching for the best indicators for our weekly snapshot. I make changes when the evidence warrants. At the moment, my weekly snapshot includes these important summary indicators:
- For financial risk, the St. Louis Financial Stress Index.
- An updated analysis of recession probability from key sources.
- For market trends, the key measures from our "Felix" ETF model.
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 recently edged a bit higher, reflecting increased market volatility. It remains at historically low levels, well 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.
I feature the C-Score, 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. Meanwhile, 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.
Georg Vrba's four-input recession indicator is also benign. "Based on the historic patterns of the unemployment rate indicators prior to recessions one can reasonably conclude that the U.S. economy is not likely to go into recession anytime soon." Georg has other excellent indicators for stocks, bonds, and precious metals at iMarketSignals.
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 almost two years 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.
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, emphasizing the best methods, 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.
Why hasn't the ECRI changed its tune in the face of the evidence?
Readers might also want to review my 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. Over a month ago we briefly switched to a bearish position, but it was a close call. The indicators quickly shifted back to neutral, which was also a close call. Three weeks ago Felix turned bullish, again by a small margin. All of the indicators have continued to improve.
These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings have improved quite a bit. 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 has declined, so we now have more 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
After last week's snoozefest, this week's calendar is more normal.
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 index (F). This remains a good concurrent indicator for employment and consumer spending.
- Building Permits and Housing Starts (F). The housing rebound is crucial for economic recovery and building permits are the best leading indicator.
- Retail sales (T). Of special interest given some weak reports from specific retailers.
The "B List" includes the following:
- Industrial production (Th). A key indicator for GDP, so it is closely followed.
- PPI (W). With no sign of inflation, there is not much market interest. It would take a few reports with a significant move to get attention.
- CPI (Th). See PPI.
There are several other reports including small business optimism, the Empire state index, and the Philly Fed. None rate to have market significance. Atlanta Fed President Lockhart speaks on Tuesday, and his comments last week were taken as bearish (early tapering) by the market.
How to Use the Weekly Data Updates
In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a "one size fits all" approach.
To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?
My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.
Insight for Traders
Felix has turned bullish, which is now fully reflected in trading accounts. The ratings are improving and there is good breadth -- including the broad market indexes.
Felix has done far better than most traders, accepting the reality of the improving market. Felix has also shifted away from the emphasis on foreign markets, although we have been invested in Europe via the Vanguard FTSE Europe ETF (VGK). There are currently many attractive choices, so this position could change in the upcoming week.
Insight for Investors
In a very real sense, this entire post carries a message for the individual investor --- what perspective to take and what sources to follow.
A key message is not to be seduced by the idea that you can time the market, calling every 10% correction. Many claim this ability, but few have a documented record to prove it. Most who claim past success are using a back-tested model. Please see The Seduction of Market Timing.
This is an opportunity for reflection. Think of it as a mid-year checkup.
- For several weeks, I have accurately emphasized the danger of yield-based investments – yesterday's source of safety. The popular name for this is "The Great Rotation." It is still in the early innings, since bond fund investors are only getting the bad news from their statements. Even the best bond managers (like Gross and Gundlach) cannot win when interest rates are rising. The exodus from their funds is starting. Most investors are emphasizing cash, real estate, and gold. .333 is good in the major leagues, but not for your investments!
It may be a "generational selling opportunity" for bonds.
- Find a safer source of yield: Take what the market is giving you!
For the conservative investor, you can buy 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%. The risk is far lower than for a general stock portfolio. This strategy has worked well for over two years and continues to do so. (I freely share how we do it and you can try it yourself. Follow here).
- Ask yourself how you are doing? Josh Brown's powerful piece earned the top admiration score from any blogger: I wish I had written it! Here is the start, but you need to read it all.
"If you had twenty five years left to live, how much time would you spend worrying about the daily ups and downs of the stock market?
If you had twenty years left to live, how much time would you spend trying to time the stock markets and the economy and other things that are both unpredictable and completely out of your control?
If you had fifteen years left to live, how much time would you spend trying to buy or sell a specific stock at the perfect price?"
And much more… For many investors there comes a time when they should focus on fun, and maybe also improve performance.
- Lose the focus on fear! Many are rewarded for making sure that you are "scared witless" (TM OldProf euphemism). If you are addicted to gold and allegedly safe yield stocks, you need a checkup. Gold works in times of hyperinflation or deflation/crisis. When neither happens, the ball is going between these Golden Goalposts. There is a good transition plan for those with a fixation and fear and gold.
And finally, 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).
I want to start with an anecdote that I hope you will find to be both amusing and helpful.
I have a friend who is very intelligent and successful in his profession. He likes to gamble in various forms, with a current emphasis on poker. He has two rules:
- He quits when he has made or lost $1000.
- He quits at midnight.
Let us suppose that he finds himself at a game where there are a number of serious, hard-eyed players who are playing "tight." They all look like pros. Even a few hours in this game might lead to a negative outcome, although my friend could always get lucky.
Let us suppose that he encounters a table full of visiting auto dealers, flush with bonuses and wearing their special convention cowboy hats. The drinks are flowing and all-around merriment ensues. Betting is aggressive and loose, often without supporting cards.
Finally, let me suppose that my friend lost his $1000 in each of the two scenarios. What should he do? For the professional player the answer would be easy. You might wait weeks to find a table with a bunch of guys in dealer-sponsored cowboy hats. Keep playing, even if you have to hit the ATM after a bad beat!
And that is how I view markets. You should too.
I am not a slave to the calendar, trying to fit market performance to a clock striking at midnight. If there is an opportunity, we should seize it. I adjust stock price targets every week. I also do not go "all in" for new accounts on the first day they open – unlike buying a mutual fund. There are opportunities, so take them as they come.
Let us look at the picture in both a general and a specific sense.
Here is the general picture, which got a lot of attention from several great sources last week.
Barry notes that looking only at the Shiller PE is confirmation bias.
Josh notes that the Shiller PE over-emphasizes 2008.
Jeff notes that even Shiller does not use his system for market timing.
Brian Gilmartin is our go-to source on corporate earnings. This week he highlighted Microsoft (MSFT) and Freeport McMoran (FCX) – value stocks with catalysts. I like and own both (with short calls against MSFT). See his charts and analysis.
The upside always gets under-estimated. The most intriguing idea that went almost unnoticed this week came from Ed Yardeni. What happens to earnings when capital spending accelerates?
This analysis got about 1% of the attention that Merle Hazard got. Too bad that Dr. Ed doesn't sing. Let us check back in six months and see which was more helpful!