The extended stock market rally has everyone checking the record books and looking for explanations. Your understanding of the rally is important since it helps to predict when it will end.
Some focus on history. Eddy Elfenbein notes the official doubling of the S&P 500. David Merkel wisely notes that the extent of the rise must be compared to the extent of the decline. (Check out his great charts). If you follow history, you would take heed of David's advice to "Consider trimming some of your hottest positions."
Some focus on the Fed. Since the most recent phase of the rally roughly coincided with the QE II announcement, many have attributed undue causation. Amazingly, some do this while simultaneously arguing that the Fed policy has been ineffective.
The explanation is much simpler. The Beat Goes On.
The grocery store's the supermart, uh huh.
Little girls still break their hearts, uh huh.
And men still keep on marching off to war
Electrically they keep a baseball score
{Refrain}
Grandmas sit in chairs and reminisce
Boys keep chasing girls to get a kiss
The cars keep going faster all the time
Bums still cry, "Hey buddy, have you got a dime"
Sonny & Cher may not have been market gurus, but the song captures the current market action. The "drums keep beating."
There are three "beats" to watch:
- The earnings beats -- still rolling along despite the skeptics. Most importantly earnings revisions (from Dirk Van Dijk at Zacks) are moving higher by a ratio of 1.73. (2012 is even better).
- The economic beats -- plenty of important data series are better, while some are flat.
- And the result? The market beat. Stocks trade on the fundamentals of earnings expectations and interest rates.
I will summarize our investment perspective and the current market threats, but first let us consider our regular review of the data.
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.
For a comprehensive look, check out Calculated Risk's weekly review with charts. The Bonddad Blog's review emphasizes "high frequency data" including some unusual items that you might otherwise miss. I also like my new colleague Steve Hansen's weekly data review. (I am delighted to be added as a contributor at Global Economic Intersection. I respect the people, love the format, and appreciate the collegial willingness to mix it up when contributors disagree).
In most of my articles I build a careful case for each point. My purpose here is different. 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 some will disagree. That is what makes a market!
Last Week's Data
The news last week was basically good with the ongoing exception of housing -- an important exception.
The Good
Most major economic indicators remain in positive territory. There is growing recognition that the economic rally now has a self-sustaining character.
- Economic growth is still improving. The ECRI Weekly Leading Index pulled back slightly while the growth index reached a fresh peak, the highest since May, 2010. This is a signal of solid growth for as far ahead as they are willing to forecast.
- Risk as measured by the St. Louis Fed Stress Index, moved to the lowest level since before the financial crisis. This measure tracks a lot of market data in the eighteen inputs. It is not a poll, nor opinions, nor a collection of anecdotes. We should all pay attention to some real data. The value moved to -.022, even lower than the .024 from last week. For more interpretation, the St. Louis Fed published a short paper with a very nice chart that helps to interpret this index. The chart does not reflect the recent continued decline in stress, but it identifies the dates for important recent events. The paper also has a longer version of the chart, illustrating past stress periods. I am not going to run the chart each week, but I strongly recommend that readers look at the paper. In the 2008 decline there was plenty of warning from this index -- no sign right now. Mark Perry at the Carpe Diem blog, one of our featured sites, highlighted this indicator. Mark gets a lot of well-deserved exposure so perhaps the 'secret risk measure' that readers of "A Dash" have profited from will now be more in the public eye.
- The Philly Fed. I said last week that this was not important unless there was a big move. There was -- 35.9 versus 21 expected. This provides support for the various measures of manufacturing improvement.
- Rail Traffic. The data came in great as noted at GEI. Bonddad adds that this series seems to be a good lead for industrial production.
- Inflation Data. The Fed has an announced policy on inflation, making it easy to profit from following the lead. They want a higher core inflation rate. I explained what investors really need to know, and debunked the extremist "money-printing" crowd. Prof. Hamilton says the same, with force and authority.
The Bad
There was some important bad news for the economy. The story is rarely one-sided. There is a continuing problem on several fronts, a widely known "wall of worry" that is already reflected in current market prices.
- Housing Sales Overstated. The most important bad news of the week came from the CoreLogic Year-end Summary of Trends. I read their reports, and so should you. Calculated Risk has a nice summary, showing that the existing home sales from the National Association of Realtors may be overstated by 15%. Consistent and aggressive critic (another of our featured sources) Barry Ritholtz has this take.
- Retail Sales. This was a big disappointment.
- Initial Jobless Claims. The highly volatile series moved higher, but the trend continues lower. It is not good enough to improve the employment picture.
The "Not Bad"
Each week there are important numbers that are not decisively good nor decisively bad. If the information is important we cannot and should not ignore it, especially if expectations were different from the reports.
This week's candidate is sentiment. Many think that sentiment is excessively bullish. These observers have (incorrectly) been calling market tops for months. Traders Narrative (Yet another hat tip to Abnormal Returns) has the most comprehensive summary of sentiment indicators I have seen. The readings are high, but not off of the charts. Personally, I do not like polls of those with little marginal money to invest. I prefer looking to big money players who could make a significant difference with a small change in asset allocation, as I wrote here.
The Big Worry: Energy Prices
The rally rests on economic growth, profit growth, a good supply of well-known worries, and attractive valuations. What might threaten this picture?
Two of our favorite sources, Bonddad and Econbrowser, are highlighting rising fuel prices and the possible threat to the economy. This bears watching.
Our Own Forecast
We base our "official" weekly posture on ratings from our TCA-ETF "Felix" model. After a mostly bullish posture for several months, Felix has turned more cautious. Three weeks ago we said it was a close call, and switched to neutral. Two weeks ago it was still close, but we shifted back to bullish in the weekly Ticker Sense Blogger Sentiment Poll. We remained bullish this week. Here is what we see:
- 77% of our 56 ETF's have a positive rating, up from 68% last week.
- 55% of our 56 sectors are in our "penalty box," down sharply from 73% last week. This is an indication of significant, but reduced short-term risk.
- Our universe has a median strength of +19, about the same as +18 last week.
The overall picture is slightly bullish. We remained fully invested in trading accounts since there are several strong sectors, but we are watching the indicators quite carefully. This has been a very close call for several weeks.
[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.]
The Week Ahead
There are a number of reports this week, but here is what I will be watching.
- Case-Shiller data. The market cares, so I must watch also. Bad news is already reflected in the market. If Diana Olick ever says anything positive, we will see a huge market rally.
- Interest rates. Watch the ongoing interplay with currencies and inflation expectations.
- Energy prices! Enough said.
- The ongoing protests in Wisconsin and the Middle East -- what a juxtaposition! I don't see a big link to stock prices right now, but I am watching.
- The chances for a federal government shutdown. It seems stupid, but who knows?
Investment Implications
Nearly everyone has been under-invested at some point during the extended rally. Even those of us who have been bullish throughout are under-invested for new accounts. Trying to time the market correction has been a big mistake. A good alternative is to watch the fundamentals and risk factors I highlight each week.
I am going to repeat my investment comment from last week:
For long-term investors I have been looking for entry points and have been frustrated by the lack of any significant correction. The market reaction suggests that I have some company.
Conditions have improved significantly over the last few weeks, dramatically reducing some market worries. The data changed our official investment posture in the last few weeks.
In distinct contrast, most of our dependable sources of market worries have seamlessly shifted from one theme to another.
Listen up! There is always something to worry about. Using actual data would be a refreshing change for many investors. The next time you read an article about "headwinds," look to see if there is any supporting data.
I have a shopping list of stocks with great earnings forecasts and a price target for my buys. If you want to find your own stocks, I recommend Chuck Carnevale as a great place to start. You need to be willing to do some work and learn about earnings. Start here.
