June 1st, 2015
by Jeff Miller, A Dash of Insight
This week's economic calendar is loaded with important data, featuring the employment situation report on Friday. The jobs story has been the most encouraging economic theme, with a recent assist from housing.
Especially in the context of the negative Q1 GDP report, next week's theme will be:
Will strong employment gains signal a second half economic rebound?
Prior Theme Recap
In my last WTWA (two weeks ago, since I had a travel weekend) I predicted that market discussions would once again focus on rising interest rate and the effect on stock prices. That was a good call for the entire two week period. Despite generally weak economic data, the Fed seems to be on course for higher interest rates this year.
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
This week's big data and event calendar comes at a time of intense debate over the state of the economy. In the context of the fresh, negative revisions to Q1 GDP each new piece of evidence is searched for any sign of a rebound. Were unusual factors at work in the first quarter? Should we expect a strong rebound?
Employment news has been the most encouraging of any of the economic data. This week's reports include several which bear upon the employment outlook, culminating with Friday's comprehensive employment situation report. I expect market observers to be asking:
Will employment growth signal a second-half economic rebound?
There are three basic viewpoints, but the differences are very sharp.
Even a good answer to the economic question leaves room to ponder what this means for the Fed and for markets. Recent FedSpeak suggests that the first rate increase is still on schedule for 2015. Will that come in the context of weak economy, despite the Fed claim to be data dependent?
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 some good news in a very mixed week.
- Travel consumption is strong. Myles Udland (BI) picks up on a Calculated Risk theme: Hotels-the best April ever! Nearly every metric analyzing hotel success is showing strength. My personal experience provides support. With more traveling than usual in the last month or so, I have experienced full flights and fully-booked hotels. People are meeting for many recreational reasons and they have money to spend.
- Pending home sales beat expectations soundly with a bounce of 3.4%.
- Consumer confidence improves modestly - on the Conference Board version. The Michigan sentiment survey is weaker, although the two usually track together. It is mixed news, but important. My favorite source for data on these series is Doug Short. His charts combine several key variables in one image.
The news also included plenty of negatives.
- Gas prices moved higher by three cents, the sixth consecutive week of increases. See Doug Short for full story and charts). On the other hand, prices are a buck lower than a year ago (Calculated Risk for charts and data).
- Weekly jobless claims increased to 282K. The four-week moving average also increased by about 5000.
- No progress in Greece. This remains a wild card. Despite the impending payment deadline, I expect an extension of some sort to take place.
- Durable goods continued the recent decline. Steven Hansen at GEI has a complete analysis with the expected charts and non-seasonal analysis.
- GDP was revised into negative territory. Many take this at face value - bad news about economic weakness. Some emphasize the temporary nature of early year effects - including unusually bad weather and the port strike. Others note the apparent problems with Q1 seasonal adjustments in recent years. Doug Short does a nice job of illuminating the contribution of each GDP component. Look at the size of each color segment to see the changing nature of those effects. Q1 is not bad on personal consumption, but weak on next exports. Justin Wolfers (The Upshot) notes that the picture shows continuing modest growth if one uses Gross Domestic Income. He repeats his argument that this is a more accurate measure than GDP.
The IRS data breach. Unlike private vendors, you have no way to avoid sharing data with the IRS. (Priya Anand, on consumer fraud for MarketWatch). Making matters worse we can now expect a raft of follow-on scams. Use care when evaluating those claiming to help with this problem. (NYT).
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, but nominations are welcome.
When so many people have the wrong idea, there must be an investment angle. Most people think that storms affect cloud computing! Hmm....
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."
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 wrote about the relationship between global leading indicators and US recessions, concluding that the signals helped for global recessions, but were less useful for the US. Here is the key chart:
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 every week. You should, too.
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 (3½ years after their recession call), you should be reading this carefully. This week the ECRI finally admits to the error in their forecast, but still claims the best overall record. This is simply not true. I rejected their approach in real time during 2011 and also highlighted competing methods that were stronger. Until we know what is inside the black box (I suspect excessive reliance on commodity prices and insistence on unrevised data) we will be unable to evaluate their approach. Also see Doug's important Big Four summary of key indicators, updated regularly.
The Week Ahead
There are fewer reports than usual this week, with a focus on housing.
The "A List" includes the following:
- The employment report (F). Still the big one for nearly all market followers.
- ISM manufacturing index (M). Highly regarded as providing concurrent information as well as some leading qualities.
- Personal income and spending (M). April data with an uptick expected.
- ADP private employment (W). A good alternative read on the employment picture.
- PCE price index (M). The Fed's favorite measure.
- Auto sales (T). Important and current private data.
- Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.
The "B List" includes the following:
- ISM non-manufacturing (W). Less history to this series, but covers more of the economy than manufacturing.
- Beige book (W). Anecdotal information that the FOMC will use at its next meeting.
- Trade balance (W). April improvement would help 2nd quarter GDP.
- Factory orders (T). April data.
- Crude oil inventories (W). Maintains recent interest and importance.
It is another big week for Fed speakers and possibly for news about Greece (good background here).
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 neutral stance for the three-week market forecast. The confidence in the forecast remains rather modest, reflected by the high percentage of sectors in the penalty box. Despite the overall market verdict Felix has generally been fully invested. 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. Felix appears almost every day at Scutify (follow him here).
The most amazing trader new of the week? It has to be Bill Gross. Just suppose that you identified the trade of a lifetime. And you were right! How much would you expect to make? "Well-timed, but not well executed" says Mr. Gross.
If you are serious about trading, treat it as a business. Check out each "product line." As always, Dr. Brett is on target.
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, it would be the advice on how to deal with a rising rate environment from Josh Brown and his colleague Michael Batnick. Their posts provide great analysis of how properly balanced portfolios have done in the past. Their advice is slightly different from my own. I prefer to avoid bond funds with my bond ladder, substitute covered calls on conservative stocks for enhanced yield, and still keep a smidgen of octane in the tank. That said, I agree strongly in concept.
Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time - at least - for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. I especially liked this link from Ben Carlson, on The Four Pillars of Retirement Savings.
Beware of target date funds! (Jay Ritter at Fortune). Too much emphasis on bond funds. Old formulas might not work.
Time to sell Time Warner (NYSE:TWC)? Philip Van Doorn has a nice article with a great point. When we are on the winning end of a takeover bid, we usually sell and move on. One member of our team is a risk/arb veteran, where he often played these trades with options. It provides a great opportunity for those who are true experts and can use leverage. It is a minefield for the average investor. If you are not an expert you do not belong in this trade! Do not try to squeeze out a few extra points.
Time to buy GE (NYSE:GE)? Michael Brush explains the case. (We often own GE, hedged by short-term calls for extra yield).
Barron's features Disney (NYSE:DIS) - not cheap, but with many new angles. It fits the expanding economy leisure theme.
Ben Carlson recounts a great story:
In The Success Equation, Michael Mauboussin tells the story of a man in the 1970s who set out to find a lottery ticket ending with the number 48. He bought the ticket he was looking for and ended up winning the lottery using his lucky numbers. When the man was asked why he wanted that specific number on his ticket he replied, "I dreamed of the number 7 for seven straight nights. And 7 times 7 is 48."
His post analyzes a history of the best and worst times to invest in stocks, analyzing the results. Here was the worst case, recommend reading for Hussman fans:
On the other hand, the worst period started in 1945 and ended in 1974 at the bottom of that nasty bear market in the mid-1970s. The ending balanced was just $774,000 or nearly $2.1 million lower than the 1999 end date. The crazy thing about these results is that the returns weren't that bad in the worst period. From 1970-1999, the annual returns on this 75/25 portfolio were very good - 12.5% per year. In the 1945-1974 time frame the returns were a very respectable 8.6% annually. That's a great return over three decades, but the low end point penalized the results.
Here is an interesting contrast:
- Investors cut US equity exposure to the lowest since 2008. (Reuters).
- Warren Buffett is close to his highest stock allocation in twenty years. (Sizemore Insights).
Who has done better over the last few decades......?
There are many worries - so many. It is easy to forget that these stories are very repetitive and very old. Ben Carlson provides a reality check.
When many market participants believe the same thing, we know that changes will be interpreted through that prism. Many attribute all or most of the rally in stocks to "pumping" or "liquidity." The rationale for how the increase in the Fed balance sheet affects stock prices is never stated very clearly, especially since the same observers usually deny the effectiveness of Fed programs. Somehow the various QE's and ZIRP's have affected stock prices without improving the economy along the way.
For investors firmly grounded in the fundamentals, neither the economy nor the Fed should be threatening to a portfolio of well-chosen investments. For those committed to catching short-term swings, it is more challenging. You have to guess the psychology of the market. History shows that the start of a tightening cycle is actually friendly for stocks. I have shown variants of this chart many times. This week's analysis comes from Roger Thomas, who summarizes several charts (including the one below) with this observation:
Presuming Fed starts hiking rates this fall, if they follow the typical hiking pattern, the market would return about 6% over the next 3/4 year (done hiking next summer).
Some think that this tightening cycle will be different in a very negative way - big balance sheet, no past experience from increases starting at the "zero bound," and a Fed that is dangerously late in changing policy.
Others, including me, agree that it will be different, but in the opposite way! This tightening cycle will be gentle and prolonged. I would not be surprised for this debate to continue for years, even after my Dow 20K target has been surpassed! (Bloomberg on Yellen plans).