The Bad
The regular economic news was mostly negative.
- China’s flash PMI hit a nine-month low of 48.3 (below 50 signals contraction). Chinese growth is important to the overall world economy and especially to commodities. Barron’s has a good cover story by Jonathan R. Laing covering the issues in Chinese credit markets and possible over-spending on infrastructure. Global Economic Intersection has a comprehensive look at the Chinese yield curve, comparisons to US institutions in 2008, and possible policy changes. There are good charts and links to sources.
- The immigration bill remains stalled. Contrary to popular opinion, the bill would reduce the deficit by almost $200 B over ten years, mostly through higher tax revenues from immigrants. (CBO estimate).
- Earnings pre-announcements are much more negative than usual, 93 out of 116 total. According to ThomsonReuters, it is typical for bad news to be announced early, but the long-term ratio is only 2.4.
- Leading economic indicators were up, but only by 0.1%, a slight miss. See Doug Short for charts that provide perspective.
- Initial jobless claims were up 18,000 over a (slightly revised) prior week. Several analysts noted that this included the survey week for the monthly payroll report. This is true, but my research shows that the payroll report is more closely correlated with the results for the entire month rather than a specific week. This makes sense because it is a level rather than a short-term change. The four-week change is only 2500 higher, meaningless noise in this context. The moving average has lost some “good” weeks recently.
- Housing starts and building permits were a bit lower than expectations, so I’m listing this in the “bad” category. Calculated Risk, however, called it a “fairly strong report” because the single-family starts were up and prior months were revised higher.
The Ugly
It was a tough week in all markets on Wednesday and Thursday. While stocks only declined about 2% on the week, for those watching very closely (perhaps too closely) it felt worse. The real damage is in the interest-sensitive assets, a theme we have warned about for several weeks. Here is what has happened to what people have regarded as “safe” assets. (SoberLook via Joe Weisenthal).
The Indicator Snapshot
It is important to keep the current news in perspective. I am always searching for the best indicators for our weekly snapshot. I make changes when the evidence warrants. At the moment, my weekly snapshot includes these important summary indicators:
- For financial risk, the St. Louis Financial Stress Index.
- An updated analysis of recession probability from key sources.
- For market trends, the key measures from our “Felix” ETF model.
Financial Risk
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 recently edged a bit higher, reflecting increased market volatility. It remains at historically low levels, well 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.
Recession Odds
I feature the C-Score, 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.
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. A few weeks ago we switched to a neutral position, but it is a close call. Felix might switch to a bearish posture if the overall market drifts lower. The inverse ETFs are more highly rated than positive sectors by a small margin, but remain in the penalty box. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix’s ratings seem to have stabilized at a low level. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings. That measure remains elevated, so 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.]
