The Bad
There was also plenty of bad news.
- The Hindenburg Omen is back! Look out below, since it has been confirmed. Three years ago I explained that this indicator was the poster boy for a bad research method – widely followed by those with multi-year forecasts of recessions and “worst times” to invest. A twitter friend suggested that I should also mention that some see it as an “alert” rather than a prediction. Read the explanation and see if you find it helpful. MarketWatch‘s “The Tell” has the right conclusion:
“Either way, the HO this past week showed how much attention you can garner with an ominous sounding name in times of market skittishness, and generated its share of Tweets.”
- China’s flash PMI was below 50. The market seemed to shrug this off on Monday morning, but we should still watch Chinese economic growth carefully.
- The ISM index was 49, down from 50.7 last month. The ISM sees this as consistent with GDP growth of 2.1% based upon historical data. (We are in a trend of manufacturing lagging overall growth). Many believe that their research on this relationship needs updating.
- The sequester effects are starting to hit. The effect is probably about 0.5% in GDP (via Rick Newman at The Exchange).
- Initial jobless claims have broken the bullish trend. I know that last week’s number was a little better than expectations. I also know that a really good number dropped out of the four-week moving average. Steven Hansen at Global Economic Intersection takes a deeper look. He compares the current moving average (which is everyone’s top choice to reduce the noise in the series) and compares it to the prior year. Both are seasonally adjusted. See the entire article for discussion and several good charts, but here is an important one:
- Fed speeches included discussions of how the current QE purchases might be tapered off. The “T” word has replaced the “R” word as the newest fear factor. The trader perception, parroted regularly on CNBC, now includes the idea that the Fed somehow orchestrated this mixed message to create ambiguity. Do these “experts” think that all of the meeting transcripts and minutes are faked? They have absolutely no idea about how government decisions are reached. The simple and incorrect meme about the Fed is taken far too seriously. It is obviously time for another article on this theme. Meanwhile, get ready for some selling whenever one of the “hawks” gives a speech, whether or not he is a voting member.
The Ugly
This week’s “ugly” award goes to the Illinois legislature. The session ended with no solution to the ever-expanding public pension problem – the most under-funded in the country. This is an issue that is not going away and gets worse with the passage of time. The immediate result was a downgrade of the state’s debt rating. The legislature did approve turning the Elgin – O’Hare expressway (which goes neither to Elgin nor O’Hare) into a toll road.
One might expect a state where one party controls the governor’s office as well as both houses of the legislature to be capable of needed actions. Illinois politics are different, with cross-cutting factions representing Chicago, the suburbs, and downstate interests as well as the two parties. One successful bill combined a downstate fertilizer plant with a new arena for DePaul’s basketball team – not close to campus but near McCormick Place.
The Governor has called for a special legislative session on the pension issue, but it will take a major new ingredient to break the logjam.
This story is something to keep in mind when we revisit the debt limit and sequestration issues later this year.
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.” I have now added a series of videos, where Dr. Dieli explains the rationale for his indicator and how it applied in each recession since the 50’s. I have organized this so that you can pick a particular recession and see the discussion for that case. Those who are skeptics about the method should start by reviewing the video for that recession. Anyone who spends some time with this will learn a great deal about the history of recessions from a veteran observer.
I have promised another installment on how I use Bob’s information to improve investing. I hope to have that soon. Meanwhile, anyone watching the videos will quickly learn that the aggregate spread (and the C Score) provides an early warning. Bob also has a collection of coincident indicators and is always questioning his own methods.
I also feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index. They offer a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy. RecessionAlert has developed a comprehensive package of economic forecasting and market indicators, well worth your consideration.
Georg Vrba’s four-input recession indicator is also benign.
“Based on the historic patterns of the unemployment rate indicators prior to recessions one can reasonably conclude that the U.S. economy is not likely to go into recession anytime soon.”
Georg has other excellent indicators for stocks, bonds, and precious metals at iMarketSignals.
Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverage of the ECRI recession prediction, now over 18 months old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. His latest comment points out that the public data series has not been helpful or consistent with the announced ECRI posture. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating.
This week there is (yet another) effort by the ECRI to suggest that there might be a recession. Doug Short notes as follows:
“Here are two significant developments since ECRI’s public recession call on September 30, 2011:
- The S&P 500 is up about 40%.
- The unemployment rate has dropped from 9.0% to 7.6%.”
The average investor has lost track of this long ago, and that is unfortunate. The original ECRI claim and the supporting public data was expensive for many. The reason that I track this weekly, emphasizing the best methods, is that it is important for corporate earnings and for stock prices. It has been worth the effort for me, and for anyone reading each week.
Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.
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 switched to a neutral forecast. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix’s ratings have been weakening over the last two weeks, and dropped significantly this week. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box. When that measure is elevated, we have less confidence in short-term trading.
[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.]