Weighing the Week Ahead: How Full is the Glass?

There is an interesting market balance right now.

1. For technical analysts, there are many bearish predictions, but the market seems to have found a trading range.
2. For fundamental analysts, the data continue to be mixed, allowing pundits of all stripes freedom to interpret as they see fit.

A key to analyzing the balance is the incessant discussion of a "double dip."  To verify that I was not imagining things, I checked out the spike in searches on Google Trends.   Gene Epstein notes the same.

More on the recession debate below.

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  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.

Last Week's Data

Most of the economic and market issues have remained the same.  Let's do our regular review.

The Good

There were quite a few positive notes.

• The Chinese indicates some flexibility on exchange rates.  It is only a small step, but it is a necessary one.  I recommend Paul Krugman's explanation on how to interpret this step.
• University of Michigan consumer confidence moved a little higher -- a good sign for job creation.
• Initial claims and continuing claims declined.  There is still a long way to go.
• Oracle (ORCL) earnings were great and the company said the right things about business investment.
• The financial reform bill, at least on a short-term basis, was bullish.  By this I mean the issue for financial and bank stocks were (mostly) corrected. There were critics who wanted more, and critics who wanted less, but nothing surfaced that was an immediate negative for the week ahead.
• Copper and rail traffic moved higher.
• Firms are stepping up spending.

The Bad

There was plenty of news for those of a bearish persuasion.

• New home sales, post incentives, were terrible, the worst miss since 1998 via the Bespoke Investment Group.  If you take the annualized rate and divide by the total homes outstanding, the "months of inventory" spiked.  This is a little misleading since the existing inventory looks a lot bigger at the new sales rate.
• Lending conditions have become much worse, halfway back to the crisis levels by this assessment.
• Even the normally sanguine James Altucher has a list of worries for this weekend.  This looks to me like a well-stated summary of old news, but it is good to have a list of concerns to monitor.
• People are less confident in the President and the country.  Readers should note two important aspects of this interpretation:
• • General poll results about the country may often be in contrast to the assessment of one's personal situation, as noted above in the Michigan confidence index.
  • This is not intended as a political verdict.  For the moment, a loss of confidence for the President and/or the country is bad for the economy.  (I made the same interpretation when President Bush was in office).  Weaker Obama ratings are bearish (short-term) for the market.  I realize that some are taking a longer view and cheering against the President.
• The S&P failed to rally through the 200-day moving average.

The Debatable

Many continue to argue that a renewal of the recession is imminent.  Typical of those taking this viewpoint is the influential John Mauldin.  I find two aspects of his position quite troubling:

1. He cites and dismisses his former favorite indicator, the yield curve slope, explaining why it is "different this time."
2. He takes the ECRI rate of growth index and cherry picks the time horizon.  By doing this he is able to back-fit a handful of past recessions.

You can come up with some fancy-looking charts from this kind of data mining.  Most readers will not see the fundamental flaw in the analysis.

Most of the Mauldin readers also do not know that the conclusions are completely in conflict with the ECRI's own interpretation of slower growth, but no likely recession.  I covered this carefully last week, and so did the ECRI in a great article featured by Barry Ritholtz:

We created the WLI not to be an infallible, stand-alone recession-forecasting machine, but as one small part of a much larger array of leading indexes (each made up of many economic indicators) — like the especially prescient U.S. Long Leading Index. This array amounts to a sophisticated sequential signaling system of the economy’s cyclical turning points. The WLI is designed to be interpreted in this broader context, and its message today is quite simple: A slowdown in U.S. economic growth is imminent, but a new recession is not.

To illustrate, you can also look at a contrasting recession indicator from Credit Suisse.  This one sees virtually no chance of a recession for six months.  It accurately called seven in a row with only one false positive.

If you begin your search for recession odds with an opinion in mind, you can be confident of finding a statistical method that will provide strong support.

Meanwhile, the public is convinced, as illustrated by Bespoke Investment Group's latest poll.

The Week Ahead

I am looking for two key economic readings:  The ISM report (which for months has been very bullish on the economy) and the employment numbers.  I'll have may regular employment preview at mid-week.

The market continues the wait for fresh information on corporate earnings and outlook.  Trading also continues to track the Euro strength.  Who knows when this will end?

Our Own Forecast

Our own indicators turned bearish right after our May 9th report and then flipped neutral when volatility increased.  We have turned bearish once again, and this is our vote in the weekly Ticker Sense Blogger Sentiment Poll.   Here is what we see:

• Only 25% of our 55 ETF's have a positive rating and three of these are inverse ETFs.  This is about as weak as it gets.
• 93% of our 55 sectors are in our "penalty box," showing an extremely high level of uncertainty and risk.
• Our Index Package now has a very strong negative rating of -20.

[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.]

For short-term accounts we were mostly neutral last week, with a small short lean.

Investment Implications

Investing continues to be a matter of time frames.  The short term seems range-bound, with negative momentum.  For those with a longer horizon, the story may improve with earnings reports next month.