June 15th, 2014
by Jeff Miller, A Dash of Insight
Into the economic news vacuum, summer doldrums, and sports stories, there was finally some real news – the renewed conflict in Iraq. This had all of the features that make for good financial television and web punditry – action, plenty of people with opinions and accusations, and the potential for a dark outcome.
Whether or not this is a big story, there was clearly a media drive to make it one. My guess is that it will continue to lead for the early part of the week ahead.
Prior Theme Recap
Last week I expected a focus on a rebound in volatility, with potential for an upside breakout for stocks. I suggested that we should all "be prepared." Sure enough, the quiet upside started the week, but lasted only two days. I did not guess that the House Majority leader would lose his primary race, sparking a round of instant-punditry on the future of many policies. The expanding Iraq conflict also demonstrated what can happen to markets in a low-volatility backdrop. Investment strategist John Canally, cited in Barron's opined that the shock to energy markets would have had a big effect thirty or forty years ago. It is less important for a service economy. The same article notes that many market participants confessed to watching the beautiful game during working hours. Quelle surprise!
Forecasting the theme is an exercise in planning and being prepared. Readers are invited to play along. I work on it each week because, it helps to prepare your game plan for the week ahead. It is not as easy as you might think. Feel free to suggest your own likely theme in the comments.
Naturally we would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.
This Week's Theme
The market discussion will start with a recap of events in Iraq, with media sources milking the story as much as possible. By mid-week the attention will probably shift to the Fed meeting and the housing data.
I have covered the latter two topics quite thoroughly in recent weeks, so I want to take a deeper look at the Iraq issue.
Here are some interesting perspectives.
- The breathless coverage from CNBC. I love the updates from Art Cashin, which accurately reflect what floor traders are thinking. Here is the sequence:
- Jim Cramer, with television in both morning and evening has plenty of air time to fill. The general theme of the Cramer warnings it that everyone remembers the stock declines associated with prior Iraq conflicts.
- On Tuesday Cramer was warning about declines while also saying that most declines since 2009 have been buying opportunities.
- On Thursday night Cramer advocated caution, profit-taking, and sitting on cash.
- Jim Cramer, who has a lot of air time to fill, opined on Friday morning that oil would move to $120/barrel in a straight line.
- The 24/7 coverage from your favorite conspiracy and doomer site. If you are determined to focus on what could possibly go wrong and get some confirmation for your opinions, you know where to go! The "analysis" there makes the CNBC stories seem wildly optimistic.
- Focus on expansion of the conflict. Whether you watch CNN or read the New York Times, The Washington Post, Politico, or The Hill (all favorite sources here) you will understand that this is not another round of major U.S. involvement. A key question is whether Sunni tribal leaders will support this particular insurgency.
- Potential effects on energy prices – maybe $15-20 per barrel at the max. This is enough for a serious economic effect. Most of the fighting (in the North) does not currently threaten reserves or exports. (Good overall analysis at MarketWatch).
- Many factors limit the impact on oil prices, including production slack. (Helpful story at Yahoo Finance).
- Stocks are not likely to suffer a major decline from the Iraq crisis. The chief investment officer of the Gabelli Funds thinks that the story will be with us for some time, but expects another 7.7% upside this year for stocks.
Which of these viewpoints is correct? I track them all as part of the job, but you need not. As usual, I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week's news and data. Readers, especially those new to this series, will benefit from reading the background information.
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.
There was some encouraging news.
- Short interest is higher and that usually leads to market gains. (Callie Bost at Bloomberg).
- Job openings increased by almost 10% to 4.45 million. This was the positive aspect of the JOLTS report. (See below for the negative on quit rates).
- Small business optimism is surging. I do not usually emphasize the NFIB results. As a small businessman and board member for two other small companies, I understand the frustration with regulation and policies that seem to stall growth. The NFIB statements express this viewpoint, and attitudes plunged with Obama's election. It is interesting to note the improvement (via the WSJ). Bespoke also has a great chart and a table of business concerns.
- PPI declined by 0.2%. Ostensibly this is good, but some take any decline as a sign of economic weakness. The market had little reaction.
- Rail shipments surge. Simon Constable notes the correlation with industrial production, including this helpful chart:
The economic news was slightly negative for the week.
- The "quit rate" from the JOLTS report showed no change. Job openings are a bit higher. Most people would be surprised to learn that almost 2.5 million people voluntarily quit their jobs last month, but it is not an improvement.
- The World Bank cut the growth forecast for 2014 to 2.8% from the prior 3.2%. In a sense this is old news, since it is reflecting Q1, but it is still discouraging. (Reuters).
- Retail sales growth disappointed – only 0.3% after some good private data. The ex-auto results were also soft. See Calculated Risk for analysis and charts, including this one:
- Oil prices spiked. Gasoline prices have been stable, but will probably soon follow the oil price increase. New Deal Democrat has the story on this, along with his regular collection of high-frequency indicators. While the gas prices are a negative, he is looking for strength in Q2 GDP.
- Bullish sentiment is spiking. Normally we treat this as a contrarian negative. Bespoke has this story as well as the chart (below). The AAII has their own study. It is a bit long for most readers, but it is worth the time for those who like to follow sentiment. The gist is that most studies incorrectly include some hindsight in the analysis of past data. If you use only data available at the time, the contrarian interpretation is not very persuasive. High neutral readings are actually encouraging for stocks and bullish readings not much of a negative.
- Michigan sentiment remains discouraging, missing expectations at 81.2.
There is plenty of ugly news in the world, but I wanted to enjoy Father's Day without dwelling on the negative. I miss my Dad. I wrote about him six years ago in this signature family story about a young sailor. It has plenty of insight for investors, which I tried to explain. I hope to enjoy tomorrow with my son, and I am sure that we'll remember his grandfathers as well.
The Big Question for This Week
The Fed has not managed to satisfy markets when it comes to communication. Fed Chair Yellen was the communications guru before assuming the lead. The problem is that traders want a clear, unambiguous message. They frequently respond as if each Fed speaker was on a mission to add nuance to the latest official statement.
Unlike those of us who have worked in non-business organizations, the market types are uncomfortable with debate, dissent, and nuance. The decision is not Yellen's, although she has special influence from her leadership. It is the vote of a committee. There are also non-voting members. Even when the vote is unanimous, the opinions vary. In an effort to improve communications, the Fed is sharing the projections of each participant. Markets seem to be focusing on this rather than the result of the voting process. Thomas Simons of Jefferies (cited at MarketWatch) has taken the public statements of Fed members and constructed chart for those who want to score at home:
If there is a deviation between the "dot plot" and the official summary, we can expect a repeat of the "taper is tightening" market fuss from a year ago.
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 Bill McBride of Calculated Risk. There is a lot of debate about labor force participation and also many misconceptions. My friend and fellow Michigan man Dean Baker is an expert economist on labor markets, and has written that the decline in prime-age workers shows weakness in labor markets.
Bill responds by looking at the trend for this age group, noting that a researcher in 2000 might well have predicted today's participation rate. This implies reasons other than economic weakness, including stay-at-home dads. I will be interested in whether Dean has a response.
Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.
Recent Expert Commentary on Recession Odds and Market Trends
RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis.
Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured "C Score." One of his conclusions is whether a month is "recession eligible." His analysis shows that none of the next nine months could qualify. I respect this because Bob (whose career has been with banks and private clients) has been far more accurate than the high-profile TV pundits.
Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (2 ½ years after their recession call), you should be reading this carefully. Doug includes the most recent ECRI discussion, which has been consistently bearish, including the blown call on the recession. He compares their "consistent" forecast with the spread of conclusions from mainstream economists in the most recent WSJ survey. I always encourage reading this summary, but I find this one surprising for three reasons:
- It seems rather obvious that a group report will have a wider range than that of a single source;
- Doug produces no evidence that any single member of the panel has been inconsistent; and
- Inaccurate consistency is not a virtue.
Doug does not mention whether he expects GDP for Q2 GDP to follow the ECRI prediction of that of about 35 of the economics panel who are looking for something between 3 and 4%. Here is the chart in question:
Doug also has the best continuing update of the most important factors to the NBER when they analyze recessions.
Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg's BCI index also shows no recession in sight. For those interested in hedging their large-cap exposure, Georg has unveiled a new system.
Jan Hatzius made important news. The inimitable "Stalwart" Joe Weisenthal says it is the Call We've Been Waiting 5 Years to Hear. Hatzius believes that growth will now be back above trend. Joel quotes him as follows:
Despite the 1% drop in real GDP in the first quarter, we believe that the US economy is now growing at an above-trend pace. The best way to see this is via our current activity indicator (CAI), which grew at an annualized rate of 3.4% in May, similar to the average of the prior two months. Although an estimated ½ percentage point of this sequential growth is due to a bounceback from the weather distortions of the first quarter, even the year-on-year CAI now stands at 2.7%, the fastest pace of the expansion so far and above our estimate of potential growth of 2%-2½%. In our view, the CAI is a far more reliable indicator of economic activity than real GDP because it is more timely, more broadly based, less noisy, and less subject to revision.
Hatzius also cites housing as one of the key drivers of growth.
Readers should also note that he was cited by Nate Silver as the economist who got the Great Recession called right, and for the right reason. This is important to keep in mind as we learn more news about how bad things were in Q1. I am seeing revisions taking Q1 GDP down as low as -2.0%.
Binyamin Applebaum of the NYT presents an alternative viewpoint, featuring George Mason economist Tyler Cowen. His research, supported by a growing group of economists, suggests that a lower long-term growth rate is in prospect. There are many sources in the comprehensive article – well worth reading. The darkest viewpoint comes from two Brown economists who are concerned about a "permanent recession."
The Week Ahead
We have an active week for economic news and data.
The "A List" includes the following:
- FOMC rate decision (W). Taper by the expected $10 B or a little more? Continuing debate over how to interpret the group message.
- Initial jobless claims (Th). Best concurrent read on employment.
- Leading indicators (Th). Remains a popular method.
- Housing starts and building permits (T). Any sign of a spring rebound. Watch single-family permits for a leading indicator.
The "B List" includes the following:
- Industrial production (M). A read on Q2 GDP after some seasonal fluctuation.
- CPI (T). Eventually this will be interesting, but currently remaining in a narrow range.
FedSpeak will be limited to the official variety because of the FOMC meeting. The regional Fed surveys are not very important unless there is a very large move. Iraq and related news will dominate, unless there are clear signs of stability.
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 sees even more opportunities -- fresh buys in the ETF universe, as more sectors emerge from the penalty box. A high penalty box level implies less than normal confidence in the ratings. This week we were fully invested in three of the top sectors for our trading accounts.
The overall call has become more bullish, after a few weeks of near-neutral readings.
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. The current "actionable investment advice" is summarized here.
The market did not provide much opportunity for fresh buys. The gentle upward action is fine for long-term investors and excellent for those trying out our Enhanced Yield approach.
Here are some key themes and the best investment posts we saw last week:
10 Lessons Learned from Peter Lynch is a great reminder story at Novel Investor. Jon pulls together items from two of Lynch's books. I am picking the lesson that most closely fits today's theme, but all of them are great.
Every day brings something different to worry about – inflation, recession, depression, natural disaster, war, market crash, and that bus when you cross the street. In the last 100 years, the market has seen it all and recovered. You can wait for the sky to fall or you can invest knowing it will happen, you'll get through it, and the market will too.
The post reminded me of a story from ten years ago, at the North American Bridge Championship in Reno. One of my friends, a retired investment professional, was walking along a corridor leading to the game. A man walking next to her asked if she knew where to find the partnership desk. (This is a place where people without a partner or team can find someone with similar experience). She replied that she did, but that she had no game herself. She said that she would be delighted to play that afternoon. And that is how my friend got to play bridge with Peter Lynch. It is amazing that he was moving through the maze of clueless highly-focused bridge players in relative anonymity. Bridge players are focused on winning. It was at this tournament where my team beat Bill Gates in a short match….but I am getting too far off course!
Beware of using the Dow ETF for long-term investments. With only thirty stocks and based upon price weighting, it does not capture an economy that has more service and technology. Do you think that your "general market investment" should be 8% in Visa (V)?
Stock prices are consistent with economic fundamentals. Ed Yardeni provides an update on his Fundamental Stock Market Indicator, which seems to work better than many others!
Investors have a low exposure to stocks, the lowest since 1959. (See Howard Gold at MarketWatch).
Another source (cited in the NYT) confirms the conclusion. One observer notes that fear is the reason.
If it wasn't fear, there'd be a much different variation by age," Ms. Duncan said. "Certain cohorts need more liquidity than others. When you find consensus across age cohorts, you realize it's not for liquidity needs but lack of trust across all age and wealth levels
If you are worried about possible market declines, you have plenty of company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. Check out our recent recommendations in our 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 and use feedback).
The resurgence of conflict in Iraq is a story with many angles.
Most importantly, it raises questions about the prospects for stability in a country torn by religious and ethnic divisions.
For the U.S., there are questions about foreign policy. Is it wise to intervene in foreign civil wars? Does it matter if regional stability is threatened? What if terrorist groups are involved? If action is taken, should it mean providing arms (which seem to find their way into the wrong hands)? Is there a special responsibility in Iraq, given the history of U.S. involvement? These are all difficult questions. While the answers will seem obvious to many, the problem is that there really is no consensus.
The issue provides political ammunition just as the mid-term elections are gearing up and the Presidential election (already) getting plenty of play. Reputations and past decisions can and will be re-examined.
These issues are important to us as citizens and the election angle is fun for political junkies.
This is the wrong attitude for investors! These are the times when people are most tempted to confuse their opinions about foreign policy and politics with the cool, unemotional decisions about their investments.
Investors should focus on two things:
- The chance for an expansion of conflict beyond Iraq. So far this seems pretty limited.
- The impact on energy prices. This could be a threat to global economic growth, so it bears watching.