by Jeff Miller
Political activity provides both an opportunity and a trap for most investors. It is so easy to use our own electoral preferences in forming conclusions about economic and investment prospects.
Click on picture to see the full parade.
Just as Democrats did when President Bush was in office, Republicans now want to make the economy seem as bad as possible — and hopeless unless Obama is defeated. This means super-spinning of every story. This week’s employment report is a good example. Read Derek Thompson’s fine article, The Official Guide to Spinning the April Jobs Report, to get your inoculation against the upcoming silly season.
Now that the Republican candidate is known this will get much worse. The Hill notes that for Obama, the gloves are coming off.
In the conclusion, I’ll offer some thoughts on how investors can take advantage of the political noise. First, let us do our regular review of last week’s news and data.
Background on “Weighing the Week Ahead”
There are many good sources for a list of upcoming events. In contrast, I single out what will be most important in the coming week. My theme is an expert guess about 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.
This is unlike my other articles at “A Dash” where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.
Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. 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 feel free to disagree. That is what makes a market!
Last Week’s Data
Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:
- The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially — no politics.
- It is better than expectations.
The general economic data continues to be soft, while earnings have been very good.
- The debt ceiling issue will not be revisited until after the election (via The Hill). This is one of those worries that people keep bringing up, but is then ignored when it proves not to be true. There is still a lot of heavy lifting scheduled for after the election, of course, but that is a very different problem.
- Corporate earnings have been stronger than expected and so have revenues. Some observers continually write that earnings estimates are too optimistic. When the beat rate is excellent, they then say that the bar was set too low. Which is it? Here is a good chart from Dr. Ed:
- ISM Manufacturing rebounded to 54.8. The “internals” in this report were all good.
- Gasoline pump prices may move lower, a boost for the consumer. The Bespoke Investment Group observes, “No matter how you look at it, current prices for gasoline are high, but if the recent trend of lower prices continues, it could provide a strong boost to the consumer.” Here is one chart, but check out the article for further analysis.
- Initial jobless claims (not part of the employment survey period) moved back to the prior range. Here is the nice chart from Doug Short (but see the full article for much more):
The most important economic news of the week was the jobs story — a big disappointment. There was some other bad news as well. I warned in my regular employment preview last week that we could have a disappointing number with big revisions. The BLS method for estimating new job creation has been missing on the low side, according to the most recent actual data.
- The earnings beat rate is declining since the start of the season (via Bespoke).
- The ISM services index dropped sharply and missed expectations. Steven Hansen notes the decline, but focuses on the overall trend. See his complete report.
- Employment growth for April was poor. The payroll jobs gain was not enough to reduce unemployment. The reduction in the unemployment rate came from a reduced labor force, not more jobs. We did not see improvement on hours worked or the hourly wage. The household survey showed a decline in jobs. Steven Hansen at GEI includes some ideas and charts you probably did not see elsewhere, concluding that it is not pretty, but there is continuing modest economic expansion.
Steven is consistent in his analysis, unlike others who, for example, only talk about the household survey when it declines. It has actually been showing much greater increases than the payroll approach. Eventually the two come into line.
This was the big report of the week. It turned out to be an anti-Goldilocks number: Not strong enough to reassure about growth, nor weak enough to suggest more QE from the Fed.
This week’s “ugly” award has to go to the stock market, where the reaction was disproportionate to the employment data. There were clearly many itchy fingers looking for confirmation of the “sell in May” meme. Charles Kirk provides the evidence:
Part of the decline was a reaction to stories about Apple suppliers. Jay Somaney, in his trading diary at Wall Street All Stars) pointed to the real story — a change in the needed parts — bad for suppliers but not for Apple.
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 Silver Oz, writing at The Bonddad Blog, for his article, Once Again Zero Hedge is Completely Clueless. One of the Tyler Durdens at ZH managed to mis-represent both the seasonal adjustment process and the birth/death adjustment in making the jobs report seem even worse. Silver Oz points out the errors and concludes as follows:
“Chalk this up as yet another reason to NEVER, EVER listen to Zero Hedge when it comes to interpretations of statistical reports.”
Trying to correct these errors is a really thankless task. Many of the ZH arguments have just enough data and apparent plausibility that effective refutation is very time consuming and provides little payoff. This is why so much bogus analysis lead the Internet hit parade.
The Indicator Snapshot
It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:
- The St. Louis Financial Stress Index.
- The key measures from our “Felix” ETF model.
- An updated analysis of recession probability.
The SLFSI reports with a one-week lag. This means that the reported values do not include last week’s market action. The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a “warning range” that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.
The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli’s “aggregate spread.” I’ll explain more about the C-Score soon. Bob also has a group of coincident indicators. Like most of the top recession forecasters, he uses these to confirm the long-term prediction. These indicators are not close to a recession signal. Bob has graciously offered the most recent report as a free sample for our readers.
The big news on the recession forecasting front this week came from The Bonddad Blog’s continuing coverage of John Hussman’s recession prediction. (Since the Hussman recession forecasting started relatively recently and relied on tweaking and backfitting, I have not included it in the group that we analyze at “A Dash.”) This sort of “modeling” should not be expected to provide solid forecasts and it is not doing so in real time. Check out John Hussman’s recession index just blew up for the full story.
“The icing on the cake is that the “all clear” signal that Hussman said he would recognize — the ECRI WLI growth index turning positive — has also come into existence for the last 3 weeks. I really don’t see any wiggle room left. Under the terms he himself set, Hussman’s recession index says we are in expansion.”
Our “Felix” model is the basis for our “official” vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. Three weeks ago we shifted from bearish back to neutral. The last several weeks have been pretty close calls. The ratings have improved a bit.
[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. For daily ETF commentary from Felix, you can sign up for Wall Street All-Stars, where I still have a few discounted memberships available. You can also write personally to me with questions or comments, and I’ll do my best to answer.]
The Week Ahead
This is a light week for economic data. We will start the week with news from the French elections, where Sarkozy is expected to lose. This is widely projected to be negative for Europe and therefore for US stocks, but it should be reflected in markets by now. The story will get continuing buzz, especially on Monday. We will also have election results from Greece, where no majority winner is expected.
There are a number of minor reports early in the week, but I am interested in trade data, jobless claims, and Bernanke’s speech on Thursday. On Friday we’ll have the Michigan sentiment index and PPI. We could see a surprise from either.
Trading Time Frame
We mostly out of the market until late in the week for trading accounts. Felix likes the current dip, so we are back in the market. The Felix forecast is for a three-week horizon, so it is best not to judge too quickly. We have long experience with this program, which does not try to call market tops and bottoms.
If Felix is wrong, it will be back to the penalty box. For now, we are looking for rebounds in several sectors.
Investor Time Frame
For investment accounts I have been buying on dips in stocks that we like. I tried to explain the most important concept for individual investors in this article about the Wall of Worry. I have had many emails from people who had a personal breakthrough in their investing when they understood this concept. If you missed it, I urge you to take a look.
Investors should not be trying to guess the next market move. Instead, take what the market is giving you. I have been offering this advice for months, and it led to a great quarter for anyone taking heed. We seem to have another buying opportunity — especially in tech and cyclical stocks.
If you are really worried, you can imitate our enhanced yield program. Buy good dividend stocks and sell short-term calls. I am targeting 8-9% returns on this approach, and achieving it no matter what the market is doing. You can, too. This has been meeting objectives in spite of the market twists and turns.
Thursday and Friday were excellent days for finding new positions for this system.
Final Thoughts on Politics, Headlines, and Fear
In principle, investors know that the right time to buy is when others are fearful. In practice, they join in the fear.
Bill Luby, in a nice guest column for Barron’s, Be Greedy While Others Are Fearful, writes as follows:
“Fear is good business on Wall Street. For starters, fear helps to encourage impulsive and emotional decisions on the part of retail and institutional investors alike. It is contagious, capable of spreading extremely quickly and can sometimes appear to be unbounded.
Fear also has been responsible for the development of a wide range of structured products tailored for institutional investors who wish to protect principal, minimize volatility and take other steps to counteract potential risks. The ugly side of fear is that it impels many people to sell at the bottom and wait to get long until markets are near a top.
These are all good reasons to want to sell fear, but not why I choose to do so. No, I am short fear because fear is almost always overpriced – and by a large margin.”
Successful investing is not reckless, but it is fearless. To achieve this requires a system and confidence in that system. I recommend the following:
- Ignore the political noise and spinning.
- Note the low level of financial stress — the European systemic failure is off the table.
- Note the low recession odds from the best sources.
- Observe the continuing growth in corporate earnings, and the low forward multiple.
These are all encouraging conditions for long-term investment. Even conservative investors can own some dividend stocks and sell calls against them.
This is what the market is giving us, and we should take it.
About the Author
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 he 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.