The Bad
There was negative news, lesser in quantity but greater in importance.
- Earnings forecasts drift lower. Brian Gilmartin, an expert on earnings both for individual companies and the overall market, tracks these trends very closely. (Similarly, Dr. Ed Yardeni) He notes the recent weakness and acknowledges the debate about what is already priced into the market. On his excellent new blog he writes as follows:
“…(A)ccording to ThomsonReuters – 2nd quarter, 2012 earnings are still expected to grow at 1.3% ( ex Bank of America and the financial sector) and 3rd quarter, 2012 earnings, which we continue to think will be the bottom for this cycle in terms of the earnings slowdown, are expected to decline year-over-year at a -2.1% rate.
The forward 4-quarter estimate for the S&P 500 estimate as of late last week was $108.02, exactly where it was 1 week ago.”
- Economic confidence remains weak (via Gallup). This measure is off the lows from last year, but still very weak — a bad sign for consumer spending.
- Foreign economic indicators (Europe and China) all declined last week. I always watch these — always. It is how I start my day, and I often comment on them in my daily diary at Wall Street All Stars. I understand that we have a global economy, and I want to put it in perspective. Offsetting some of the decline, China will do more stimulus. Analyzing the impact on US stocks is a challenge.
- The official jobs numbers reflected a weak economy, worse than expected and worse than needed. Discussing this objectively is nearly impossible for most, since the issue is so salient for voters. There was nothing good about this report. The net job gain of 96,000 is less than needed to keep up with the growth in population (perhaps 125k, although the target changes with trends in retirement and immigration). Downward revisions for the last two months subtracted another 40K jobs, half of which were in government. The household survey also showed a decline in jobs, although this series has fluctuated wildly. The decline in the unemployment rate was not statistically significant (after rounding) and mostly reflected a reduction in the labor force.
The official employment data is roughly consistent with the rest of what we see — growth of 2% or so. Putting aside the political rhetoric, everyone realizes that more economic growth and a greater increase in net jobs is needed.
The Ugly
The ugly award goes to the rather surprising result of diversification into commodities. Tom Brakke always combines clear-headed analysis with great charts. He analyzes the concepts behind the chart below. Check out the full discussion, but this point describes investor behavior: “Investors have embraced these alternatives, only to find that they don’t really know much about them other than they’re not stocks or bonds.”
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 SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events. It uses data, mostly from credit markets, to reach an objective risk assessment. The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.
The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli’s “aggregate spread.“
Bob and I recently did some videos explaining the recession history. I am working on a post that will show how to use this method. As I have written for many months, there is no imminent recession concern. I recently showed the significance of by explaining the relationship to the business cycle.
The evidence against the ECRI recession forecast continues to mount. It is disappointing that those with the best forecasting records get so much less media attention. The idea that a recession has already started is losing credibility with most observers. I urge readers to check out the list of excellent updates from prior posts.
Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.
The single best resource for the ECRI call and the ongoing debate is Doug Short. This week’s article describes the complete history, the critics, and how it has played out. The article highlights the most important economic indicators used in identifying recessions, showing that none have rolled over. Doug updates the recession debate every week and includes a great chart of the “big four” indicators used by the NBER in recession dating.
Meanwhile, the ECRI story continues to change. The latest variation is that the data will eventually be revised lower to show that we are already in recession.
Note on the Fiscal Cliff — A thoughtful reader asks whether our recession forecasts include the fiscal cliff, a good question. Methods derived from historical experience are not helpful on issues like the cliff, so the general answer is “no,” but some of the market-based methods will capture this as the time comes closer. I treat factors like the fiscal cliff, the collapse of Europe, the collapse of China, an attack on Iran, and similar factors as relevant elements of “tail risk.” There is no good way to incorporate these into standard recession forecasting methods, so no one even tries. (I am ignoring those with a semi-permanent recession forecast!)
I frequently cite and monitor these factors in the weekly commentary, especially in “the ugly” section. If you insist on waiting for a time when there are no low-probability risks, you are a spectator, not an investor.
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. This week we continued with our recent switch to neutral. We have been bullish since June 23rd, with a one-week move to neutral a month ago. These are one-month forecasts for the poll, but Felix has a three-week horizon. The ratings have moved lower, and the confidence has deteriorated from last week.
[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.]
