by Jeff Miller
When stocks have had a big rally, it can lead to nervous longs. How much of the ownership is in “weak hands” or with short-term traders, people ready to sell at the first sign of bad news?
So far, any selling has been limited — evidence of waiting buyers. Will this change?
The Bonddad Blog, as I have noted in some past weekly reports, has warned about some economic weakness. The team there does a nice job of sticking to the data. This week they summarize prospects as follows:
…I sincerely hope that readers of this blog were not surprised by the several suddenly punk reports this past week. Back in January I said that I expected the economy to stall in the second and third quarters due to Oil and Austerian stupidity. Week after week for at least three months in this column I have been reporting the slowly deteriorating YoY numbers in many indices. This week the MSM’s complacency was finally broken. So was the speculative surge in several commodities, most especially silver – which caused Oil to back off 10% in a single week. For the next several months I expect to be chronicling the coincident damage, while we wait to see how long it takes high prices to cure high prices, and how much Austerian stupidity emanates from Versailles.
Read the entire article for a nice look at “high frequency data.”
I will evaluate this further in my own weekly conclusion. First, let us do our weekly summary of the most important data.
Background on “Weighing the Week Ahead”
There are many good services that do a complete list of every event for the upcoming week, so that is not my mission. Instead, I try to single out what will be most important in the coming week. If I am correct, my theme for the week is what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.
In most of my articles I build a careful case for each point. My purpose here is different. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but some will disagree. That is what makes a market!
Last Week’s Data
The news last week was somewhat negative, saved mostly by Friday’s employment report.
Most major economic indicators show that the US economy has returned to its normal state, self-sustaining growth. Many seem to have forgotten that economic growth is normal, including the use of slack resources to expand and to build new businesses.
- The death of Osama bin Laden. The evidence shows that this was a blow against global terrorism. I realize that some who are determined to find a negative in anything that happens are even spinning this event. In this weekly column I just state my conclusions rather than arguing them. I have been monitoring factual news sources and interpretation all week. The data show that there will be a loss of leadership and some operational control.
- Payroll employment gains were 244,000, better than most pundits expected, and much better than my own estimate. Check out Steven Hansen’s excellent review of the entire report. My method compares these job gains with other economic data. A fair way to summarize what is happening would be to say that employment is actually running a little ahead of other indicators. It may be that businesses are finally reaching the limits of what they can squeeze out of existing workers, something that I have been predicting for months. Colin Barr has a nice article on this topic.
- Falling commodity prices reduce inflation fears. The WSJ suggests that this lends credence to the Bernanke viewpoint. The Fed was not watching commodities, but the FOMC does pay attention to market expectations.
- Mortgage rates hit a new low — the lowest since January and down nicely from last year. This is in sharp contrast to the forecasts of some leading bond pundits like Bill Gross. In case you missed it, check out the forecast from Jeffrey Gundlach, who has done even better than Gross over the last ten years.
- Economic growth forecasts improved. The ECRI Weekly Leading Index decreased from 129.2 to 128.7, but remains at solid levels. The growth index, a widely-misinterpreted acceleration term, also move a little lower.
- Risk as measured by the St. Louis Fed Stress Index, remains very low. This measure tracks a lot of market data in the eighteen inputs. It is not a poll, nor opinions, nor a collection of anecdotes. We should all pay attention to some real data. The value moved to -0.174, a bit lower than last week’s -0.166 (adjusted). These are completely normal readings for a scale measured in standard deviations from the norm. For more interpretation, the St. Louis Fed published a short paper with a very nice chart that helps to interpret this index. The chart does not reflect the recent continued decline in stress, but it identifies the dates for important recent events. The paper also has a longer version of the chart, illustrating past stress periods. I am not going to run the chart each week, but I strongly recommend that readers look at the paper. In the 2008 decline there was plenty of warning from this index — no sign right now. The scale is in standard deviations, so anything short of 1.0 or so is neutral territory. I am doing more extensive research on this indicator.
NB: The ECRI and SLFSI are actually readings from week-old data.
There was a lot of disappointing news — all qualifying as “bad” in terms of my weekly update. I look for things that are fresh — unexpected. I would characterize the data as a slowing in the rate of growth.
- The ISM service index was only 52.8, much lower than the expected 57. Cullen Roche has a good summary.
- Initial jobless claims spiked much higher. We are continuing with the 4-handle, now for four weeks. It is important not to read too much into a single week, but this series is important. While it is only one part of the employment story, everyone agrees on the significance. It is a real-time data series from a good source. I follow it closely, and the story has not been good.
- The earnings “beat rate” declined to 60%. This is a weaker record than accomplished over the last few quarters. Check out the Bespoke Investment Group chart for the full story.
- Unemployment moved higher, to 9%. This was in contrast to the payroll report, something that happens as a result of two different surveys. However you measure it, we are not adding enough jobs, as noted by the NYT. Dean Baker explains why, and corrects the Washington Post editorial writers.
Memories of the Flash Crash. This gets combined with those who want to “sell in May.”
Mark Hulbert finds a source who tells us that we should expect another such episode.
The first line of defense on the flash crash problem is to avoid sell stops that turn into market orders. The stop always sounds like a good idea when it is presented. It is seductively attractive to those who are not actively managing their accounts. There really is no substitute for paying attention. The flash crash was not too important for those who did not attempt to trade during the most volatile hour.
Our Own Forecast
We base our “official” weekly posture on ratings from our TCA-ETF “Felix” model. After a mostly bullish posture for several months, Felix has turned much more cautious. We shifted from our neutral posture to bullish four weeks ago, and we continue that posture in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. This is based on improved ratings in the various index ETFs, as well as the general trend. Here is what we see:
- 80% of our 56 ETF’s have a positive rating, up nicely from 73% last week.
- Only 50% of our 56 sectors are in our “penalty box,” the same as 50% last week. This is an indication of moderate short-term risk, and the picture is improving.
- Our universe has a median strength of only +23, up nicely from +11 last week.
The overall picture is a little better than last week. We are still 100% invested in trading accounts, since there are many attractive sectors.
[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list. You can also write personally to me with questions or comments, and I’ll do my best to answer.]
The Week Ahead
The coming week will feature the PPI and CPI, but the data will be viewed as irrelevant if the commodity volatility continues.
Thursday’s initial claims will attract more than normal attention because of last week’s spike.
News on the debt limit, European aid packages, and commodity prices will be more significant than the economic reports.
Earnings season is winding down, but there are still some important reports left.
This is a tricky time for both traders and investors. We seem to have a wide trading range. Charles Kirk, after a couple of weeks off, is back with his weekly chart show. (Some have pointed out that my link is to a paid site, and that is true. Charles has a modest charge that goes only for expenses and then to charity. He has many satisfied followers, both for his weekly take and his various stock screens). It is impossible to do justice to this in a summary. He is essentially neutral, looking to get long, but willing to respect the tape in either direction. He sees the programs as more important than fundamentals right now.
My own viewpoint is a bit more positive for long-term investors. The 60% earnings beat rate cited above is viewed as negative by most observers! Think about that for a moment. These are pundits who claim that analyst estimates are too high and then celebrate when most of the estimates are actually too low. I track the one-year forward earnings closely, and those estimates continue to march higher while interest rates hold at low levels. The earnings story remains positive, with many attractive stocks.
While I watch economic data closely, small changes are not that important for earnings. We are nowhere close to a recession risk, and the SLFSI shows a high comfort level on the financial side.
I understand that everyone wants to avoid risk. There are many ways to construct a very safe program that still allows the investor to share in stock gains and fight inflation.
The Week Ahead: Focused on Employment by Jeff Miller
BLS: Jobs Up Strongly in April by Steven Hansen
Initial Unemployment Claims Shocker: Up 10% by Doug Short
Global Stock Markets Send Mixed Signals by Erik McCurdy
Profiting from Forward Earnings Estimates by Jeff Miller
Using Forward Earnings Estimates by Jeff Miller
Charts of the Week: Commodity Correction Develops as Anticipated by Erik McCurdy
ADP Publishes Painfully Low Employment Growth in April 2011 by Steven Hansen
Jeff Miller has been a partner in New Arc Investments since 1997, managing investment partnerships and individual accounts. He has worked for market makers at the Chicago Board Options Exchange, where found anomalies in the standard option pricing models and developed new forecasting techniques. Jeff is a Public Policy analyst and formerly taught advanced research methods at the University of Wisconsin. He analyzed many issues related to state tax policy and provided quantitative modeling which helped inform state and local officials in Wisconsin for more than a decade. Jeff writes at his blog, A Dash of Insight.