Last week was wild and driven by news. Each week is a clean slate, so what should we expect?
Background on "Weighing the Week Ahead"
There are many good services that do a complete list of every event for the upcoming week, so that is not my mission. Instead, I try to single out what will be most important in the coming week. If I am correct, my theme for the week is what 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. Until last week, my guesses have been pretty good. Last week I was OK through Monday's trading, but the idea of a quiet week before the employment report -- well -- that was not very accurate!
It still helps to have a game plan for the week. Giving advance thought to the issues leaves you better prepared to adjust, even when events are surprising.
Resources
Each week I review a lot of news, economic reports, and commentary from leading economists. I also consider the perspective of top traders. Charles Kirk is always helpful, and he was right on target last week. He is doing a nice weekend video with interesting charts. (This is a membership feature, but well worth it for active traders.)
I am sorry to lose the trading insights from Dr. Brett Steenbarger, who is "winding down" his excellent blog. His latest articles have included links to some of his most important topics. It is a great review for regular readers like me, and even better for new readers. I recommend bookmarking the page and reading something whenever you need trading information or coaching. If you like what you read, you will consider one of Dr. Brett's books.
Reviewing Last Week
There was so much action, it is difficult to summarize in a short article, but here are the high spots.
The Good
- Most economic data -- ISM manufacturing and services, personal consumption, and productivity are all consistent with economic recovery.
- Housing data were solid, but not meaningful until we see how it looks without government incentives.
- The employment report was very good on the surface. A payroll job gain of 290K looks great and the prior months were revised upward. I have some reservations. I am worried about the methods for estimating job creation -- not the birth/death adjustment, since that is only a minor part of the process. I am concerned about the first part of the BLS estimation process, the imputation step. While most observers do not understand this process, it is much more important than the birth/death model. At the risk of over-simplifying, it imputes the behavior of firms in the sample to those that have dropped out. This does not seem to be supported by data about new businesses.
- The household survey was very good, despite the uptick in the unemployment rate. We really need to see labor force expansion. If you look at subgroups, the unemployment among those over 25 did not change. The labor force is expanding and more people are finding work. we have a very long way to go.
- Weekly jobless claims are still elevated. This is an important part of the job picture. The rate of initial claims seems to have stalled at an unhealthy level.
- Europe. Political maneuvering about Greece and the downgrade of credit ratings (Greece, Portugal, Spain, and ??) had worldwide markets on edge. Initial proposals sparked objection and conflict.
- The oil "spill". We still do not yet know the extent of the cost, since the spill continues. I noted last week that "one cost will be the effect on energy prices as people re-evaluate this energy sources." Oil prices moved lower this week, but it was partly a result of dollar strength. Higher oil prices remain a significant economic threat. Check out the analysis from Prof. James Hamilton to understand the crucial role played by offshore oil.
The Ugly
- Televised rioting. Financial television featured coverage of rioting by Greek protesters. While the linkage from this activity to US stocks might have been a bit vague, it certainly could not be good news.
- Thursday trading -- especially in the afternoon. Those who just checked closing prices, or who stepped away for an hour, missed a historic downdraft. So far there is no good explanation for the wide, short-term variation in prices. In the absence of a convincing story from the exchanges, we will get an inquiry from President Obama and a Congressional investigation, perhaps followed by more regulation. Let us hope that the exchanges can swiftly find a voluntary plan.
There are plenty of carryover issues from last week. The sharp decline in stocks was seized upon as confirmation by adherents of assorted theories, including the following:
- US equities are overvalued;
- Traders have crowded into "risk trades" of various types;
- The global economy is about to collapse;
- European problems are the beginning of a global contagion; and
- Variations on all of the above.
The dramatic Thursday downdraft gave credence to these ideas. The canceling of some trades, but not others, and the mysterious circumstances increase fear ans suspicion among average investors and traders.
There are many thoughtful replies to these questions, but distinguishing European sovereign debt and the 2008 crisis is most important. Paul Krugman, focused on the economy, not stocks, provides this conclusion:
So, is Greece the next Lehman? No. It isn’t either big enough or interconnected enough to cause global financial markets to freeze up the way they did in 2008. Whatever caused that brief 1,000-point swoon in the Dow, it wasn’t justified by actual events in Europe.
Nor should you take seriously analysts claiming that we’re seeing the start of a run on all government debt. U.S. borrowing costs actually plunged on Thursday to their lowest level in months. And while worriers warned that Britain could be the next Greece, British rates also fell slightly.
I expect serious progress by the European governments over the weekend, with more realistic proposals. Democracies do not do well in anticipating and dealing with crises. The evidence has to be clear before political leaders will act.
A key factor in trading was the strength in the dollar. This is a return to the short-term correlation that prevailed for much of last year. As I showed in this article, a strong dollar has been positive for stocks in the long term. European countries will address Euro weakness next week.
The S&P 500 is still holding the 200-day moving average, so that is another factor to watch. There is only about a 1% cushion.
Our Trading Forecast
Our own indicators remain bullish by a very slender margin, and that was our vote in the weekly Ticker Sense Blogger Sentiment Poll. Here is what we see:
- 80% (87% last week) of our ETF's have positive ratings. This is moderately strong.
- The median strength is only +10 (down from +18 last week). This is only a slight positive.
- 60% (down from 90%) of the sectors are in the "penalty box," showing a moderately high level of uncertainty and risk.
- Our Index Package now has a very small positive rating.
[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 email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]
Investment Implications
I did some buying on Wednesday, but the increased volatility suggested patience, even for those with long-term confidence in the economy and the market.
The selling was very broad-based -- indiscriminate. I continue to avoid energy and banks in long-term individual stock portfolios. (The ETF trading is a bit different).
My favorite theme for the year is the technology cycle linked to Windows 7. Every data point has shown increased business spending. The European impact on these products was grossly exaggerated last week.
There are many interesting opportunities for investors. As usual, when stocks are really "on sale" most people are too frightened to buy.
Long MSFT, INTC, AAPL and some other tech names.
