by Jeff Miller
If you want to understand stock prices, eventually it all comes down to earnings.
In low-volume, holiday-shortened trading weeks, there can be plenty of volatility. Every story is amplified by breathless coverage from financial media. Traders try to outguess the macro economic and political stories. Investors need to take a longer view. As we get greater insight into corporate earnings, we can all sharpen our market forecasts. Meanwhile, here is an important consideration:
Earnings and the stock market have thrived while the economy has lagged. This may well continue.I will comment on the upcoming week, but first let me review last week’s data.
Background on “Weighing the Week Ahead”
There are many good services that do a complete list of every event. 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
The economic news may have seem mixed to most, but I think the balance is turning positive.
The Good
There was good news in important indicators.
- A default of Greek debt was avoided — at least for now. There is a continuing process where the European authorities try to include private investors (bondholders) in the sacrifices of adjusting obligations without triggering a “credit event.” Regardless of one’s opinion about the long-term consequences of this policy, for now it is market friendly.
- Private sector job growth in the ADP universe was solid, up 157,000 jobs in May. ADP has solid, real-time data on a subset of private employers. For their universe, the results are more accurate than the BLS outcome. More on this subject below.
- Most businesses are adding jobs — according to (via featured source Karl Smith) the Gallup Job Creation Index.
- There was progress on the debt ceiling discussions. I write this on Saturday evening with some key meetings scheduled for tomorrow. There is a lot of posturing. Having said this, it continues to develop as expected. If you are worried about this subject, you should read my more comprehensive analysis.
- The Drudge Report Indicator! Leave it to the innovative minds at The Bespoke Investment Group to spot this. Check out there objective quantitative indicator based upon the breathless headlines from Drudge — and especially showing how much their take on today resembles the market low.
The Bad
The pattern of weak economic data continues to show up in several indicators .
- Initial jobless claims of 418,000 — still too high to expect solid job growth. If this is a temporary story from the auto parts supply shortage, we should soon be seeing some improvement. Very soon!
- Gasoline prices bounced back. So much for the Obama initiative with the Strategic Petroleum Reserve. At best this is looking like a push.
- The ISM services index disappointed. It was a touch below consensus, but not taken that seriously. I have no idea how anyone forecasts this.
- Lesser indicators are also very weak. The Bonddad Blog monitors all of the shipping and rail factors, and they are still pretty glum. I note that M2 was significantly higher on the week. This is important and necessary.
The Ugly
The employment situation report — payroll jobs and household survey — was terrible news. For economic improvement we need job growth in the 200K range at least, and the story is much worse. Many sources documented the low job growth rate, increased unemployment, lower hourly wages, and other disappointing details. Let us accept this as a starting point. Here are some other perspectives:
- The BLS monthly report is not the ultimate answer. It is one measure of truth. I understand that the market and the politicians are going to treat this report as “official,” but we all know better. The BLS does a great job of trying to count every job in the economy each month via a survey and subtract the difference. I think their method of imputing job creation is pretty good, given the limits of the overall approach. Having said this, it is not the method that any of us would use if asked to measure monthly changes.
- ADP, TrimTabs and other sources show more optimistic results on job creation. They use real-time sources, but only cover part of the data. Eventually we have an objective number, but it takes about nine months for us to see the final state employment data.
- My own approach was very good at predicting the final monthly result — after all of the revisions and benchmark adjustments. It does not seem to be worth reporting when everyone unwisely insists on scoring my prediction against the BLS result.
It would be nice to compare all of these approaches against the final state employment results. I have so many interesting topics for analysis and so little time. It is still on the agenda.
Finding Objective Analysis
If you are a trader, you have to guess what the BLS result will be. The sampling error alone is +/- over 100K jobs. This does not count revisions. It is difficult enough to predict truth. Predicting someone else’s estimate of truth is an insane task. Meanwhile, you can usually just trade the employment report from the short side, waiting on the spin machine to kick in. I have covered this for many months.
For an investor, it is vital to ignore the spinning. We are interested in the actual economic progress over a period of several months. With this in mind, I have been looking for strong sources that take an investor perspective.
I have been reviewing the results from “Mr. Model” created by Robert F. Dieli. Regular readers of “A Dash” know that I am not easily impressed and I am tough when evaluating systems and models. Bob has great credentials (Texas PhD in econ, top job at Northern Trust) but I mainly go by the results and the logic. His recession forecasting is first-rate, transparent, and not the result of over-fitting dozens of variables. I’ll write more on that in a future article. Meanwhile, I want to highlight some of his insights on employment.
Compare this year to last. Bob notes that the reasons are different, but the effects may be similar. He writes as follows:
Here are the rest of the observations for 2010. They are not intended as a forecast. They are intended as a reminder that each and every one of them was announced to be the last of its kind.
Month after month the double-dippers told us that the economy was going to nose over.
That didn’t happen, largely for reasons we have been advocating for some time: namely there was no good reason for the economy to nose over. The question now is whether those reasons, which we shall review as we go along, will still hold in the months ahead.
He does not sugar-coat the overall analysis. There is a good and hard look at employment participation and the jobless rate. Something I like about Mr. Market is that it really is a “no-spin” approach. The indicators always remain the same. Most analysts seem bent on looking for the best or worst in each report, selectively choosing what to emphasize.
I also look for added value — something everyone else is missing. Here is one such concept:
Although it seems counterintuitive, a rising share of short-term unemployed is usually an indicator of a good labor market because it means that people are not out of work for very long when they lose or leave their jobs. So far, there has not been much change in the percentage of people who are unemployed because they left a job, so one has to wonder whether the up-tick we are seeing on the blue line is due to a fresh batch of jobless people.
Following this theme, Steven Hansen also has a contrarian take on the employment report internals. Many analysts focus on temporary jobs as a leading indicator for employment. Steven explains that looking at transportation is much more powerful. Check out the full article for analysis and two great charts.
Briefly put, the job picture continues to be a major negative for the economy. If you look more deeply, using the best data sources, you may get a little more insight.
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 focus of the coming week will be the new earnings season, starting with Alcoa on Monday. The market skeptics will be looking at profit margin compression from Q2 inflation, extrapolating any Q2 soft patch, and questioning any positive outlook. This is not like a trifecta, since they only need to win on one of these points, not all three. Any bad story will be trumpeted as the start of a trend.
Skeptics will also highlight the fact that the earnings beat rate, which I expect to be in the 60% range, is due to reduced expectations. Some of these sources will be the same people who consistently tell you that the market is overvalued because forward earnings estimates are too optimistic. I invite readers to send pointers to those who take both sides of this argument. They definitely need more publicity — and an opportunity to explain!
The economic reports on jobless claims, PPI, and CPI will all command some attention, but it is more about how the earnings story plays out.
I expect the political news to grab attention, with a continuing crossfire of zingers.
Investment Implications
In trading accounts last week we had no positions. Despite improving sector strength Felix is still cautious. This is not a market prediction. It is all about uncertainty. Felix looks for good trading opportunities and abhors unpredictable situations. I expect some buying during the coming week.
For investment accounts we were more aggressive last week in establishing new positions, and shifting holdings to those with more economic exposure. These include technology and cyclical stocks. As I have noted in recent weeks, the investment time frame requires looking for opportunity when traders are scrambling.
Investors should focus on tangible and objective measures of risk. These are all in normal ranges, historically profitable for investments, despite the debt ceiling controversy.
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