The Week Ahead
This week brings plenty of data despite the holiday-shortened week.
The “A List” includes the following:
- The employment report (F). This is always given the most market attention, and the Fed emphasis can only increase that.
- Initial jobless claims (Th). The most timely and responsive employment indicator.
- ISM index (M). Widely followed as an important concurrent indicator of manufacturing.
The “B List” includes the following:
- ADP private employment (W). I view this as an important independent employment measure.
- ISM services index (W). Less historical data than manufacturing but a growing part of the economy.
- Construction spending (M). May data, but interesting given the importance of growth in construction.
- Trade balance (W). Interesting both for overall economic health and as a component of GDP.
- Factory Orders (T). May data.
NY Fed President Dudley speaks on Tuesday. Markets around the world have various vacation days. Were it not for Employment Friday I would expect a really slow week beginning Wednesday morning. Even so, we may have the “B Teams” on duty for Friday morning trading with things getting quiet swiftly after the opening. It could provide a good opportunity for those of us at work!
How to Use the Weekly Data Updates
In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a “one size fits all” approach.
To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?
My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.
Insight for Traders
Felix has moved (marginally) to a bearish posture, but this is not yet reflected in trading accounts which have no positions. The overall ratings are slightly negative, and we might purchase one or more inverse index funds in the coming week. While it is a three-week forecast, we update the model every day and trade accordingly. It is fair to say that Felix remains cautious about the next few weeks. Felix did well to avoid the premature correction calls that have been prevalent since the first few days of 2013, accompanied by various slogans and omens. I should also note that the last time we anticipated the purchase of inverse funds, the market stabilized and the inverse funds never emerged from the penalty box. The bearish tilt is marginal.
Insight for Investors
This is a time both of danger and of opportunity for investors. The changes are not just about markets in general, but a shift in what is safe and what is not. My recent themes are still quite valid. If you have not followed the links, find a little time to give yourself a checkup. You can follow the steps below:
- What NOT to do
Let us start with the most dangerous investments, especially those traditionally regarded as safe. Interest rates have been falling for so long that investors in fixed income are accustomed to collecting both yield and capital appreciation. An increase in interest rates will prove very costly for these investments. It has already started. Check out Georg Vrba’s bond model, which continues to signal the risk.
- Find a safer source of yield: Take what the market is giving you!
For the conservative investor, you can buy stocks with a reasonable yield, attractive valuation, and a strong balance sheet. You can then sell near-term calls against your position and target returns close to 10%. The risk is far lower than for a general stock portfolio. This strategy has worked well for over two years and continues to do so. I have had a number of questions about this suggestion, so I wrote an update last week. That post provides background as well as concrete examples showing how you can try this strategy yourself.
- Balance risk and reward
There is always risk. Investors often see a distorted balance of upside and downside, focusing too much on news events and not enough on earnings and value. You need to understand and accept normal market volatility, as I explain in this post: Should Investors be Scared Witless?
- Get Started
Too many long-term investors try to go all-in or all-out, thinking they can time the market. There is no reason for these extremes. While last week was a tough one for traders. Most were surprised by the market reaction to more FedSpeak. Our Felix model was safely on the sidelines.
For investors it was a different story. If you had your shopping list, there were good opportunities to buy stocks. For those following our enhanced yield approach you had both the chance to set new positions and to sell calls against old ones.
And finally, we have collected some of our recent recommendations in a new investor resource page — a starting point for the long-term investor. (Comments and suggestions welcome. I am trying to be helpful and I love feedback).
My friends from the various competing groups are all very intelligent and experts at what they do. A policy maker has a long-term time frame and a viewpoint of avoiding imminent disaster. A trader, of necessity, translates any information into a simple rule. Doing otherwise can mean “blowing out.” My academic friends develop data and evidence that stands up to peer review, but may not fit the relevance of the market.
At the moment, I think that all of these groups are correct. The Fed has accurately identified the actual economic effects of the QE policy – pretty minimal. The traders have exaggerated the Fed effects through rules like “don’t fight the Fed,” the Bernanke put, POMO, and the like. Perception becomes reality. Academics refuse to engage with the pop economists, which makes their work much less relevant than it could be. At least they are trying.
There are a few very savvy fund managers who understand what is going on. They know that higher interest rates are actually a sign of economic and market health. Barron’s finally hit this theme in the current issue, and I predict that you will see it much more frequently in the weeks ahead. Take a few minutes to watch the advice of these three great interviews. It will be time well spent, explaining how stocks can thrive as interest rates rise.
For my own take, I find it helpful to think about a likely destination for the economy and financial markets. This is helpful in avoiding excessive focus on any single variable in a world where so many things are correlated. I expect the economy to improve, interest rates to move higher (starting with the long end), PE ratios to increase (as is usually the case when rates go to 4% or so), profit margins to decrease somewhat, and the U.S. deficit to decrease. This climate will be very negative for some stocks and sectors and very positive for others. (I provide more detail here.)
A key element is to avoid the fixation on the Fed. The idea that the Fed determines long-term interest rates is rapidly being proven wrong. James Hamilton shows (It’s not just the Fed) that interest rates actually increased after the announcement of both QE2 and QE3. He writes,
“It’s worth emphasizing that the recent rise in interest rates has been a global phenomenon, not just something seen in the United States.”
I have demonstrated that Fed buying is only 1% of daily trading in the cash markets. Nearly everyone confuses net new issuance of debt, total new issuance, and the float. This is a big mistake, and it can be a costly one.
If you read one thing this week it should be Josh Brown’s message about individual investors and market timing. You really need to read the entire post (and you should join me in reading everything else from Josh as well). Here is the key chart, showing the effect of investor attempts at market timing:
Josh gets our highest accolade: We turn off the mute button and TIVO back when we see him on TV!
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