The Week Ahead
This week’s schedule will be dramatically affected by the government shutdown. Private data will assume unusual significance. Even if the government reopens, it will take several days to get the data machinery going again, including the September employment report.
The “A List” includes the following:
- Initial jobless claims (Th). Still interesting as the most responsive employment indicator, but very noisy due to California problems and the shutdown.
- The Fed Beige Book (W). This provides anecdotal information from around the country. It is part of the evidence in front of FOMC members at the next meeting, and sometimes influences market thinking about the economy.
- Leading economic indicators (F). Still popular with many market followers.
Bernanke is speaking on Monday. While the topic is the Mexican central bank, there are always policy questions. Bernanke speeches will now have a lower relevance factor.
Mostly we will be watching news about the debt limit negotiations.
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 switched to a bearish posture. For our trading accounts we decreased positions to 2/3 long. The long positions are rather defensive. This is not a short position, but we could find ourselves buying the lightened up at mid-week, but we are once again fully invested. This happens when we find three or more attractive sectors, even in a neutral or soft market. Felix’s ratings have been in a fairly narrow range for several months. The rapid news-driven shifts are not the ideal conditions for Felix’s three-week horizon. The high penalty box rating continues to underscore the uncertainty.
Insight for Investors
The challenge for investors is to distinguish between the major trends and the short-term uncertainty. The main themes are not related to headlines news, even though sentiment may drive market fluctuations. Do not 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.
Last week was a perfect illustration of how difficult it can be for investors to adjust when there is breaking news. Many who choose to go “all out” because of fear have no plan for re-entering when the risk is lower. Eddy Elfenbein – as he does so often – provides excellent historical perspective. Much was made of VIX levels (the implied volatility gauge that many view as the fear index) reaching 20. Eddy writes as follows:
But viewed in proper perspective, a VIX of 20 really isn’t that high. It’s just that recent volatility has been so low. Last quarter, the S&P 500 had an average daily volatility of just 0.45%, which was a seven-year low. The S&P 500’s close on Tuesday was 4% below the all-time high close from a few weeks ago. In 2011, the market fell nearly 20%.
(Geeky math interlude: If you’re curious as to what exactly the VIX measures, it’s the market’s estimate for the S&P 500’s volatility over the next 30 days. The number is annualized, so we can get it down to one month by dividing the VIX by the square root of 12, which is roughly 3.46. That gives us the market’s one-standard-deviation estimate for the S&P 500’s plus/minus range for the next month.)
Let’s take a step back and remember that during the last Debt Ceiling fight two years ago, the VIX came near 50. During the height of the Financial Crisis, the VIX topped 80. Traders are nervous today over a 20 VIX. The VIX was above 20 almost continuously for five straight years during the late 1990s and early 2000s. The stock market is far calmer today.
I recently wrote about how investors can manage risk, specifically considering the role of bonds and the risk of bond mutual funds. As I emphasized, “You need to choose the right level of risk!” Right now, it is the most important question for investors. There is plenty of “headline risk” that may not really translate into lower stock prices. Instead of reacting to news, the long-term investor should emphasize broad themes.
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).
Final Thought
As I have noted in recent weeks it is very difficult to trade around the Washington headlines. For long-term investment positions I use the fluctuations as opportunities to adjust positions, not as major risk factors. My current working hypotheses include the following:
- There is a real chance that no solution will be reached by the official D-Day – Thursday. Stan Collender puts the odds at worse than 50-50. That was also the verdict on several of the Sunday morning talk shows. Senate action will be further delayed since many procedures require unanimous consent to avoid delay. Some objectors are now calling for votes on unrelated issues.
- There will not be an actual default on Thursday. Here is a better timeline. We might still be wrapping up this issue next weekend.
- Whenever you can see overlap in the positions of two opposing parties, the eventual resolution is just a matter of time. There is pressure on the GOP from business leaders. There is pressure on Obama because of the very real effects. There is pressure on everyone from declining approval in polls.
- The eventual solution will combine some face-saving accomplishments for the GOP while also avoiding any precedent-setting notion of success. This is actually the trickiest point.
Daily trading will react and over-react to each piece of news, beginning with a soft opening tomorrow. This will all soon be forgotten, with a renewed focus on corporate fundamentals.
Biggest risk: The longer the issues drag on, the greater the chance that reduced consumer and business confidence has a real effect.