September 7th, 2014
by Jeff Miller, A Dash of Insight
In the absence of major economic news and events, the punditry usually tries to squeeze a little more juice out of old themes. The Fed reaction to the employment report will, no doubt, get some attention, but there are interesting corporate stories this week. Between the Apple iPhone announcement on Tuesday and the start of the Alibaba road show, there is news to fill the vacuum before late-week economic data.
Going out on a limb a bit, I expect this week's market focus to be: What stocks have the best potential for the rest of 2014?
Prior Theme Recap
In my last WTWA I expected that the news would focus on economic growth - especially jobs - and the Fed reaction. This was an accurate forecast of the theme, but the disappointing jobs report removed any suspense about Fed policy.
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. That is the purpose of considering possible themes for the week ahead.
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This Week's Theme
As I noted in the last WTWA installment, the holiday-shortened week included an avalanche of economic data and crises from around the world. We have the following elements:
- A light economic calendar
- Little fresh fodder for the pundit favorite - second-guessing the Fed
- Big corporate news
- Fund managers who are lagging in their YTD performance (see Steven Russolillo at WSJ for a good analysis)
If ever there was a time to talk about stocks, this is it. As he so often does, Josh Brown highlights the key issue. He is writing about fund manager performance and the rolling story of the "year of the stock picker." He explains as follows:
For obvious reasons, this is not what the majority of active managers are able (or willing) to do in the mutual fund complex. That kind of activity is better left for traders who want to chop their own money to pieces, not for pros who have a responsibility to others.
I have some trader friends who are doing really well this year in the stock picking arena so far this year - they've focused on areas like tech and biotech that have been chock full of winners. It can be done. Just not by the majority of people - even among the best and the brightest. While the majority of stock picking mutual fund managers struggle, their more highly compensated brethren in hedge fund land aren't doing much better, with the average fund up just 2 percent year-to-date - but that's just par for the course.
This is great insight into how professionals think about the market and time frames. Should you do the same?
As usual, I have a few thoughts to help with that question. 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 a lot of very good news.
- Progress (?) in Ukraine. There is a lot of posturing from Putin. The story of a cease fire deal was announced and then withdrawn, leading to some modest swings in overnight futures trading. The final version (so far) is that an outline has been agreed upon. Skeptics think that this was designed to upstage the Obama speech to the NATO summit. I have no illusions that we are close to an ultimate resolution here, but this kind of news is how you measure progress. We'll know it is working when sanctions are reduced, something that would be a big boost for stocks. (Gregory L. White and Olga Razumovskaya at Market Watch have a good account).
- Factory orders had a record gain in July. (Reuters).
- Auto sales beat expectations with a run rate of 17.45 million versus 16.6 million. (See Scott Grannis for charts and analysis). The F150 truck sales indicator was a bit lower, perhaps because of the model changeover. Bespoke has that story and an updated chart.
- ADP private employment showed solid gains of 204K. This should be treated as a useful and independent measure of job growth. That is how it plays out in the long run.
- The Beige Book showed a continuing pattern of economic improvement. (The GEI account is a nice summary).
- The ISM manufacturing beat expectations, hitting a three-year high. Bespoke has the story and charts:
- ISM services (59.6) hit another new high, including all-time records on some components. Scott Grannis looks at the internals from this, including charts for key questions.
There was also some negative news, including the most important data of the week.
- Immigration reform is again delayed. Political accusations are flying, but that is not our interest. We simply note the market-unfriendly news. (See The Hill and here).
- Gasoline prices edged higher. The weekly change was 0.4 cents per gallon, but the increase for 2014 is 12.5 cents. (See GEI).
- The employment report missed expectations. I am scoring this as "bad" even though the market reaction was muted. Stronger economic data would be market-friendly, and this was an important "miss." The report was a disappointing exception to the rest of the week's news. There were plenty of negative accounts of this story, and they have gotten plenty of play. It is important to keep perspective. Calculated Risk has a great table of the worst months in the best years of job growth. Here are some other aspects that you might have missed from other sources.
- The report is an outlier from all of the other current data. New Deal Democrat summarizes using his regular review of weekly indicators, but this was a popular interpretation. People seem to forget that the sampling error alone on this report is +/- 100K.
- The "internals" do not make the case stronger. If there is sampling error, it affects everything, including the sub-categories.
- For those who parse everything in terms of Fed policy, this confirms the current Yellen posture on labor market slack and time until the first rate hike. (Jon Hilsenrath at WSJ).
- Those who claim to know the direction of revisions are blowing smoke. Revisions come as late-reporting firms check in and with "concurrent seasonal adjustments." Anyone who has a method for predicting the direction of revisions should publish it. Mostly this is an excuse for people who did not like the original number.
- Despite what you may have seen, the part-time/full time employment story is benign. Bob Dieli's regular monthly employment update (subscription required) covers the story effectively. Most part-time employment is voluntary. Here are two key charts:
Our "ugly" list for the last few weeks remains unfortunately accurate. We had headline news from all conflicts with plenty of violence and death competing for our attention. The Ebola crisis, cited a few weeks ago, continues to worsen. We may have to accept these as the "standing ugly list" so that we can consider new issues.
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. No award this week. Nominations are welcome.
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
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 (almost three years after their recession call), you should be reading this carefully. Doug includes the most recent ECRI discussion, which has been consistently bearish, despite the blown call on the recession. This now includes a fresh warning about inflation.
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."
RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. Dwaine's "liquidity crunch" signal played out as projected. This week he highlights his HILO Breadth index which he has designed to pinpoint bottoms and to warn of protracted corrections. Current readings imply an opportunity that usually shows up only once a year. Check out the full post for a description and charts.
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. Georg now has another new program, with ideas for minimum volatility stocks for tax-efficient returns. He also has new advice for those seeking a safe withdrawal rate, now featuring the use of put options to protect against extreme events.
The Week Ahead
After last week's avalanche of news, we have a more normal week for economic data and events.
The "A List" includes the following:
- Initial jobless claims (Th). The best concurrent news on employment trends.
- Michigan sentiment (F). Good concurrent read on employment and spending.
- Retail Sales (F). Any change from recent weakness?
The "B List" includes the following:
- JOLTS report (T). Increasing importance for insight into the level of structural unemployment. Also watch the quit rate.
- Business inventories (F). July data, but relevant for GDP revisions.
Breaking news from Ukraine and Iraq has become a part of the investment landscape, nearly impossible to handicap on a short-term basis.
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 remains bullish. Uncertainty remains high but is moving lower. This generated some fresh buy signals in equity ETFs. Our Felix trading accounts are once again fully invested. Broad market ETFs are also positive.
You can sign up for Felix's weekly ratings updates via email to etf at newarc dot com.
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. In addition, be sure to read this week's final thought.
We continue to use market volatility to pick up stocks on our shopping list. We do this because we also sell positions when they reach our (constantly updated) price targets. Being a long-term investor is not the same as "buy and hold."
Here is our collection of great advice for this week:
Abnormal Returns, famous for helping investors distinguish between signal and noise, has a great piece of advice: Don't watch the market intra-day. He tells a great story about Billy Beane from Moneyball, and then underscores the significance:
You are in a very real sense the general manager of your portfolio. You have the ability to make decisions about it at any time. The problem that Beane identifies, and tries to offset, is that emotions will always get in the way of making sound decisions. Managing money is difficult enough. Don't let the daily noise cause you to make errors along the way.
Many seem to agree, since CNBC ratings have hit a 21-year low.
The real "smart money" is looking past the obvious worries. Last week we highlighted a report with some unusual information from
Blackstone Advisor Byron Wein reports on a series of lunches he hosted, something he does every year. If you missed this one last week, please check it out.
In a similar vein, Barron's reports their latest survey of the "10 top stock market strategists." Their basic take? The stock market rally mostly reflects improved earnings and a small increase in the multiple. Stocks are not over-valued and remain attractive compared to alternatives. They expect selloffs to be limited. See the entire article for a list of their favorite picks. On a sector basis, they favor cyclical choices over the defensive names, just about the opposite of YTD performance from this table:
And here is a list of suggested stocks from Goldman Sachs, one of the cited sources (via Clayton Browne at Value Walk).
Speaking of market valuation, most of the popular sources seem to emphasize a couple of indicators that never show stocks to be fairly valued and have little application in the investment process of most professionals. (When is the last time you saw anyone recommend a stock based upon the Q ratio?) Abnormal Returns has a refreshing look at several different valuation approaches and charts, offered without commentary.
Stock ideas. My firm monitors hundreds of stocks, with about 100 on our watch lists at any given time. We have about fifty positions, split into three categories: Low risk with good dividends (which we use for Enhanced Yield), Value plays or growth at reasonable price (which we use for our theme-based long stock program), and some "high octane" ideas that have great potential, but higher volatility. Each approach is strong, but the objectives and time frames differ. I have often mentioned names from the first two methods in past posts. Today I want to highlight a new source, John McCamant, Editor of the Medical Technology Stock Letter. I have used his work for many years and had the opportunity to meet him in person on my recent trip to SF.
I understand that investors prefer free information, but that often limits you to widely-covered mainstream stocks. I use a combination of sources. With permission, I am quoting from John's most recent newsletter. It includes an overview of the current biotech sector. The recent issue explains why the InterMune (ITMN) buyout has implications for the entire sector. It updates a model investing and trading portfolio. There are breaking news segments on various names (including a few that I hold) and also information about a new idea (which I am considering). Here is the scoop on Nektar Therapeutics.
On A Roll As BAX-855 Hits Phase III Endpoint; Movantik Approval Next
The registration trial met its primary endpoint as BAX - 855, a long-acting Advate for hemophila A, controlled and prevented bleeding, routine prophylaxis and perioperative management for patients (>12 years old)
John has a "buy under" price of 13 and a target of 20. While I never buy a stock for takeover potential (and neither does he) that extra kicker is in play on this name. There is a free newsletter available for those interested.
Don't spend so much time on monthly or seasonal averages. Cullen Roche puts it strongly, saying that historical monthly stock data is "useless." I agree that the average seasonal move is modest compared to other important factors. Most of those trying to trade these "trends" have simply missed out on the bulk of the rally.
Some are not seeking opportunity because they are worried about possible market declines. If that is your situation, 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. You can get our report package with a simple email request to main at newarc dot com. Also 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).
I have two main ideas - why managers lag this year and what to do now.
This year has surprised many, including me, on one front - interest rates. I expected a stronger economy to increase the slope of the yield curve. This would help financials and reflect cyclical strength. While I had technology and health care exposure, the interest rate thesis has not yet worked.
This means that many managers will be moving to new ideas, reflecting new perceptions about current prospects. Why wait until the calendar turns? The biggest factor is that the European economy and ECB policies seem to be holding down US interest rates - not the rapidly tapering QE.
The question is whether the thesis is wrong or delayed. I think it is some of each.
The future depends upon the economic cycle. As part of my presentation at the SF Money Show I highlighted the most important takeaway: This economic cycle features a short and steep decline but a long and gradual recovery. Ignore those who try to make comparisons with the averages. The recovery will continue to frustrate those who have been left behind. (I'll post more about the specifics from the presentation. I need to figure out how to translate from verbal to writing, and also to adjust the length).
Barely had I returned when I saw that Morgan Stanley now thinks that the expansion could last for another five years and reach to S&P 3000. Here is their chart of the business cycle:
I congratulate their team on discovering this important information, but it does raise the question about why it took so long. At the start of 2013, they were calling for a market increase of about 2.5% - only off by 30% or so. Their cycle indicator is a back-tested method with proprietary inputs. Who knows how it will work in the future, or whether they will still be using it a year or two from now.
Meanwhile, please compare with this article, written at the start of 2013. I called it "the most exhaustive and challenging piece I have written. It was worth the effort because understanding the business cycle is crucial to making great investment decisions. To get the full benefit, I urge readers to spend some time reading the background links and watching the videos." It included Dr. Dieli's version of the business cycle chart, which has one important comparative strength. It is not the result of a back test. He developed it decades ago and has used it in real time. Please compare and see how it has worked over time.
You can also check out my 2010 piece (and follow ups) on Dow 20K.
While I have no fixation on the calendar, I constantly re-evaluate current ideas and theses. The stage of the business cycle is my blueprint for the months ahead. It should also be yours.