April 12th, 2015
by Jeff Miller, A Dash of Insight
Despite a full slate of economic news and data, I expect earnings season to command special attention in the week ahead. For the first time since the Great Recession it is possible that corporate earnings will contract for two consecutive quarters. With the media penchant for colorful characterizations, I expect this to be a dominant theme as we all consider next week's earnings reports.
Is this the start of an "earnings recession"?
Prior Theme Recap
In my last WTWA I predicted that attention would center on the apparently growing potential for a correction in stocks. That was the right question at the week's start, with a carryover effect from the prior Friday's employment report. With stocks not trading and futures down on the employment news, everyone knew the week would have a bad start.
This was the big theme on CNBC and MarketWatch on Monday and Tuesday. There were more recession calls. Michael Batnick has a nice post on how quickly the market shrugged off the employment news and the general irrelevance of short-term economic data.
When became clear that this story was not playing out, producers, editors, and writers switched to the Apple watch and the GE restructuring. The question of whether a correction was looming was timely, and for now, the answer seems to be "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.
This Week's Theme
There is plenty of economic data this week, including some major reports. More important will be the first big week of corporate earnings. If you are not familiar with the term, "earnings recession," then get ready. You will hear it a lot, especially if there is weakness in early reports.
An earnings recession describes a circumstance where corporate earnings decline for two consecutive quarters, somewhat analogous to the commonplace (but flawed) definition of a recession as two consecutive quarters of negative growth. While earnings season is always important, this one has special significance. After a quarter of softer economic data, everyone wants to know what effect there was on profits. Look for pundits to be asking:
Is this the start of an earnings recession?
The viewpoints cover the typical wide range.
- An earnings recession is likely and important. (Akin Oyedele at BI summarizes the Bank of America take).
- A quarter of lower earnings is likely, as the result of energy stocks, weather, and a stronger dollar - all temporary.
- An earnings recession is possible, but unimportant. (Paul Vigna - WSJ)
- No way! Earnings will eke out a small gain despite the temporary effects. Brian Belski says "Bunk." He cites the delayed benefits from lower energy prices and the lower bar set by estimate reductions.
Stefan Cheplick reports on the decline in estimates, including this helpful chart:
As always, I have my own ideas in today's conclusion. But 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 mostly good news last week.
- Initial jobless claims. 281K slightly beat expectations and took the closely-watched four-week moving average to the lowest level since 2000. (Calculated Risk)
- Job openings are increasing. So is the quit rate, a sign of employee confidence. I was an early fan of the JOLTs report, which many sources still do not use effectively. I am delighted to see that Doug Short has started coverage of this series. He has several charts, but this one combines important elements and allows you to see the quit rate.
- Mortgage applications rise suggesting more home buyers. Diana Olick (CNBC) notes that overall levels are still low:
Despite the increase in applications, mortgage application volume is still considerably lower than historical norms, and especially low today, given pent-up housing demand. Some argue that credit availability is still too tight, which is keeping potential buyers on the sidelines.
- The Fed plans shallow rate increases according to NY Fed President Bill Dudley. His comments helped to set the tone for the week.
- Global PMI is stronger, something that might be surprising to many. (Contra: IMF global growth forecasts via the FT). Ed Yardeni has analysis and this chart:
- Business lending is "booming" according to Scott Grannis's analysis, including this chart:
There was not much bad news. Feel free to add anything I missed in the comments.
- ISM services registered a slight miss, but the 56.5 reading is still very solid.
- Rail traffic remains weak, unchanged on a year-over-year basis. Steven Hansen provides analysis as well as this interesting table showing a "weak growth cycle":
- High frequency indicators show weakness, especially anything where the US is connected to the world economy. New Deal Democrat has his weekly update. This is a granular update including items you might otherwise miss. I read it every week to round out a comprehensive view of the data.
Teens and smartphones. 25% spend almost all waking hours online, mostly on social media. (Pew data via PBS). There is a fundamental question about productivity and access to information - potentially very good, but perhaps with unexpected consequences.
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 known better as "Calculated Risk." Bill started with a blog focused on housing, but expanded to comprehensive economic commentary. He earned the respect of the economic and financial communities.
At the end of last year Bill made a series of ten forecasts about the economy with a full post on each. He provided a three-month update this week. While early in the year, I found it quite impressive. It is more measured than the optimistic economic predictions and much better than those always seeing the worst from any report. See for yourself, and you will understand why I emphasize this source each week. If you are interested in economic growth, housing, employment, the Fed, or oil prices there is something for you.
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
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."
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 has the latest interviews as well as discussion. Also see Doug's Big Four summary of key indicators.
RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting market indicators. He recently noted an increase in his combined measure of economic stress, although the levels are still not yet worrisome. Recently Dwaine introduced a valuation model that is much more sophisticated than the popular Shiller CAPE method. It also provides a much less worrisome conclusion, 13.7% returns through the end of 2016.
Georg Vrba: has developed an array of interesting systems. Check out his site for the full story. We especially like hisunemployment rate recession indicator, confirming that there is no recession signal. He gets a similar result from the Business Cycle Indicator. Georg continues to develop new tools for market analysis and timing, including a combination of models to do gradual shifting to and from the S&P 500. I am following his results and methods with great interest. You should, too.
EconomPic shows why we should all spend time on the macro picture as part of the long-term investment process.
The Capital Spectator updates some quantitative methods for spotting bubbles. This is a refreshing alternative to the sources that see all bubbles, all the time, in nearly every market. He notes 0.95 as a key point on one indicator, charted below. We remain well short of this risk level. Another featured approach is even more sanguine about the low bear market probability.
The Week Ahead
It will be a big week for economic data.
The "A List" includes the following:
- Retail sales (T). Are consumers buying or saving?
- Building permits and housing starts (Th). Remains a key hope for fueling the economic rebound.
- Michigan sentiment (F). Combines information on job creation and spending.
- Beige book (W). Anecdotal evidence for each Fed district provides color for the next FOMC meeting.
- Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.
- Leading indicators (F). Despite changes over the years, still viewed by many as significant for economic prospects.
The "B List" includes the following:
- PPI (T). Inflation measures are still a minor influence on markets. Someday this will change, but not yet.
- CPI (F). See PPI (above).
- Crude oil inventories (W). Maintains recent interest and importance.
- Business inventories (T). February data but some relevance for Q1 GDP.
There is a little FedSpeak at mid-week, but I expect earnings news to take center stage.
There are some regional Fed surveys, but these rarely have a major market influence.
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 continued a bullish stance for the three-week market forecast. The confidence in the forecast is now a bit stronger, reflected by the percentage of sectors in the penalty box. Our current position remains fully invested in three leading sectors. For more information, I have posted a further description - Meet Felix and Oscar. You can sign up for Felix's weekly ratings updates via email to etf at newarc dot com.
Do you want to make some options trades during earnings season? Savvy traders understand that the OTM options can be more expensive than those close to "the money." You are wiser to use implied volatility for pricing rather than the dollar price. You can buy cheaper deltas. (If what I am writing does not make sense, you are not ready to trade options). Steven M. Sears of Barron's cites the Goldman derivative desk.
Make sure you are not trading "too big." Adam H. Grimes tells a familiar story in an effective fashion. Using simulated data for a trader with significant edge, he shows how easy it is to blow out from excessive size. You might also enjoy my 2007 post on this theme, where I recount some blackjack exploits of famous expert Ken Uston.
Felix did not enter the hedge fund manager contest at Scutify.com ($20,000 in cash and prizes), but he is making a daily appearance to mention a top sector. Check in yourself to get some ideas and join in the discussion.
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. Major market declines occur after business cycle peaks, sparked by severely declining earnings. Our methods are focused on limiting this risk. Start with our Tips for Individual Investors and follow the links.
We also have a page summarizing many of the current investor fears. If you read something scary, this is a good place to do some fact checking.
Here is our collection of great investor advice for this week:
If I were to recommend a single source this week, it would be David Rosenberg (via Sam Ro at BI). He has a great analysis of the theme that nearly everyone is getting wrong - the length of the business and stock cycle. This is a familiar topic for readers of "A Dash" but it looks like Rosenberg might be a lonely bull at the Mauldin Conference!
The problems with the economy and the stock market don't start with the first rate hike, but rather the last one - it is that last one that inverts the yield curve that bites and by then it is too late.
The stock market typically rolls over in less than a year and the economy shifts to recession three to four months after that - but dating the process from the first rate hike to the start of the recession is three years, on average.
So even if the Fed were to begin tightening as early as September, the historical record would suggest that the next downturn would not start until the third quarter of 2018 and the stock market won't begin to price in until late the spring of that year at the earliest.
BlackRock's Global Chief Investment Strategist, Russ Koesterich, has a similar view - the rally can continue for at least another year.
Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor, even if busy, should join with a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition.This week he has an emphasis on practical advice, including this disturbing chart about saving:
And also this important advice for millennials - the best things to do first, via Vanguard.
Time to sell GE says Avi Salzman. (Barron's)
Energy stocks may soon be attractive. I always enjoy posts by "Davidson" often brought to us by Todd Sullivan. This one explains the seasonality and fundamentals of the energy market with a view toward a return to $90/barrel for oil. Even a hint of that would move energy stocks. This is a nice analysis of speculative trading versus fundamentals.
Low Yield Environment
The lack of dependable yield raises many issues and alternatives. Here are some ideas from this week's commentaries.
- Do not double down. Just because yields are lower does not mean that you should take more risk. Ben Carlson has some ideas.
- Watch out for "liquid alts." A promise of something for nothing? (WSJ)
- Or maybe not. (The Sovereign Investor)
- Or get educated. Alts Democratized is a comprehensive look which I am reading from cover to cover. For most people it could be a reference book. Skip to Chapter 18 for an idea of the overall fund selection process.
- Watch out for bonds. A modest increase in rates could generate a double-digit loss. (Philip Van Doorn at MarketWatch).
Trading less is good. (Jason Zweig at the WSJ).
As Warren Buffett wrote in 1991, "the stock market serves as a relocation center at which money is moved from the active to the patient."
Did you know that Ben Graham changed his methods with each revision of his classic book? Morgan Housel has a fascinating post explaining why those of us following the value approach should be constantly updating our methods.
Everyone with a bearish outlook cites the "Buffett Indicator" to show the overall stock market capitalization relative to GDP. Mr. Buffett mentioned this about fifteen years ago and it has been a popular method of scaring investors witless (TM OldProf) for the last several years. There are many reasons why it might not be so useful right now - a below-trend economy, more earnings from abroad, extremely low inflation and interest rates - so you might want to ask Mr. B about his current thoughts. I asked on Twitter and I also invite readers to send a citation for any recent statement of his applying the indicator to the post-recession market. Meanwhile, he told CNN that he likes stocks and does not see a bubble.
Eddy Elfenbein has updated his comparison of stocks and bonds, helping to illustrate why most serious investors and managers continue to find stocks more attractive.
The combination of the "R word" with earnings is a great way to put investors on edge and increase viewership and page views. Who would care if you just said that a combination of factors was sending earnings slightly lower? What is the fun in that?
As we look at individual stock reports, we will all pay attention to the outlook for future sales and earnings. Watch to see how frequently anyone talks about Tobin's Q or the CAPE ratio for a stock. When it comes to individual stocks, we all try to look ahead, to see what current trends are doing with that company's prospects.
We now can consider the work of hundreds of analysts, looking more deeply at companies than we can. I recommend getting as much information from this as possible. Do you suppose that Ben Graham, if he were alive and writing a new edition, would ignore this information?
If you look more closely at the "squiggle chart" in the introduction - the one that purports to show wildly optimistic estimates by analysts - you might see something useful. Try picking a point that is the start of the year for each estimate - not the two-year period used on the squiggles. You will see that the estimates are not bad for a one-year period, something that I reported in this post. Analysts got much better in the post Sarbanes-Oxley era.
We need objective data about past earnings and a willingness to consider forward earnings. My main source for this useful data series is Brian Gilmartin, who has also taken a careful look at the effect of oil price cuts. He expects earnings ex-energy to be up 5-6%, an important comparison. He also notes that Q4 earnings growth ex-energy was 9%, virtually unreported in the media.
The year-over-year growth rate for forward earnings has once again turned positive. We can and should be on the watch for a true recession - the source of major earnings declines. The talk about an "earnings recession" should not be a source of worry.