November 17th, 2013
by Jeff Miller, A Dash of Insight
In the early days of television (starting in 1955), one of the most popular programs was The Lawrence Welk Show. The audience demographic can be inferred from the sponsors, which featured Geritol (which addressed the issue of "tired blood"), Polident (for dentures) and Serutan (spell it backwards). The effervescent dance sound from Welk's orchestra was called "Champagne Music" and they added to the entertainment value with a bubble machine.
Just as bubbles increased the audience of yesteryear, we have a modern day equivalent. Instead of merely entertaining, today's bubble illusionists frighten people who might otherwise make normal investment allocations.
It is time to move beyond the bubble talk!
Investors would find it cheaper and more fun to listen to some old bubble music! Suppose that you had to "pay" for each hour of reading that conspiracy site by first listening to one hour of Welk's champagne music….just a thoughtJ (You can check out a famous show with Jack Benny here, or with Welk as a guest on Benny's show here. I hope you have as much fun with these old classics as I did in doing the research.)
Over the last few weeks I have highlighted the changing market concerns. We worried about the government shutdown and debt ceiling. More recently my emphasis has moved from earnings and seasonal worries, to the possibility of a year-end rally. Check out the past three themes:
- Will Disappointing Earnings End the Stock Rally?
- Time for a Year-End Rally?
- Do Sidelined Investors Face Upside Risk?
This has been a pretty accurate read on the changing market mood – and generally done one week in advance. This week we are witnessing another change – a delayed shift away from the focus on spotting bubbles.
Josh Brown highlights the Barron's cover story that "everyone's talking about". Josh explains why Andrew Bary "gets the bubble meme right." One aspect is that the cover has "Bubble?" (With a question mark).
Is there a bubble? Undeniably, there are few of them – in some areas of tech and in the IPO market. Also, some credit bubbles in terms of who can get debt financed at what price. But the entire marketplace or economy is not one giant bubble, as the Prophets of Doom will have you believe. Today's Tech and IPO bubbles are symptoms of the economic improvement this time around – people feeling good about the future – but they are not the drivers of it.
And here is a key segment from Andrew Bary's article:
"The first stage of the bull market was a revaluation to something resembling reasonable levels as it dawned on investors that the world wasn't going to end," says Stephen Auth, chief investment officer at Federated Investors. "The second stage began this summer with a transition to the view that the economy is accelerating and that earnings are poised to increase significantly in the coming years."
Tom Lee, the bullish JPMorgan strategist, says "We're in a secular bull market that will last at least another three years." Adds Jim Paulsen of Wells Capital Management, "If inflation stays at 3% or less, the market P/E could get into the 20s."
This is consistent with my own theme – one that will be familiar to regular readers. I summarized it Friday morning on Scutify, where you can exchange trading and investment thoughts. I am a very lonely voice. Most of my colleagues and the vocal traders see a crash as "when, not if." While I commented on Yellen and other events, here was the key take on bubbles:
I do not see a bubble in the general stock market. Bonds seem way overvalued, as do some spec names, small caps, and pure dividend stocks. There is lots of opportunity to capture rotation.
I have some thoughts about the opportunities, which I'll discuss 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 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, including some you have not seen elsewhere. 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 mixed week for news, despite the market gains.
- The Yellen Confirmation Hearings. From a market perspective, our definition of "good," the hearings were a big success. Yellen was professional, prepared, and responsive. She had met with all of the members in advance. While some disagreed with her policies, she enjoys widespread support as well as acceptance. Her confirmation is not going to be an issue. Communicating Fed policy and unwinding the balance sheet are matters for the future. Those objecting to Yellen were mostly people who question the entire concept of a central bank and/or the stated dual mandate for the Fed. For investors who accept reality, this is good news.
- The technical picture has improved. I often recommend the work of Charles Kirk. He has a fine weekly chart showthat highlights the various bullish and bearish setups. Charles is never doctrinaire. He is willing to change positions with the evidence. His most recent report (small subscription price required) is more bullish, but also shows what is required for technical traders to accept another upward leg in stocks.
- Banks chasing traders out of chat rooms. If you read some logs of past conspiracies, you will understand why this is good for markets and the average investor. Will traders simply move to Snapchat, perhaps a multi-billion dollar company?
- US oil production is leading to energy independence. Izabella Kaminska has the story, complete with charts. She cites energy expert Stephen Schork, who argues,
"In hindsight, you drive oil to $147 barrel and lo and behold, five years hence the world is swimming in oil. It really is that simple."
The news updates also included some bad news. I did not see too much, but feel free to add suggestions in the comments. These should be items from the current week, not the repetition of something you could have said (and probably did) six months ago!
- Q3 Earnings beat rate was disappointing, at 58.6%. The chart below is the summary from Bespoke. Year-over-year growth was 5.6% with revenue growth of 3.2%. Brian Gilmartin has the full story, with updates on forward earnings, comparison of Thomson/Reuters with FactSet, and an excellent analysis of the impact of JP Morgan on the overall quarter. Great stuff.
- Eurozone recovery is weakening. The WSJ thinks it "feels like recession." Barry Ritholtz has a powerful rejoinder.
- Industrial production declined by 0.1% in October. Steven Hansen takes a deeper look at unadjusted data, and is more optimistic.
- The US recovery has left many behind. Barry Ritholtz analyzes it by income class. NPR looks at small towns. Both are great reads.
- Immigration reform seems dead – at least for the current term. (See The Hill for the two-part video story).
- Consumer holiday spending is looking down. (Via Gallup). See also Doug Short's excellent treatment of the same data in real terms.
The ObamaCare rollout. Putting aside the political viewpoints, we all hope for more general access to affordable health care and insurance. Even those who see the Affordable Care Act as a step forward, acknowledge that the implementation has involved a step back.
There are various investment implications, ranging from a distraction from other business to changing prospects for health care companies. For the moment, it remains an important theme to monitor.
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 David Merkel, cited by Tom Brakke. David explains the various risks in one of the popular choices as investors chase yield – the leveraged, closed-end municipal bond fund. Tom uses his famous charts, and concludes as follows:
Big yields (especially tax-free ones) are so alluring and so dangerous. Most investors can't parse the risks and, frankly, many of those purporting to provide guidance aren't going to bother to educate them.
A Touch of Humor
A study finds that money managers with doctorates outperform less-educated peers. Good SAT scores also show a relationship. Who would have thought that intelligence and education are relevant? And of course, I know plenty of exceptions!
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 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. Theirmost recent report provides a market-timing update for those considering whether to "buy the dips."
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. His most recent update revisits Albert Edwards's year-old prediction that the Ultimate Death Cross was imminent. Georg refuted the claim at the time, and now takes a more complete look. Here is the key chart:
Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverageof the ECRI recession prediction, now 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. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating. The ECRI approach has been so misleading and so costly for investors, that I will soon drop it from the update. The other methods we follow have proved to be far superior. Here is Doug's most recent chart of the Big Four indicators:
Readers should review my Recession Resource Page, which explains many of the concepts people get wrong.
Here is our overall summary of the important indicators.
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 the last two months Felix has ranged over the full spectrum – twice! The market has been moving back and forth around important technical levels, driven mostly by news.
Felix does not react to news events, and certainly does not anticipate effects from the headlines. This is usually a sound idea, helping the trading program to stay on the right side of major market moves. Abrupt changes in market direction will send sectors to the penalty box. The Ticker Sense poll asks for a one-month forecast. Felix has a three-week horizon, which is pretty close. We run the model daily, and adjust our outlook as needed.
The penalty box percentage has decreased dramatically, meaning that we have more confidence in the overall ratings.
[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
We have finally caught up with the delayed data, and this week brings an unusually thin calendar of events.
The "A List" includes the following:
- Initial jobless claims (Th). Resuming a key role as the most responsive employment measure.
- Retail Sales (W). Of special interest given mixed announcements from retailers and lower consumer sentiment.
- FOMC minutes (W). Could move the markets if trader parsing suggests a more hawkish tone.
The "B List" includes:
- Existing home sales (W). Not as important as new construction, but still a key economic sector.
- CPI (W). Not very important while it remains so low. Eventually it will be. One of the unusual instances where this report comes before the PPI results.
- PPI (Th). See CPI comment.
FedSpeak is hitting a near record, with at least six scheduled speeches. For good measure, we also have ECB President Mario Draghi giving the keynote at the European Banking Conference.
The Philly Fed report is significant only when there is a big move, but that is possible this week.
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 continues in bullish mode. In our trading accounts we have been fully invested and the positions have gradually become more aggressive. 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. This week we continue to see somewhat lower ratings and fewer sectors in the penalty box. It is one of the most encouraging combinations in months.
Insight for Investors
I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. I am covering some detailed ideas and links in this section, but also see the conclusion.
- Headlines. 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.
- Risk Management. It is far better to manage your 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.
- Stepping in gradually. If you are completely out of the market, you are not alone. Consider buying dividend stocks and selling calls against them. This strategy has been working great both for our clients and for many readers. (Thanks for the email responses!) This will work in a sideways market. You can also buy some stock in the sectors with the best P/E ratios.
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).
The bubble theme has been very costly for investors. Research in behavioral economics has demonstrated that even wildly inaccurate concepts have an anchoring effect, distorting the ability of many to reach logical conclusions. The Wiki article on heuristics and decision making is pretty good. Read the anchoring section. Even ridiculous concepts distort perceptions. Many have allowed the incessant discussion of bubbles to distort their perceptions.
The Barron's cover story includes thirteen specific stocks to consider as well as some with excessive valuations. The current market has experienced several years of simplistic trading: risk on, risk off. Things are starting to change.
We are moving from a climate of fear to one of opportunity. Sector and stock picking will be rewarded. There are some good themes:
- Out of bonds.
- Out of simple yield plays that trade like bonds.
- Out of precious metals which depend on either fear or hyper-inflation.
- Out of stocks that have extended valuations – including some small caps, recent IPO's, and pure dividend names.
- Into the less-favored sectors – large cap tech, cyclicals, and financials.
And most importantly
The investor does not need to go from zero to 100 in a few seconds. If you are worried about the market, but also worried about missing out, it is easy to start small. There is no need to go "all-in" like the players in the World Series of Poker! You can right-size your risk (via individual bonds or covered calls on dividend stocks) and still benefit from the continuing improvement in the economy and in US equities.