by Jeff Miller, A Dash of Insight
In last week’s prediction for the week ahead I guessed that it was time for action. That was an accurate guess for the bountiful news flow, but not so much for the markets. We had some significant intra-day swings, but the reports had an offsetting effect. Those who were not following the daily news might have looked at the final result for the week and given it a “Ho hum.”
This week I am expecting the opposite – a snoozefest.
The economic calendar is the thinnest ever. Congress is out. It is summer in the city and the “A Teams” are on vacation.
CNBC warns that August is a negative month 53% of the time, but slow trading can lead to volatility.
The calendar is not the key factor.
Because column inches and air time must be filled whether there is real news or not, I expect a week laden with speculation about tapering, who will become the new Fed chair, and whether economic data warn of a new recession.
I have some thoughts on what our real focus should be which I’ll report in the conclusion. First, let us do our regular update of last week’s news and data.
Background on “Weighing the Week Ahead”
There are many good lists of upcoming events. One source I regularly follow is the weekly calendar from Investing.com. For best results you need to select the date range from the calendar displayed on the site. You will be rewarded with a comprehensive list of data and events from all over the world. It takes a little practice, but it is worth it.
In contrast, I highlight a smaller group of events. 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. Each week I consider the upcoming calendar and the current market, predicting the main theme we should expect. This step is an important part of my trading preparation and planning. It takes more hours than you can imagine.
My record is pretty good. If you review the list of titles it looks like a history of market concerns. Wrong! The thing to note is that I highlighted each topicthe week before it grabbed the attention. I find it useful to reflect on the key theme for the week ahead, and I hope you will as well.
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.
This was a really good week for economic data — right up until the end!
- China’s PMI shows expansion and beat expectations. Only by a little, but it is a positive. (Via Business Insider).
- Q2 GDP growth of 1.7% beat expectations. I am scoring this as “good” only because there was plenty of concern about this number, with some even suggesting that a negative print was possible. We also had revisions and adjustments (normal, and done every five years). The good news is that the overall economy is better than we thought, as is the current growth. We did get a bit lower in a couple of the past quarters. Those using the GDP-based recession tracking cited this as showing increased risk, including one of our favorite sources, Dr. James Hamilton, whose indicator moved to 30%. He carefully explains that this is based on the revised Q1 numbers, not the most recent report.
- The FOMC changed the date on the statement. I’ll score this as “good” because the market parsed the language and squeezed out the inference of a delay in QE tapering. I do not think this really matters, but that was the verdict.
- The earnings beat rate continued at 73%. Revenues and year-over-year growth were not as strong. Dr. Ed says that this does not matter, since we should focus on the strong forward earnings. These are “flying with the hawks.” My own research shows that this is the best indicator for one year ahead.
- Light vehicle sales are surging. Bespoke has the story on Ford Truck Sales. For anyone traveling in the Midwest, a strongly recommend the Ford Rouge factory tour and a visit to The Henry Ford museum. These are educational and unforgettable experiences. My family loved it and yours will, too. On the issue of whether we should provide public help to Detroit, check out Felix Salmon’s story.
- The ISM manufacturing report was very good on all fronts: headline, employment, and future growth. (See Steven Hansen at GEI).
- Initial jobless claims dipped again. There are many seasonal fluctuations and timing effects from auto plants. We shall see.
There was not much bad news except for the jobs report. Please feel free to join in the comments if you think there is recent news that I missed.
- Personal consumption and income trend weaker. The data were mixed, with an apparent beat on spending. Steven Hansen analyzes the combined effects as well as the revisions in what he calls a “mixed picture.” Doug Short shows the long-term disposable income effect adjusted for inflation and population.
- The monthly employment situation report showed disappointing growth. The headline number was a payroll gain of only 162K jobs and there were downward revisions to the prior two months. The recent trend is now in the 180K range instead of the prior 200K range. Hours worked moved slightly lower as did the hourly wage. Cardiff Garcia has a good general analysis. The Bonddad Blog ponders the negative internals. The ADP private employment numbers were stronger (200K gain), and I like to consider data from various sources, especially given the wide error band (100K) on this report. I score it as slightly disappointing, and the market seemed to agree.
Speed trumps accuracy. Bloomberg, an authoritative and reliable source, sent out the wrong tweet on the “Fabulous Fab” verdict. The Huffington Post has the evidence — both the error and the correction. This seems to have ended the career of a twenty-year editor who authorized the dispatch of the wrong pre-written tweet.
I doubt that anyone was trading on this information, but WonkBlog explains why you should care about the verdict for someone who played a “bit part”.
At least this account was not hacked, as was the Thomson Reuters account this week.
For most of us it is wise to take some time. We should both verify and interpret the news. That advice would have been helpful for the misguided and naïve trader who bought an outlandish number of calls in an illiquid stock in advance of what seemed to be takeover news. Jeff Matthews has the story of this lucky trader (highlighted, as so often happens, by a helpful tweet from @eddyelfenbein). You can decide for yourself what might have inspired this high level of conviction, which seems to have worked out well!
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 Bob Dieli who corrects the record on the part-time employment issue.
There is a deceptive theme about employment, disparaging the quality of the net jobs created. Some of the writers have obvious political motivations or enjoy reputations as leaders of the tin hat movement. What is alarming is that the theme has gained credibility with some mainstream pundits who spend too much time on the wrong websites. Egregiously bad was the John Mauldin article citing Charles Gave’s analysis. Not only is this wrong on the part-time employment issue, it blames everything on QE. I tweet infrequently, but I managed a 140 character response to this one:
To Charles Gave and John Mauldin: Blaming QE for the trend toward part-time employment is like blaming the firemen for the fire.#causation
Bob Dieli does not profit from ratings or page views — only from accurate analysis in his regular reports on the economy. Last week he produced research showing that the alleged “trend” to part-time employment is poor analysis. You really need to read the entire report (which he has now made public) but here are the key points:
- The main effect occurred at the time of the recession, and is now getting smaller.
- The effect seems to have important seasonal components – conveniently ignored by some.
The May/June effects are rather obvious, as are September and October. This story needs a deeper look, but it also deserves immediate attention. More to come on this story.
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.
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.
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 almost two years 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. Over a month ago we briefly switched to a bearish position, but it was a close call. The indicators quickly shifted back to neutral, which was also a close call. Two weeks ago Felix turned bullish, again by a small margin. All of the indicators have improved over the last two weeks.
These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix’s ratings have improved quite a bit. 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 has declined, so we now have more 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.]
The Week Ahead
This week brings very little data and scheduled news.
The “A List” includes the following:
- Initial jobless claims (Th). This is especially important after the monthly employment report for July.
- ISM services index (M). The service sector has become larger than manufacturing, but this index has a shorter history than .the regular ISM index. There will be special attention to the employment component.
The “B List” includes the following:
- Trade balance (T). Important both as an overall economic indicator and a factor in the official GDP calculation.
Some of the Fed regional bank presidents will be on the speaking circuit, including Fisher (Dallas), Plosser (Philadelphia), and Pianalto (Cleveland). I suppose that Fisher might say something leaning hawkish in his Monday speech in Portland. With so little going on, anything off message might get attention.
Earnings reports continue, but we are through the heart of the season.
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 turned bullish, which is now fully reflected in trading accounts. The ratings are improving and there is good breadth — including the broad market indexes.
Felix has done far better than most traders, accepting the reality of the improving market. Felix has also shifted away from the emphasis on foreign markets.
Insight for Investors
This is an opportunity for reflection. Think of it as a mid-year checkup.
- For several weeks, I have accurately emphasized the danger of yield-based investments – yesterday’s source of safety. The popular name for this is “The Great Rotation.” It is still in the early innings, since bond fund investors are only getting the bad news from their statements. Even the best bond managers (like Gross and Gundlach) cannot win when interest rates are rising. The exodus from their funds is starting. Most investors are emphasizing cash, real estate, and gold. An average of .333 is good in the major leagues, but not for your investments!
- 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 freely share how we do it and you can try it yourself. Follow here).
- Ask yourself how you are doing? Josh Brown’s powerful piece earned the top admiration score from any blogger: I wish I had written it! Here is the start, but you need to read it all.
“If you had twenty five years left to live, how much time would you spend worrying about the daily ups and downs of the stock market?
If you had twenty years left to live, how much time would you spend trying to time the stock markets and the economy and other things that are both unpredictable and completely out of your control?
If you had fifteen years left to live, how much time would you spend trying to buy or sell a specific stock at the perfect price?“
And much more… For many investors there comes a time when they should focus on fun, and maybe also improve performance.
- Lose the focus on fear! Many are rewarded for making sure that you are “scared witless” (TM OldProf euphemism). If you are addicted to gold and allegedly safe yield stocks, you need a checkup. Gold works in times of hyperinflation or deflation/crisis. When neither happens, the ball is going between these Golden Goalposts. There is a good transition plan for those with a fixation and fear and gold.
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).
Most of the punditry takes a very narrow focus. For the bears, the market has already moved to far, so it must move lower. Even the bulls are pretty conservative – they have already won the calendar-year sweepstakes. Why raise targets?
If you are a real manager instead of a pundit the calendar does not matter. Every day is a new start. The investor needs to start with the right question. Beginning now — right now…
What do you expect for the upcoming year?
Start with the facts that we all know:
- Below trend growth and slack in the economy
- Main Street has not profited as much as Wall Street
- The sluggish economic recovery has left many behind.
Another obvious interpretation is that this is a longer business cycle. Government policy, including Fed actions, can be expected to continue for much longer.
Those who are using an old playbook and talking about average cycle lengths are making a big mistake.
Here is my own perspective, which has proven quite accurate.
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.)
I try to emphasize sources whose interests are aligned with individual investors – people like me. I am skeptical of those selling a single product whether it is gold, annuities, structured products, bonds, fear, or page views. Let us look to two sources who meet my strict criteria.
Of the various investment choices, and despite the recent rally, stocks are attractive.
Here is how Eddy Elfenbein puts it:
“The argument for stocks is very simple, and it comes down to math. Right now, Wall Street expects the S&P 500 to earn $123 next year (that’s the index-adjusted figure). That means the stock market is currently going for 13.7 times next year’s earnings. Or you can say that the market has an earnings yield of 7.3%.
There’s nothing in the bond market close to 7.3% at the moment. The furthest-dated US Treasury will yield you 3.7%, and higher-rated corporates run around 4.4%. That’s a pretty big gap, and much wider than I think can be justified due to a risk premium. Stocks offer the best bang for your buck.”
And here is the best CNBC video of the week, where Josh Brown explains about eventual Fed tapering. He was thoughtful and prepared. Watch the few minutes of this video, which also has good advice from Art Hogan.
“…what you have to do is start preparing for it. and b, and be acceptful of the fact you that you might be early. so the first thing you that want to start thinking about is whether or not you really need to stick with these core bond allocations that everyone believes are so conservative. The reality is they’re probably not quite so conservative. If you’re going to get volatility, Larry, from both sides of the portfolio, which side is worthwhile taking that volatility from? Odds are it’s the stock side. You’d rather get the volatility where at least the up side is going to pay you off over time.”
And kudos to Larry Kudlow for including this segment.