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posted on 14 May 2017

The Week Ahead: How Would Markets React To Another Watergate?

Written by , A Dash of Insight

We have a very quiet week for economic reports. The housing data are quite important, but it will be a Tuesday story without legs. The White House drama will be compelling for the media. Whether investors like the idea or not, we should expect another week of news that is mostly political.

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My mission at WTWA has two parts:

  1. Recognize the reality - like it or not.

  2. Find the investment implications - however modest.

In a light week for data, it will be easy for the punditry to jump on the Comey firing story. Expect everyone to be asking:

Is this like Watergate? Should investors be afraid?

Last Week

Last week the economic news was good, but mostly ignored.

Theme Recap

In my last WTWA I predicted that a bored punditry, lacking fresh data, would be looking at tea leaves to find a message from the markets. That proved to be my worse forecast of the year! After a day of analyzing Mr. Buffett and the Sohn Conference, President Trump grabbed the spotlight. I hope people benefitted from the discussion, even though it never became the focus for the week.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. She notes the weak Friday trading, the narrow range, and the closeness of the all-time high.

Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read the entire post for several more charts providing long-term perspective, including the size and frequency of drawdowns.

The News

Each week I break down events into good and bad. Often there is an “ugly" and on rare occasion something very positive. My working definition of “good" has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news - and you should, too!

Once again, the economic news last week was good, but there was little market reaction. Of course, there were other considerations.

The Good

  • The EIA’s energy outlook suggests stable prices. People seem to regard different prices as “good." These levels are fine for consumers. The distress in the oil patch has been mitigated. (EIA).

  • Hotel Occupancy increased again matching a record pace. This chart from Calculated Risk provides a nice comparison.

  • Corporate earnings have been strong on all fronts: improvement over last year, beating expectations on earnings, and beating expectations on revenues. FactSet details this important story for investors, illustrated by the chart below. Brian Gilmartin makes a key point, highlighting the modest revisions in earnings expectations:

    The question we should ask for readers is what sectors (using the above data listed in 2nd set of bullet points) are seeing the smallest negative revisions as we approach Q2 ’17?

    Real Estate: +3.6% today vs. +3.5% on April 1 ’17.

    Financials: +9.5% today vs. +10.5% on April 1 ’17.

    Industrial’s: +1.1% today vs. +1.3% on April 1 ’17.

    Technology: +9.6% today vs. +11.5% on April 1 ’17.

    Health Care: +2.2% vs. +3.3% on April 1 ’17

    Readers should remember, that Technology, Financials and Health Care - those 3 sectors alone - comprise about 50% of the SP 500 by market cap.

  • Port traffic strength continues at a better rate than the economy. Steven Hansen (GEI) takes his expected deep dive into the data.

  • Initial unemployment claims dropped to 236K. Calculated Risk provides this interesting, long-term chart. It is consistent with the tighter labor market conditions in last week’s JOLTS report.

The Bad

  • Retail sales disappointed. Core sales increased 0.4%, less than expectations. This was somewhat mitigated by revisions to prior months. The data are not adjusted for inflation, notes Steven Hansen (GEI), so the picture is a bit worse.

Retail same store sales also disappointed. The entire sector is challenged. (MarketWatch). J.C. Penney hit a record low and big-name department stores were also hit.

The Ugly

Some stories do not die, perhaps illustrating why they qualify for the “ugly" category. This week a major ransomware meltdown occurred. Wired asks whether it might be the long-awaited “big one."

North Korean nuclear and missile development is another regular concern in this section. As I write, there is news of another missile launch, but few details.

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. No award this week, but I welcome nominations. The investment world is full of misleading information and bogus conclusions.

The Week Ahead

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.

The Calendar

We have a normal week for economic data, but with few important reports.

The “A" List

  • Housing starts and building permits (T). Continuing strength expected in the April data.

  • Leading indicators (Th). Popular economic summary remains in solid growth range.

  • Initial jobless claims (Th). Continues with record low levels.

The “B" List

  • Industrial production (T). Will the rebound continue?

  • Philly Fed (Th). Moves markets, perhaps because it is the earliest read on a new month.

  • Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.

FedSpeak is down a little after last week’s heavy schedule. I don’t care much about the Empire State index. There are still some earnings reports, including Wal-Mart.

Next Week’s Theme

As I noted last week, when there is not much important news, it creates a vacuum. It does not change the need to fill on-air minutes or column space. If nature abhors a vacuum, the punditry hates it even more! I was right about that, but wrong about what the news would be!

The Comey firing, the suggestion of recordings of Oval Office conversations, and the Kissinger picture have fueled plenty of speculation. Everyone is asking:

Is this like Watergate?

Financial media might also ask:

Do events increase risk for investors? What does it mean?

Expect to be bombarded with speculation, beginning with the Sunday shows.

Some will emphasize Watergate parallels, while others will cite differences. I have a list of such sources, but the arguments are mostly political.

The investment implications are much more difficult to follow. The early theme is that the controversy will derail the Trump agenda. Since recent market gains assume Trump tax cuts, etc. the stock rally is threatened.

This is certainly a big story, but it is not yet a market story.

The Comey firing is “more of a political story than a markets story…Implications directly for the market are pretty muted," Chris Zaccarelli, chief investment officer for Cornerstone Financial Partners, told MarketWatch. (William Watts).

As usual, I’ll have more in my Final Thought.

Quant Corner

We follow some regular featured sources and the best other quant news from the week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

The Featured Sources:

Bob Dieli: The “C Score" which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has several interesting approaches to asset allocation. Try out his new public Twitter Feed.

Georg Vrba: The Business Cycle Indicator and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli’s enhanced aggregate spread, considering when it might first give a recession signal. His interpretation suggests the probability creeping higher, but still after nine months.

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies.

Doug Short: The World Markets Weekend Update (and much more). His Big Four chart is the single best method to monitor the key indicators used by the National Bureau of Economic Research in recession dating.

Eddy Elfenbein has his inimitable take on the VIX - clear, common sense, and accurate:

I have a slightly heterodox view on the VIX. You’ll often hear the VIX discussed on the financial news as if it’s the market’s heart rate. It’s not.

In fact, the VIX is largely tied to what the market is doing. When the market is up, volatility drops. When the market falls, volatility rises.

Ploutos has another analysis of Selling in May. Returns are lower, but still positive - as I think readers know. He also comments on the possible reasons for how this persists in the face of arbitrage.

Peter F. Way provides a careful explanation and a good example of how to use market maker hedging data to find solid stock values. Even if you do not accept the market makers as the “smart money," this is interesting information about the perceptions of big players. Here is an interesting example:

And an application to the overall market.

Click for larger image.

Read the entire post carefully for an overview of the methodology. This is an aggressive, market-timing approach.

How to Use WTWA (especially important for new readers)

In this series, I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. Most readers can just “listen in." If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have eight different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

Most of my readers are not clients. While I write as if I were speaking personally to one of them, my objective is to help everyone. I provide several free resources. Just write to info at newarc dot com for our current report package. We never share your email address with others, and send only what you seek. (Like you, we hate spam!)

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and the top sources we follow.

Felix, Holmes, and Friends

We continue with a strongly bullish market forecast. Most of our models are fully invested. RoadRunner is fussy about entry criteria. The group meets weekly for a discussion they call the “Stock Exchange." In each post I include a trading theme, ideas from each of our five technical experts, and some rebuttal from a fundamental analyst. If you followed my recommendation last week, you had a chance to evaluate the unusual agreement among our models (Four Thumbs Up for Nvidia!) and with guest expert Cody Willard. I hope that some readers (after doing their own research) could join in the post-earnings gains.

This week was much different - no consensus at all among our experts in their discussion of some big-name stocks. We try to have fun, but there are always fresh ideas. RoadRunner plays upward trending channels and likes Take-Two Interactive Software (TTWO).

Top Trading Advice

Brett Steenbarger is required reading for traders, posting many great ideas almost daily. He has two posts this week that are required reading:

What should you do if you have lost your edge? Brett has great practical advice, explaining how to be open to fresh ideas and how to leverage your strengths.

He also explains why traders should always be updating their methods - and provides a fresh idea.

The other post is of special interest for me and my colleagues: Will Quant Blow Up? He distinguishes between successful approaches and pseudo-quants. His experience lets him identify the imposters easily. There is a solution:

The answer to the limitations of pseudo-quant strategies is not to abandon mathematics altogether, but rather to employ rigor in the application of mathematics. Just as medicine has evolved from a discipline dominated by village doctors to more of an evidence-based science, finance is doing the same.

As a bonus, he also cites MAFFIA. There is plenty of information for identifying the pseudo-quants, and a respectful refutation of the Jason Zweig article that sparked the discussion.

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week it would be the collection of ideas from this year’s Buffett fest. The topics cover a wide range, including both methods and specific stock ideas. Plan to take some time and enjoy these.

Stock Ideas

Bad luck for Blue Harbinger, writing a great post within a few days of Warren Buffett’s big week. Mark’s analysis of Frontier Communications (FTR) is excellent. It covers the fundamental analysis and the stock history, but that is just a start. Should you consider the stock, the bonds, or the options? These are important questions which investors rarely consider. It is a first-rate article.

Barron’s recommends buying Europe and emerging markets, providing a list of ETFs. I’m not so sure, but it is worth a look. (I get exposure to these markets through stocks trading in the U.S. and following accounting rules).

Dana Lyons also takes a look.

The Sohn Conference raises money for charity by featuring big-name hedge fund managers to present their ideas. The audience pays five grand for a ticket (nearly all of it going to charity) and trades from their smartphones during the presentation. The speakers talk their books. Barron’s has a nice discussion of how it works and the volatile stock movements during a presentation.

With that background, readers might wish to consider some of the ideas. (Diana Britton, Wealth Management) has a video and slideshow.

Our Stock Exchange always has some fresh ideas. There are ideas from five different approaches. To my surprise, Felix (our long-term investor proxy) likes Valeant. (VRX).

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, this is a must-read. Even the more casual long-term investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. As usual, investors will find value in several of them, but my favorite is about retiring early. It raises several interesting questions - not just financial calculations.

Watch out for…

Whole Foods (WFM). Stone Fox Capital and Barron’s both raise questions.

Stone Fox also raises warnings about ConocoPhillips (COP).

TV pitches for questionable IPO’s. Dan Bobkoff and Rachael Levy (BI) highlight a Seinfeld actor pitching this one under the latest SEC rules. For the record, every stock idea I have ever seen on TV or heard on the radio has been a disaster. These pitches raise my blood pressure, since good, working people are the targets.

Final Thoughts

The Watergate analogy makes a good story, but the similarities are superficial - so far. I do not see a great downside risk, but the hoped-for growth from tax cuts has a lower probability.

The key differences from Watergate include the state of the economy (especially pressure on prices), turmoil over the Vietnam war, and the VP controversy regarding Spiro Agnew.

Investors must get past the political theater and ask how much this matters to the economy and their investments. So far, not much. There are many sources, but let us highlight something old and something new.

Warren Buffett notes that his investments do not depend upon who is President. He does not call them. He does not send messages.

Josh Brown cites the “fake Trump trade," a theme familiar to WTWA readers, and also opines that the market would rally if Trump resigned.

Morgan Housel emphasizes the story that investors would be watching, were it not for the sideshow - housing.

He shows this chart and then writes as follows:

We’re still near a level associated with previous bottoms. The only other times since World War II that housing investment has been as low as it is now was during or near recessions. And that’s not because we’ve declined to these low levels, but because the rebound since 2009 has been so meager.

Which is promising. It’s a humble suggestion that we’re not as close to the top of this nine-year expansion as you might think.

I see daily evidence in my own contacts; other wealth managers make similar reports. People are sitting on cash, out of the market, chasing yield, or turning to real estate and gold. Many expect a violent end to the current slow and long-term economic expansion - just as they did three or four years ago. It is a time when investors can expect a reward for careful analysis instead of blind fear. The Fear and Greed Trader calls it a market in search of a catalyst. Maybe so, but catalysts are not always easy to predict.

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