September 21st, 2014
by Jeff Miller, A Dash of Insight
In the wake of the FOMC meeting and the IPO hype, we face a week with little new information - the lull before earnings season. This sort of vacuum makes it difficult to predict the week ahead, but I have an interesting idea:
This week will feature discussion about market divergences - gold, oil, small caps, and bitcoin are losers. Large cap stocks have been winners. Why?
A lot of buzz came from a Bloomberg article saying that 47% of NASDAQ stocks were "mired in a bear market." This was portrayed as showing a narrowing appetite for risk and loosely links it to prospective changes in Fed policy. It is an intriguing topic for further study.
Prior Theme Recap
In my last WTWA I predicted that the media focus would be the FOMC and the potential for changing course. That was very accurate, since the Fed meeting was the center of attention through Thursday. My question of whether the Fed would change course was answered with a firm, "No."
Feel free to join in my exercise in thinking about the upcoming theme. 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
Whenever there is a light schedule for data and events, the market focus can easily change. We have some important housing data this week, but my sense is that many are still digesting the implications of the Fed meeting. It seemed to be a non-event, with no change in the "considerable time" language or the pace of QE tapering. Despite media efforts to coax a story out of nothing, the "spikes" in stocks and bonds exhibited less volatility than we often see on the average trading day.
What was interesting? The continuing strength of the dollar. The currency market was the closest to showing a real spike, even when the Scotland effect removed one threat to the Euro. The dollar strength is a combination of the perception of increasing US interest rates, the relative rate advantage for US investors, and the comparative strength of the US economy. If you are a European investor, and you do not see a currency risk, why not take the higher US interest rates? We can guess that some fund managers are doing this trade on a leveraged basis.
The expectation of higher interest rates comes not from the official policy statement or from Fed Chair Yellen, but from the "dot plots." This chart reveals the individual expectations of Fed members. Despite repeated warnings that this is not official policy, that the group decision is not the sum of individual opinions, that not everyone has a vote, etc., etc., the market takes the dot plot seriously. Here is the recent version via MarketWatch:
Here are some interesting supporting themes. Expect to read and hear more about them in the week ahead:
- Outflows from European stocks (FT).
- Smallcaps struggling (Bespoke with the chart you expect).
- Gold has "looked like death" according to Joe Weisenthal. Josh Brown highlights the same point in time, comparing gold to stocks. Eddy Elfenbein joins in.
- Oil prices are falling (WSJ) and so are oil stocks.
- Izabella Kaminska sees "the end of bitcoin." Josh Brown wouldn't trade it, but thinks it is at a key support level. Kaminska has some interesting charts, but here is the key argument:
Well it's the same old story of frivolity, irrational exuberance, hysteria and of course the mistaken belief that something like a free lunch is truly possible. (Not to mention the cult's last great hope being lost, that of Scotland adopting Bitcoin...)
As usual, I have a few thoughts to help with these questions. 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, supporting the general thesis of economic strength.
- Dow Transports have been strong. Bespoke observes,
"Many investors look for the Transports to lead the way, and the fact that it has done so well is a bullish sign for the major indices like the Dow and S&P 500 in our view."See the full post for the expected fine chart.
- BLS benchmark revisions were extremely low. This little-followed story is actually very important. Each year, the BLS checks their monthly estimates of net job change by comparing the employment data from surveys with actual reports at state employment agencies. It takes months to compile, but it avoids the popular criticisms of the monthly employment data. There are no issues about seasonal adjustments, surveys, revisions, or the birth/death model. The job count is not exaggerated because no business will pay employment taxes on non-existent employees. It is our best employment data, but it comes with a delay. Barry Ritholtz highlights the story, quoting from employment experts at The Liscio Report:
The annual benchmark is based on the unemployment insurance system's records, which cover close to 100% of establishment employment, and are the last word in employment. It will be made official early in 2015.
The revision, through March 2014, was an unusually small 7,000 jobs, which is less than +0.05%, far below the +/- 0.3% average of the last ten years.
This is, of course, a disappointment for those of us who await the annual benchmark with bated breath, but it might quiet some chatter about the birth/death model, whose job is done once the benchmark is in place. It was remarkably accurate for the 12 months ended March 2014.
This is something to keep in mind each month as we get the employment data. Those who intone "birth death adjustment" while rolling their eyes, or complain about seasonal adjustments, or claim that data were fabricated -- they were completely wrong last year.
- Initial jobless claims hit a new low. Most people follow the seasonally adjusted four-week moving average, shown in the chart below. Bespoke also provides the NSA data and chart, the lowest reading for this week of the year since 2000.
- The Scotland independence referendum failed. Please note that I am scoring this as "good" because it was market-friendly, not because of the merits of the issue. There were many dire warnings about what would happen had it passed - bank failures, plunging European currencies, and worldwide ripples. Overnight futures rallied as the results came in.
- Homebuilder confidence is at the highest level since 2005. (Calculated Risk). Are they seeing something not apparent from the reported sales data? Builders report an increase in buyer interest and traffic. See also Nick Timiraos at the WSJ.
- Retail sales were in line, but the revisions were positive. Ed Yardeni shows the relationship with his earned income proxy and the continuing growth of both series.
- FOMC policy. No matter what you think of the Fed, the market quietly celebrated the decision and even held ground through the Yellen press conference.
- Inflation data were benign. See Doug Short's deep dive for comprehensive analysis and his typical fine charts.
There was also some important negative news, especially housing data.
- Industrial production fell 0.1%. A gain of 0.3% was expected. Steven Hansen of GEI looks at the story from several viewpoints, including the unadjusted data. See the full post and the interesting collection of charts.
- Student loan debt is hurting home sales. Nick Timiraos of the WSJ has a helpful account of a report from John Burns Real Estate Consulting. The estimate is that each $250 in monthly loan payments reduce purchasing power by $44,000. Those with $750 payments or higher are often completely priced out of the market.
- Earnings revisions drop significantly. Check out the green line in Ed Yardeni's chart below and you will see the dramatic decrease in Q3 estimates. Dr. Ed looks on the bright side, expecting a strong beat rate. Earnings expert Brian Gilmartin still sees a chance for 2014 growth of 10% and highlights the potential in financial stocks.
- High frequency indicators show deceleration. New Deal Democrat has his regular important weekly update for these data.
- Housing starts were poor. So were building permits, my own preferred lead indicator. Calculated Risk comments as follows, while noting that the months in 2014 still show improvement over the same month in 2013:
This was a disappointing report for housing starts in August.
Starts were only up 8.0% year-over-year in August.
There were 670 thousand total housing starts during the first eight months of 2014 (not seasonally adjusted, NSA), up 8.6% from the 617 thousand during the same period of 2013. Single family starts are up 3%, and multi-family starts up 23%. The key weakness has been in single family starts.
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, is deepening. Some are calling it a "Katrina moment" for the World Health Organization.
Looking for some new themes to worry about- a panel has suggested an overhaul in end-of-life health care. Here is another political third rail. We are delivering costly care that patients do not want while depriving them of counseling and comfort that they need. Until you have witnessed this personally, you do not really understand how dysfunctional our system is. Despite this, it defies correction.
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 (three years after their recession call), you should be reading this carefully. Doug includes the most recent ECRI discussion concerning continuing economic weakness in Japan. Doug covers the possible implications for the US.
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. Georg continues to develop new tools for market analysis and timing. Some investors will be interested in his recommendations for dynamic asset allocation of Vanguard funds.
Barron's summarizes reasons to expect 3.5% economic growth through 2015. Check out the four interesting reasons.
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.
- New home sales (W). Housing remains crucial to the economic rebound and new homes have the biggest impact.
- Michigan sentiment (F). Good concurrent read on employment and consumption.
The "B List" includes the following:
- Existing home sales (M). Will we finally see a real rebound?
- Durable goods (Th). Wild swings in the headline number; ex-transportation was weak last month.
- GDP final estimate for Q214 (F). This is old news, but still an interesting baseline.
There is plenty of Fedspeak on tap. We might think that there is little fresh news on that front, but we still see surprises that add color to the official statements.
Breaking news from Ukraine and Iraq has become a part of the investment landscape. These stories are having an effect, but are 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 has shifted from bullish to neutral based upon overall strength. Ratings for the broad market ETFs are mixed. Our Felix trading accounts remain fully invested for now because there are still at least three solid choices. With the generally modest ratings, Felix might signal a move to more cash during the coming week. The trading program can sometimes go short via the inverse ETFs, but that has not happened in more than a year.
Traders should all be reading everything from my friend, Dr. Brett Steenbarger. This week I especially liked his article about going "on tilt," the emotional response familiar to poker players. Hint: Be realistic in your expectations.
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:
Economic prospects are better than most people think - including Alan Greenspan. Last week I featured the former Fed Chairman's 9 Reasons Why the Economy Stinks. It seems only fair to include a response from John Kim, Chief Investment Officer at New York Life, who notes that he has access to a perspective different from Greenspan's. He has 9 Reasons Why Alan Greenspan is Wrong about Everything. This is an interesting list, and I recommend taking a minute to consider the various points, listed in reverse order. The final point relates to big data. The following is a key section:
We are at a point where we can quantify the positive impact of Big Data, Kim said, noting that as we realize some $300-$600 billion in annual cost savings and productivity gains from Big Data, the U.S. economy is building fresh GDP equivalent to about +1.5 to +3%...all from Big Data. The Economist noted that data is new big natural resource, analogous to what steam was in the 18th century, what electricity was in the 19th century and what hydrocarbons were in the 20th century.
And the U.S. is driving it.
Beware of unregulated and leveraged commercial loans. Lisa Abramowicz at Bloomberg has an excellent story, Dirty Secret of $1 Trillion Loans Is When You Get Your Money Back, showing the dangers, the big payoffs for banks, and the possibility for cascading effects throughout the financial system. The reach for yield has driven fund managers to include these holdings, which are not securities. The article does not explain exactly how to protect yourself. I am studying this further. It fits a general pattern of investments that supposedly offer safe yield.
Celebrity stock pickers? Be careful. Barry Ritholtz starts with a story about leading jazz musician Kenny G (a favorite of Mrs. OldProf). He starts his day with Starbucks - the stock price, not the coffee! Barry reviews the results from Playmates, actresses, and models, as well as the infamous story of Lenny Dykstra. Remember when Gisele Bundchen insisted on payment in Euros? This article is fun, but it also has an educational lesson.
Beware the pump-and-dump schemes. I know that I have emphasized this topic before, but I am trying to help individual investors. People continue to fall for these schemes. What is your defense? My colleague at Scutify, Cody Willard, will not permit the penny stock promotions that you see on other investment sites. Global Economic Intersection is all over these stories, with regular updates. Here is the key quote from the SEC on this one:
Zirk de Maison concocted an array of reverse mergers and company name changes on his way to gaining control of the vast majority of Gepco stock in order to conduct a multi-faceted manipulation scheme. To help avoid the pitfalls of microcap fraud, it's important to check the histories of companies and determine their legitimacy before deciding whether to invest in them.
Speaking of Scutify, there is a new feature that you might want to try. If you register at the site and add #question to your scuttle, you can get answers from a number of experts with differing methods. It is easy, fun, and educational. There was a good debate Friday on Alibaba. (I was bidding for one of our programs - the "high-octane" portfolio - but it was too rich for us. Others bought and some were very skeptical.
Don't go "all out" of the market. The safest investment strategy is not one of all cash. AllianceBernstein shows that even risk-averse investors should have a 20% stock allocation - even with time horizons of only three years.
If you are stuck in gold or out of the market completely, you might want to reconsider your approach. The current economic cycle is in the fifth inning. 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 currently have a free trial subscription to an "independent" take on the news. Each night I am told that the official government data are wrong, the stock rallies are all contrived, and the wheels will come off at any moment. Reading it is an interesting exercise, but I have an advantage. I know what to look for and taught graduate level classes in research methods and statistical analysis. My guess is that most consumers are either deceived or falling victim to confirmation bias.
The divergence story is a bit like that. When small stocks were leading the rally, we were warned that the market was frothy - a sign of a top. Now that the big stock/small stock relationship is coming into line, it is a sign of a "dangerous divergence."
I have two suggestions:
- Ignore the various death crosses and omens. Adam Grimes does a careful analysis of the Death Cross, showing that the effect lasts only a week or so and then quickly decays. His method is actually more likely to show an impact than you usually see, since his comparisons use the upward-sloping baseline from stock performance. His post, which you should read carefully if you are an investor who depends on technical indicators, notes that much of technical analysis depends upon compelling visual impressions rather than statistical support.
- Many of the current effects are dollar-related and difficult to time. The obvious first-line effects are energy and materials stocks. These are core holdings for value managers because they are all cheap by traditional metrics. Gold is also a casualty.
The strong dollar will eventually be good for the US economy, consumers, and stock investors. It is important to understand this instead of chasing short-term dollar effects. Investors who want to understand the time frames better could start with this Barron's article by Schwab's Liz Ann Sonders. It is right on target.