by Jeff Miller
Six weeks of stock declines raise the question: For how long will the market keep responding to the same news?
From one perspective, weakness in economic data was to be expected. Everyone knew there were supply chain disruptions from Japan and consumer cutbacks from higher fuel prices. The mainstream economic thought is that the tepid recovery will continue after these aberrations.The bearish viewpoint is that the economic weakness is the sign of something much worse, possibly augmented by the end of fresh QE II purchases. This is conclusion is quite extreme given the actual data. Even sources that have been very cautious on the economy emphasize that they are forecasting a lower pace of growth, not another recession.
The video discussion below from The Kudlow Report has some excellent information that you probably will not see elsewhere. Ed Leamer is bearish on the economy since it is tracking at 11% below trend. By this he means that he sees 2 1/2 – 3% growth for the rest of this year instead of the 5-6% that would be expected in a robust recovery. David Malpass explains that several indicators are not really giving indpendent reads on the economy. Initial jobless claims are reflecting auto layoffs because of Japan supply chain issues and the ISM is also reflecting similar large company factors. Here is the complete interview, well worth watching:
Neither of these two noted economists is out to score political points, a refreshing change from much of the current pseudo-economic commentary.
The conclusions square with mainstream forecasts and with Prof. James Hamilton’s summary reported here last week.
The stock and bond market action contrasts sharply with the mainstream economic forecasts.
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.
Readers often disagree with my conclusions. That is fine! Join in and comment. 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
As I wrote last week, we expected little in the way of important data. The results did not lean strongly to the good or the bad side, although the market reaction was very negative.
The Good
There was a little good news.
- Bank lending standards are getting easier. This is necessary for growth in the money supply (M2) and job creation from smaller firms. This indicator and M2 are the real measures of QE II effects. This is an indicator that was highly celebrated by the bearish community when standards were getting tighter, since it was supposed to project lower consumer expenditures.
- The trade deficit included record exports. Brian Wesbury explains why this is positive for GDP and future employment.
- The Beige Book basically confirmed the slow growth story with some impact from Japan and energy. This is not really good news, but it is noteworthy and better than the general market perception. This will be information in front of the FOMC.
The Bad
There was not much fresh bad news.
- Initial jobless claims of 427,000 — still too high to expect solid job growth. Some attribute (see here) the recent levels to unusual seasonal factors and the Japanese supply chain effects. For the moment, I am taking the results at face value.
- The media coverage of the QE II story was really terrible. Most journalists have adopted the simplistic and incorrect shorthand that the end of new Treasury purchases constitutes some sort of policy tightening. In fact, the Fed is continuing to ease through this month, and will maintain this position — the easiest money in history — for the indefinite future.
You can get a good explanation of this from Michael Santoli, James Hamilton, or A Dash. This remains the single most important market topic, given the chasm between the common perception and reality. This deserves more attention, so it will be a continuing topic. Eventually those who understand this issue will profit. In the meantime, unwarranted conclusions reign.
- The Greek debt bailout hit another snag. I report this because the market treats it as bad news. It is a story that changes each week.
The Visionary
Sometimes it is good to take a break from the ugly and think about what could make the world better. Doug Kass is pretty pessimistic on overall economic prospects, but his article in Barron’s has some important ideas that policy makers should consider. [I have frequently mentioned some Barron’s links in this weekly article, but there is an ongoing issue. With this source (and some others) the links require a subscription, but you can get around the paywall using a Google search on the title and author. Everyone knows this, so the inability to link is a source of frustration for bloggers and a losing approach for the MSM companies. They are all still trying to figure out how to monetize content. Meanwhile, I try to link to clean and free sources. When there is an important article like this one, I point to it and hope that you can get there.]
The economic recovery and the U.S. stock-market rebound ring hollow in a screwflating economy. The U.S. must address both parts of the problem with policies that increase income for the middle class and fight commodity-price inflation.
Policies that could help quickly include: extending the payroll-tax cut initiated by the Obama administration; reducing income taxes for the middle class; providing federal funds for infrastructure spending; creating incentives for businesses to make new capital investments; allowing tax-free repatriation of U.S. corporate earnings made abroad, if they are earmarked for the creation of American jobs; the launch of an energy plan that taps domestic resources; and the use of federal-housing financing to slow foreclosures and distressed sales.
These are interesting and constructive ideas from Doug Kass. It would be encouraging if the political debate turned positive, but don’t hold your breath.
The Indicator Snapshot
It is important to keep the weekly news in perspective. My weekly indicator snapshot includes important summary indicators:
- The ECRI Weekly Leading Index and the derivative Growth Index
- The St. Louis Fed Stress Index
- The key measures from our “Felix” ETF model.
There will soon be at least one new indicator, and the current choices are under review.
The indicators show continuing modest growth at a slowing pace, with little indication of economic risk. The market fears, as is often the case, are greater than one might expect from the data.
Felix is the basis for our “official” vote in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. We have a long public record for these positions.
[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 not provide much in terms of important data. Retail sales will not be significant unless far different from expectations. Jobless claims will be significant if the seasonal adjustment or one-off explanations gain credibility.
News on the Greek debt situation continues to move exchange rates and the equity market, but these developments come with no fixed schedule.
We have something of a data vacuum pending fresh earnings reports. Weak data are shrugged off by bullish analysts as a “one off” result. Strong data (like earnings) are dismissed by bears as not reflecting the inflationary effects of high enery prices, profit margin compression, and the “end” of QE II.
This will not be resolved for many weeks.
Investment Implications
In trading accounts last week we added two inverse ETF positions, so we are net short 40%.
For investors, it is a different picture. It is attractive to invest when fears are worse than fundamental conditions, as they are now. I see many stocks trading at prices that represent great opportunities. The long-term fundamental investor is often shopping at the same time the short-term trader is selling or even going short.
I have gotten some questions on this point. Why buy anything at all if the market outlook is bearish? If only it were that easy! Most individual investors are terrible market timers and even fund managers just break even.
Successful results require a method that works in your planned time frame. This is a topic that I covered a few years ago here and here, but it is probably time for another look at the value of a long-term time frame with active management — not “buy and hold.” At the moment, trader sentiment, fear, and market momentum point one way. Earnings, risk, and valuation point another. Both approaches can be successful, but trying to mix the two can be dangerous, as the cited articles demonstrate.
Related Articles
Weighing the Week Ahead: An Economic Tipping Point? by Jeff Miller
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What’s Up With Employment? by Steven Hansen
Forecasts: What and How Do Business Economists Thinks? by Menzie Chinn
Chart of the Week: Whither Stocks? by Erik McCurdy
Overview of the Markets by MacroTides
Stock market Cycle Analysis by Erik McCurdy
Consensus: Groundhog Decade for Stocks by Ed Easterling
Margin Debt and the S&P 500 by Doug Short
Investor Sentiment Leads Price by Guy Lerner
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.
