posted on 10 April 2016
by Jeff Miller, A Dash of Insight
The economic calendar is moderate. Fed Heads are out in force. More significant is the start of "earnings season." There is always speculation about earnings, but this time is special. I expect a focus on the question:
Will earnings spark a break in the trading range for stocks?
Prior Theme Recap
In my last WTWA I predicted a focus on the parade of Fed speakers, with special attention to their apparent economic optimism. That was indeed a recurring subject, highlighted by Thursday's discussion among the current Fed Chair and three predecessors. One of the "Fast Money" participants even used my mixed metaphor (Fed painted itself into a box). Unlike me, he was not smiling when he said it! Doug Short notes that it was the worst week in the last nine, and also that Q1 GDP estimates are now barely positive. See his discussion and context as well as his excellent weekly chart. (With the ever-increasing effects from foreign markets, you should also add Doug's World Markets Weekend Update to your reading list).
Doug's update also provides multi-year context. See his full post for more excellent charts and analysis.
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. You can make your own predictions in the comments.
This Week's Theme
The economic calendar is moderate. Once again, the Fed participants will be out in force. More importantly, earnings reports begin with Alcoa on Monday and the big banks late in the week. This season might be the most important in recent years. Economic reports reflect only modest growth. The Q1 GDP estimate is plunging.
For equity investors, nothing is more important than earnings and future earnings potential. With stocks in a recent trading range, many wonder whether there is a potential to break out - and in which direction! Options expiration may provide fuel for an explosive move either way. I expect many to be asking:
Can earnings news move stocks out of the trading range?
The earnings story is crucial for stocks. Unlike many who focus on backward or concurrent data, FactSet shows why earnings expectations are important.
To these results one must also add the effect of the P/E multiple.
The basic themes, moving from bearish to bullish, are as follows:
These viewpoints have all been vigorously expressed in recent days, but my sense is that short-term traders are mostly negative on earnings.
As always, I have my own opinion in the 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 an "ugly" and on rare occasion something really good. My working definition of "good" has two components:
There was a little good news in a light week for data.
Some of the news was negative.
The Panama Papers. The news of how the rich and powerful escape taxation has many dimensions. Expect it to remain in the news. Here are a few current themes:
The most popular tax havens, from Felix Richter via GEI:
Banks have a "tail risk" because prosecutors may pounce. (ValueWalk)
This is a big story in the U.S. (Value Walk)
And dismiss the conspiracy theory about the Russians being responsible. (Brookings)
I am leaving out the effects on Presidential politics. More to come, but generally not good.
An Ugly Update
In January I cited the Flint water problem as evidence of infrastructure neglect, suggesting that it was something to monitor. This week we have an update from VOX. I cannot do justice to the interactive chart in my static format. Please check it out to see the threat in your own community. I was surprised at the variation even with small geographical changes. Here is the basic map (click here for interactive map at Vox):
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 Ethan Harris of Bank of America Merrill Lynch (via BI) for refuting the conspiracy theory about central banks and the dollar. Those who have been on the wrong side of the market embrace any way to blame the Fed. This is a breath of fresh air.
It is not the only Fed conspiracy theory, but taking on this one is a start.
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. Beginning last week I made some changes in our regular table, separating three different ways of considering risk. For valuation I report the equity risk premium. This is the difference between what we expect stocks to earn in the next twelve months and the return from the ten-year Treasury note. I have found this approach to be an effective method for measuring market perception of stock risk. This is now easier to monitor because of the excellent work of Brian Gilmartin, whose analysis of the Thomson-Reuters data is our principal source for forward earnings.
Our economic risk indicators have not changed.
In our monitoring of market technical risk, I am now using our new model, "Holmes". Holmes is a friendly watchdog in the same tradition as Oscar and Felix, but with a stronger emphasis on asset protection. We have found that the overall market indication is very helpful for those investing or trading individual stocks. The score ranges from 1 to 5, with 5 representing a high warning level. The 2-4 range is acceptable for stock trading, with various levels of caution.
The new approach improves trading results by taking some profits during good times and getting out of the market when technical risk is high. This is not market timing as we normally think of it. It is not an effort to pick tops and bottoms and it does not go short.
Interested readers can get the program description as part of our new package of free reports, including information on risk control and value investing. (Send requests to info at newarc dot com).
In my continuing effort to provide an effective investor summary of the most important economic data I have added Georg Vrba's Business Cycle Index, which we have frequently cited in this space. In contrast to the ECRI "black box" approach, Georg provides a full description of the model and the components.
For more information on each source, check here.
Recent Expert Commentary on Recession Odds and Market Trends
Georg Vrba: provides an array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal. He gets a similar result with the twenty-week forward look from the Business Cycle Indicator, updated weekly and now part of our featured indicators.
Doug Short: Provides an array of important economic updates including the best charts around. One of these is monitoring the ECRI's business cycle analysis, as his associate Jill Mislinski does in this week's update. She notes that their interpretation is that the business cycle will not turn higher. His Big Four update is the single best visual update of the indicators used in official recession dating. You can see each element and the aggregate, along with a table of the data. The full article is loaded with charts and 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."
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 systems. These include approaches helpful in both economic and market timing. He has been very accurate in helping people to stay on the right side of the market.
Dwaine's RAVI model forecasts 30% upside for 2016. Readers are invited to contrast this with a typical Hussman article and explain why one should be preferred. More on this in articles to come.
Dwaine also has an interesting animated depiction of unemployment by state.
Barry Ritholtz opines that a recession is not imminent and cites the key elements involved in official recession dating. Barry is one of our frequent and favorite sources. I am delighted that he is helping his wide audience understand this conclusion. Since he has been known to read WTWA on occasion, I am also a bit disappointed. We have been all over this theme since mid-2011. Our top recession forecasters have done much better than his lunch pal from the ECRI. Bob Dieli's methods have worked in real time for decades and include all of the points Barry cites. When Barry next visits Chicago I would be delighted to take him to lunch with Bob. I guarantee that all would enjoy the experience, and Barry would get to meet the recession forecaster with the best real-time record.
The Week Ahead
We have a light week for economic data. While I highlight the most important items, you can get an excellent comprehensive listing at Investing.com. You can filter for country, type of report, and other factors.
The "A List" includes the following:
The "B List" includes the following:
There is once again a daily diet of FedSpeak. Friday is options expiration, with the potential to amplify big moves during the week.
I am not very interested in the regional indexes. I am very interested in corporate earnings!
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 six 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?
WTWA often suggests a different course of action depending upon your objectives and time frames.
Insight for Traders
We continue both the neutral market forecast, and the bearish lean. Felix is still 100% invested, catching much of the rebound. The more cautious Holmes lightened up a bit this week, reducing to 85% invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. Holmes holds a maximum of 16 positions at one time. For more information about Felix, I have posted a further description - Meet Felix and Oscar. You can sign up for Felix and Oscar's weekly ratings updates via email to etf at newarc dot com. They appear almost every day at Scutify (follow here). I am trying to figure out a method to share some additional updates from Holmes, our new portfolio watchdog. (You learn more about Holmes by writing to info at newarc dot com.
Peter Brandt raises a topic well known to pros, but a big source of failure for beginners: Position size. He writes as follows:
Read the full post to see how to deal with this.
Dr. Brett keeps bringing it, week after week. Improving your trading is not just a matter of learning rules and avoiding mistakes. He suggests a comparison to an athlete who always competed and never prepared.
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. Pick a topic and give it a try. Feel free to suggest new topics if your "fear" is not on the list.
Many individual investors will also appreciate our two new free reports on Managing Risk and Value Investing. (Write to info at newarc dot com).
Here is our collection of great investor advice for this week. It was especially difficult to screen for WTWA since there were so many good articles. Please enjoy!
If I had to pick a single most important source for investors to read, it would be David Fabian's commentary on when an investor might need a (new or first) financial advisor. Some people are extremely successful in business and expect that skill to transfer readily to investing. That frequently does not work. The list of warning signs is typical of what I see in new clients, just as it is for the author. The entire list is good, but here are a few great examples:
Apple could hit $150 a share this year. Jack Hough (Barron's) gets the story from two different Wall Street sources who go beyond the regular analysis of low P/E and $38 per share of cash. Hint: Apple is not just selling devices. The multi-platform service business has started.
Chuck Carnevale has another interesting stock screen. This one considers companies with a smaller market cap, a needed portfolio addition for many. This demanding screen generates a list of good ideas. We have already bought one from the list and others are under consideration.
Michael Mauboussin explains why, like Babe Ruth, you need to consider magnitude as well as frequency. Please read the entire article, including this comment from Mr. Buffett:
Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. There are several great posts, but I especially liked the advice about how to draw down savings during retirement. It is important for so many people.
Another link from this post is our "best investment advice" for the week. Welcome back from vacation, Tadas!
Joe Fahmy has four reasons to expect Dow 20K this year, a prediction that "no one on Wall Street" is making. Hmmm.
Why is "everyone is miserable" despite the strength of stocks? There is a lot of FOMO (fear of missing out). (Josh Brown)
Watch out for....
Passive bond funds and ETFs. The rules for these funds require passive, cap-weighted investments. This means that energy exposure got higher as more companies sought financing. At this point there is extra risk. Lisa Abramowicz at Bloomberg has a nice explanation, including current risks.
Even those staying in a single mutual fund do worse than the overall fund performance. Why? Attempted market timing. (Morningstar via WSJ).
Why such big mistakes? Alan Steel's entertaining post offers a good explanation:
What if some of the most successful investors needed to get funding on Shark Tank? Josh Brown has the witty answer. I can't do justice to it with a quote, so you'll just have to read to see how Bezos, Musk and others might have fared. I am still laughing.
Our top sources - Brian Gilmartin and FactSet are always mandatory reading, but especially so during earnings season.
FactSet shows that actual reports almost always beat the expectations at the end of the quarter. (Last quarter was a notable exception). They also show the probable prolonged "earnings recession" with four consecutive losing quarters.
Brian Gilmartin is "growing more confident," that this quarter will mark the earnings bottom. Like FactSet, he notes that the energy sector is key, and he thinks the bottom is in there. Brian did extremely well in avoiding the energy decline for his clients, but he is now gradually building up a position. It is probably wise to pay attention!
Oil and Energy Insider agrees with Brian. (Read to the very end). Their "premium" publication is even stronger concerning this conclusion.
I agree with Brian that we have reached an earnings trough. It might be another quarter before the investment community joins our conclusion.
There is a chance - and perhaps a good one - that this earnings season will do the trick. Analysts always reduce estimates and companies always hurdle the lower bar. This season includes two significant factors, mostly unnoted by the punditry. Over the years I have read thousands of analyst reports. Your best chance occurs when the herd is wrong about something. I especially like it when the analyst loses focus on the company, ignores their firm's economist, and decides to play "amateur economist." Here are the two current factors:
If I am right, earnings will beat expectations by a wider margin than usual. We might even see some positive comments on outlook.
I expect a good earnings season.
Because of cherry-picked spinning, investors watching the reports will probably still have a buying opportunity. At least we know what to watch for: dollar effects, no recession, and outlook.
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