A Dash of Insight

Weighing the Week Ahead: Economic Transition from Stimulus?

The long list of government stimulus and assistance programs were all intended to be temporary.  As the programs gradually end, one question is paramount:

Will there be a successful transition from government stimulus to a self-sustaining economic recovery?

Some economists are maintaining solid growth forecasts for the remainder of the year.  They see the current slowdown as the result of follow-on effects from the Japanese earthquake and tsunami and from higher gasoline prices.  If these effects are temporary, the moderate growth should improve.

Economic growth expert Michael Mandel, another of the impressive group of Kauffman Conference participants, notes that the expected transition from government stimulus to business investment is not yet showing up.  Here is one of several key charts.  See the full article for his fine analysis of this problem.

 

I do not yet see a "double dip" recession from the slowing data, but the lower trajectory of growth leaves less room for error.  Check out Econbrowser's analysis of economic forecasts and you will see that mainstream economists embrace this position.  One reason is that the effect of the end of QE II buying has been overstated by many investment analysts.

 

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.

Readers often disagree with my conclusions.  That is fine!  Join in and comment.  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 mostly negative.

The Good

These are all items that are either important right now, or bear watching -- a little bit of good news.

• State tax collections are up 9.1% over last year.  The Rockefeller Institute at SUNY-Albany (HT Calculated Risk for the pointer) monitors 47 early-reporting states.  Revenues are still 3% lower than peak levels, but the story is improving nicely.
• University of Michigan Consumer sentiment improved by 2 points, beating expectations.  The results were probably helped by lower gas prices.  The general level of confidence is still lower than we need for a good recovery. 

The Bad

There was a lot of disappointing economic news. 

• Initial jobless claims of 424,000 -- too high to expect solid job growth.
• Housing data was even worse than expected.  This week's bad housing data were the pending home sales.  As Calculated Risk points out, this suggests weaker sales data in the months ahead. 
• The "minor" reports were very bad.  This included industrial production and the GDP "internals."
• European sovereign debt issues, bailouts, and scandals.  The headlines included the lack of a solution in Greece and more negative credit watches.  The IMF still has not chosen a new head.  These headlines are still getting attention, and the effects have not shown up in the SLFSI data.  Some see this as the biggest market threat, although the linkage to US markets is always a little vague.  I am certainly watching, and you should be, too.

The Very Sad

The unexpected death of CNBC's Mark Haines is a loss felt by everyone in the investment community.  Mark has been a part of my morning for over twenty years.  His interviews reflected his preparation and legal background.  While he had a viewpoint, the interview subject always had a fair chance to make his case.

We will all miss him, and our team extends condolences to his family and CNBC colleagues.

The Indicator Snapshot

It is important to keep the weekly news in perspective.  My weekly indicator snapshot includes important summary indicators:

• The ECRI Weekly Leading Index and the derivative Growth Index
• The St. Louis Fed Stress Index
• The key measures from our "Felix" ETF model.

There will soon be at least one new indicator, and the current choices are under review.

The indicators show continuing modest growth at a slowing pace, with little indication of economic risk.  The market fears, as usual, are greater than one might expect from the data.

Felix is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. We have a long public record for these positions.  This is our first bearish forecast in a long time.

[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

There are some very important economic reports this week, especially the ISM index and the monthly jobs report.  Payroll employment growth, still much lower than needed, has actually done better than one would expect from the rest of the economic data.  With higher jobless claims and weak consumer confidence, I am not expecting a strong report.  I'll do my regular preview at mid-week.

Case-Shiller home price data will probably also be weak.

Investment Implications

In trading accounts last week we pulled back on the asset allocation to the 40% range, including only utilities (XLU) and consumer staples (XLP).  The index inverse ETFs have small positive ratings, but are currently in the penalty box.

For investors, it is attractive to invest when fears are worse than fundamental conditions.  Having said this, we continue to exercise caution in establishing new positions..  There is no rush and a lot of uncertainty.  We always try to find good entry points.

 

Weighing the Week Ahead: Keeping Turmoil in Perspective

Will the next month bring an important market inflection point?

Many seem to think so, raising a good question:  When many market participants expect something, does that make it more or less likely to happen?

Nearly everyone is anticipating a market correction.  Even those with a bullish viewpoint have one foot out the door.

Barry Ritholtz is willing to see opportunity here.  In a great interview with Forbes, entitled Stop Criticizing Bernanke, Start Finding Investment Opportunities, Barry emphasizes the need to put aside your politics and policy opinions and pay attention to specific stocks.

We’re now about 86% long and have been for some time.

We have been finding names on a bottom up basis. I think many people had expectations that with the coming end of QE2 the world was coming to an end and that the market was coming to an end. We just don’t see that happening anytime soon. Right now, I think we’re at the phase of the market where a lot of people are specifically looking for a correction, and we just don’t see that as imminent. While there’s very likely a 25% correction, somewhere out in the future, we’re just not there.

I agree.  The skeptics have been looking for a 25% correction while the market has rallied 75%.  Corrections are part of investing and they are difficult to time.

My own approach is to focus on a collection of indicators that capture the risk/reward tradeoff. The biggest current market questions come from four sources:

1. The reduced rate of economic growth.  This is popularly described as a slowdown and in one case, a "cruel summer."  Since few seem able to distinguish between a reduction in the rate of growth  and a growing economy, there is an opportunity for those who can.  The ECRI is not forecasting a recession, but you should watch the video for yourself. 
2. The end of QE II.  Regular readers know that I think this will be a non-event in terms of the fundamentals.  We still must deal with perceptions.  In the first of several planned articles on this topic I explained why the recent stock market rally makes complete sense to those of us focused on market fundamentals.
3. The long-running, widely-publicized, and so far inaccurate prediction about declining profit margins.
4. Various theories described in terms of cockroaches, dominoes, or headwinds.

The challenge for investors is to put these valid questions into a sensible perspective.  If you are unable to recognize excessive worries, you will never make a good investment.  In an interview last week with Tadas Viskanta of Abnormal Returns, I tried to pull together several of these themes.  Even regular readers might enjoy watching the screencast, if only to put a face and a voice together with the text.

Despite this constructive background, I am more cautious this week, as I explain in the conclusion.  But first, I will do the regularly weekly data review -- with a few changes.

In response to comments and suggestions (Thanks to all!) I am introducing some new ideas in the format for the WTWA article.  My objective is to display the indicator data in a way that is easy to see and also provides additional historical perspective.  Today's piece is the first step.  Over the course of the next few weeks I will have a separate discussion of each indicator, as well as a new addition or two. 

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.

I always do the work to think through the issues, my preparation for the week ahead.  Writing the article and Readers often disagree with my conclusions.  That is fine!  Join in and comment.  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 mostly negative.

The Good

These are all items that are either important right now, or bear watching -- a little bit of good news.

• Gas prices fell by about ten cents.  The decline still does not reflect the fall in oil prices and the reduced risk for Louisiana refineries.  Calculated Risk does a good job discussing the importance of high gas prices on consumer confidence and the economy.
  
• Mortgage rates hit another new low.  The Bonddad Blog also points out the increase in refinancing activity, as part of the regular weekly data review.
• Bank lending to small and medium sized businesses has improved (via Scott Grannis).
• Initial jobless claims dropped sharply, 70,000 lower than two weeks ago, but still holding in the unacceptable +400K range. 

The Bad

There was a lot of disappointing economic news. 

• Housing data was even worse than expected.  Whether you look to overall sales, housing starts or (my favorite) building permits, the data were even worse than expected.  Check out Calculated Risk for full analysis and the expected fine charts. 
• The "minor" reports were very bad.  In last week's preview I noted that I did not see much significance in the regional Fed reports or the LEI unless they were significantly outside the normal range.  They were all bad -- part of the general pattern.
• European sovereign debt issues, bailouts, and scandals.  These headlines are still getting attention, and the effects have not shown up in the SLFSI data.  Some see this as the biggest market threat, although the linkage to US markets is always a little vague.  I am certainly watching, and you should be, too.

The Amazing

The LinkedIn IPO was a big story last week.  The first-day gains have held up so far, but we still do not have options trading or short selling.  Everyone had an opinion (check Abnormal Returns for the ultimate LinkedIn linkfest), but the opinions ranged widely.  Some see the event as showing investor appetite for the newest technology, some thought it was the sign of a new bubble, and one observer even seemed to conclude that the overpricing was the fault of Ben Bernanke!

While I share the astonishment of those questioning the current price, I am not surprised.  Investors are continually warned about "normal" stocks, told that government data is false, informed that analysts are biased and error prone, and confronted with a wide range of Apocalypse alternatives, only one of which was removed last week.

Is it any surprise that people turn to investments that defy any modeling or analysis?

The Indicator Snapshot

It is important to keep the weekly news in perspective.  My weekly indicator snapshot includes important summary indicators:

• The ECRI Weekly Leading Index and the derivative Growth Index
• The St. Louis Fed Stress Index
• The key measures from our "Felix" ETF model.

There will be at least one new indicator, and the current choices are under review.

 

 

Felix is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. We have a long public record for these positions.

[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

There is not much in the way of important economic data next week.  We get the government version of home prices and personal income and spending at the end of the week.  Earnings news is winding down.  Jobless claims will still be interesting, mostly because the series has been so volatile.

I do not see a clear focus in the expected announcements.  I have been fairly accurate at guessing the big stories for the upcoming week, but it is important to know when you just need to be flexible and to keep perspective.

Investment Implications

In trading accounts last week we pulled back on the asset allocation to the 60-80% range, emphasizing some sectors that are defensive -- utilities and consumer non-durables.

For new accounts we have moved very cautiously on new positions.  There is no rush and a lot of uncertainty.  We always try to find good entry points.

In another six weeks we will have gotten past the official QE II end, and possibly have better news on gas prices.

Talking Stocks, Blogging and System in an Interview with Tadas Viskanta

This week I had the opportunity to do a screencast with Tadas Viskanta, the founder, curator, and editor-in-chief at Abnormal Returns, one of our original featured sources.  Tadas keeps making a good thing even better.  We now enjoy early linkfests, the regular daily linkfest, topical stories, screencasts, and ARTV on the StockTwits Network.

One reason everyone likes this source is the non-ideological approach.  You will find sources for arguments and information from many philosophical, economic, and ideological perspective.  It is no conincidence that Tadas draws upon a background of employment in the investment business and publications in leading journals.

I like interviews which draw out new themes and ideas.  In this conversation we talked about how system can help you avoid emotion in trading and investing, the need to separate your politics and your investing, using fundamentals in stock-picking, and some current market threats.

Some of the topics will be familiar to readers of "A Dash," but you might still enjoy hearing the discussion.

Here is the video link at his site, in case you have problems here.

 

 

Tadas suggests the following links, all used in the video:

Debunking the myth of the QE2 rally.  (A Dash of Insight, ibid)

A guide to the debt ceiling debate.  (A Dash of Insight)

Getting the most from the econoblogosphere.  (A Dash of Insight)

Choosing a great stock.  (A Dash of Insight)

Do profit margins or actual profits matter more?  (A Dash of Insight)

 

 

Debunking the Myth of the QE II Rally

The single biggest market question is this one:

What happens at the end of QE II?

I have explained this on several occasions and promised more detail.  After listening to countless talking heads talk about the QE II rally, we need some clarity.

Background

There are two views of the world:

1. Gains in various markets are all the result of Fed policy and things will reverse as soon as Fed policy changes.
2. Stock market gains have resulted from improved fundamentals.

Viewpoint #1 gets most of the attention, especially when the market sells off a bit.  The second viewpoint is almost a state secret.  Too many people confuse actual market fundamentals with what they call "headwinds."

The Facts

If you really want to understand market fundamentals, you need to consider valuation, risk, and future potential.  I discuss these concepts every week in my Weighing the Week Ahead series.  Today I want to consider a longer time frame.

My approach is very simple and based on hard data.  It is easy to understand.  It is contrarian since most traders and pundits want to use words and anecdotes rather than data.  Here is the key table.

 

 Let us consider each of the three key elements.

Valuation

I use the one year forward earnings from the "bottoms up" estimate from Thomson/Reuters.  Many critics take the inconsistent position that forward earnings are too optimistic, but explain the typical 70% beat rate by saying that estimates are guided down.  I have written about this at length and challenged the skeptics.  I maintain that there is a point where forward estimates by bottoms-up analysts are quite useful -- the best we can do.  That point is  approximately one year ahead.  I continue to invite any loyalist for another method -- particularly those espoused by Hussman or Shiller -- to show that they can predict earnings one year in advance with greater precision.

With this in mind, the "Jackson Hole" forward earnings yield was 8.31% and it has declined to 7.74% now.  When compared to the ten-year yield (interest rates in the table) the risk premium was a huge 5.75% last Fall and is still 4.61%.  On a long-term basis this is a juicy premium unless risk is huge.

Risk

When considering the yield premium, you need a way to evaluate risk.  Most people do this by producing a laundry list of unquantified (and maybe unquantifiable) worries.  I choose to focus on data.  An excellent candidate is the St. Louis Fed Stress Index, which uses 18 different data series.  The methodology employed isolates the specific contribution of each factor.  These are not government measurements, but actual market data.  It is a sophisticated way of letting the market speak to you.  It was also a great method for spotting problems in 2007-08.

At the time of the Jackson Hole speech the SFLSI was at a worrisome .69 level.  (1.0 is a one standard deviation change.  I am doing reserach on the best warning level).  Right now the SFLSI is in negative territory.  Simply put, if you measure risk in objective terms, it is vastly different from last fall.

Potential

I view economic growth as the potential for future earnings.  While the market is not a GDP futures contract, it does have a good long-term relationship with economic growth.  Stocks famously have predicted ten out of the last three recessions.  There is incessant skepticism, for political, mercernary, and publicity reasons.  Let us compare then and now.

Last August

The ECRI growth index was at negative 10.  Many widely-publicized pundits insisted that this never happened without a recession.  Double dip was on everyone's lips.  Nearly everyone ignored the ECRI's own interpretation.

Now

The ECRI growth index is in positive territory and has stayed there for many months.  A realistic estimate is a continuation of modest growth, but only extremists expect a recession in the next year.  The perma-bears of last autumn have fallen silent.

Briefly put, the potential is much better.

Conclusion

For those of us looking at data, it is so easy to understand the stock market rally.  The big question is why the market has not moved even higher.  I see many specific stocks that are more attractive than ever on a P/E basis, even if the prices are higher.  (JPM, AAPL, and CAT are among current choices).

This article has emphasized the real reasons for the rally, but I still expect to write about some of the alternative explanations.

In an era where many data series have moved higher, it is easy to find strong correlations.  While most people pretend to know about the difference between correlation and causation, very few market studies demonstrate the ability to distinguish.

A Final Thought

I have tried to interest various economists in discussing the QE II effects.  Most are completely uninterested because they only see a few basis points of effect.  When I explain that traders and financial television (not to mention the conspiracy sites) are completely focused on this, they just express amazement.

One of my roles is to bridge this gap.

 

Understanding Economic Progress

Sometimes investors focus so closely on each economic data release that they completely lose perspective.  This is especially true of those who criticize the measurement of inflation.  Their arguments have a superficial plausibility and earn some undeserved media attention.

The story about the "clueless BLS" is always popular.  No media source does the work to check out the facts.

In fact, the following propositions have proven true over the broad sweep of time:

1. The US economy has a natural state of growth, finding the best use for various resources.
2. The US economy rewards innovation and therefore generates productivity improvements.
3. The price of many goods has decreased over time.
4. People change their behavior to substitute products that are equally attractive and have lower prices.

If you think about this with an open mind, these propositions have substantial support from history.  I have offered data on this subject in the past, but tonight I want to try a different approach.

Here is a joke, some analysis, and a wonderful educational resource -- something for everyone!

The Source

I am enjoying listening to material from The National Jukebox, via the Library of Congress.  When I visited there on a recent DC trip I did not see this as a feature, so a hat tip to Modeled  Behavior, one of our featured sources for today's "tweet" on this subject.

The Joke

Here is a joke from 100 years ago.  It is timeless humor, and it has a great punchline in the last ten seconds.  Having said this, I know that few will have the patience to listen for nearly three minutes.  We are so accustomed to one-liners.  This is like a Bill Cosby story, but 70 years earlier.  I am putting up the entire link.  For the impatient, there are some hogs running around wildly in a field.  An observer is curious and inquires of the farmer.  He is fattening them up, but he has a cold so the normal hog call does not work.  He has trained them to respond to tapping on a tree.

You should listen to the entire segment, but the impatient can skip to the end....

 

 

The Lesson

Let us get the facts of this straight.  What value would you place on this joke?  In 1910 or so people paid about $100 for a device to play various records and 75 cents each for the records.

In 2011 dollars this is $17 for the joke and over $2200 for the player.

The price for single songs was similar.

So you would invite friends over.  After dinner you would sit in the parlor and listen for three minutes to hear this joke.

Conclusion

There are many aspects of modern life that we take for granted.  These include inexpensive technology.

Many people highlight increased costs while ignoring quality improvements.  A look at the history of music and recordings might help us to get some balance on this subject.  The BLS has been inartful at best in naming the various adjustments.  That does not mean that they are wrong.

I know that every time I try to explain inflation measurement, most readers will disagree.  I hope that even the critics will enjoy learning about the National Jukebox and exploring some history.  Perhaps a few will find this perspective useful.

 

Weighing the Week Ahead: Any Bottom in Housing?

With earnings season drawing to a close, attention has returned to the economic data point of the moment and to technical factors.

Many technical analysts look no further than the commodity trade.  Eddy Elfenbein has a great perspective on this apparent relationship: 

Let me help explain what’s been going on in the market over the past few days. Now that earnings season is mostly over, there’s been a rush out of formerly hot commodities as investors have sought shelter in very low-risk bonds or in stocks in non-cyclical industries.

To give you an example, the Silver ETF ($SLV) got as high as $48.35 two weeks ago. Today it’s been as low as $31.97. Ouch! The Gold ETF ($GLD) has backed off from $153.61 last Monday to $145 today. Oil ($USO) has dropped from $45.60 to $38.59. (Prices at the pump, however, are still high.)

Now let’s check out what’s happening in the debt market: The yield on the one-year Treasury has dropped below 0.17%. Sure, it’s one thing for short term rates to be microscopic, but now we’re talking about one full year.

Let’s take a step back and see what that means. One year at 0.17% works out to about 21 Dow points stretched out over a full year. Plus, that doesn’t include dividends. In other words, the Treasury investor would lose to the broad-based investor even if the Dow fell by (roughly) 1.8% over the next twelve months. So what is it that debt investors want so badly? The answer is security. They want it so badly, they’re willing to vastly overpay for it.

I think that’s nuts, but there’s a buyer for every seller.

I wish I could have captured his argument with a shorter quote, but I wanted readers to understand his valuable perspective.  People should join me in reading Eddy every day.  My own posiitons have a few cyclicals, like Caterpillar (CAT), but I always pay attention to Eddy's comments on this theme, his stock screens, and his own recommendations.

I will provide my own take on commodities and current investment posture at the end of this article.  First, let us consider last week's 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.

I always do the work to think through the issues, my preparation for the week ahead.  Writing the article and sharing all of the links takes me another six hours.  While writing something always sharpens your thinking, it really is a lot of extra work.

Readers often disagree with my conclusions.  That is fine!  Join in and comment.  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 important news last week was mostly negative.

The Good

Most major economic indicators show that the US economy has returned to its normal state, self-sustaining growth.  Many seem to have forgotten that economic growth is normal, including the use of slack resources to expand and to build new businesses. 

• Mortgage rates hit another new low -- the lowest in six months.  The link for this news is Mark Perry's article showing mortgage rates and CPI inflation.  His conclusion is that the low rates demonstrate that inflation expectations are contained.
• There were 3.1 million job openings at the end of March.  The last two months have had the highest level of job availability since November of 2008.
• Economic growth forecasts remain solid.  The ECRI Weekly Leading Index increased to 129.7 from 128.7.  The growth index, a widely-misinterpreted acceleration term, edged slightly lower.  Mark Hulbert has a nice article discussing this indicator.
• Risk as measured by the St. Louis Fed Stress Index, remains very low.  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 -0.092, a bit higher than  last week's -0.178 (adjusted).  These are completely normal readings for a scale measured in standard deviations from the norm.  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.  The scale is in standard deviations, so anything short of 1.0 or so is neutral territory.  I am doing more extensive research on this indicator. 

NB:  The ECRI and SLFSI are actually readings from week-old data.

The Bad

There was a lot of disappointing news -- all qualifying as "bad" in terms of my weekly update.  I look for things that are fresh -- unexpected.  I would characterize the data as a slowing in the rate of growth. 

• Housing prices moved still lower.  The CoreLogic index registered an eight consecutive decline, taking prices lower than in 2009.  Check out Calculated Risk for full analysis and the expected fine chart.
• Initial jobless claims remained elevated.  There was a decline from the prior week's spike, but initial claims in the 430K range constitute bad news.  This is a real-time data series from a good source, probably indicating a poor jobs report for May.
• Small business optimism moved lower (via Calculated Risk).   This is somewhat at odds with the improvement in the Monster job index, which is "full of good news" (via Scott Grannis). 
• Medicare and Social Security projections worsen.  The trust fund "exhaustion dates" have been moved up to 2024 and 2036.  This is a complex story, but an important one for taxing and spending.
• Debt limit wrangling became more strident.  The market is clearly worried about this issue.  I still think there will be a resolution, but it may take weeks of posturing.  I explained last week in an investor-oriented guide to the deficit debate -- something that I hope will be more helpful than the headlines.
• European sovereign debt issues, bailouts, and scandals.  These headlines get attention, but the effects have not shown up in the SLFSI data.

The Ugly

Commodity and market swings continue in a world where causation is difficult to understand.  The key issues seem to be the following:

1. Did the change in margin requirements cause the collapse in silver prices?  I have been studying this.  My first reaction, based both on trading and reactions of traders was "no."  There is an intriguing argument from The Streetwise Professor, now added to my list of featured sources.  He suggests that volatility-based rules like those currently used and well-understood, can exacerbate volatility.  I am not yet convinced, but I am interested in studying this further.
2. Why were the commodity moves so large?  Taking out stops was probably a factor -- great Reuters piece and HT to Felix.  James Hamilton, the go-to economics expert on oil prices, explains why this is silly.
3. Do lower commodity prices cause lower stock prices?  I think not, and there is support from Goldman Sachs.  Last week I explained why this has nothing to do with "demand destruction."
4. When will this silly linkage, mostly based upon perceptions, come to an end?  I do not know!

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 much more cautious.  We shifted from our neutral posture to bullish five weeks ago, and we continue that posture in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close.  This is based on improved ratings in the various index ETFs, as well as the general trend.  Here is what we see:

• 48% of our 56 ETF's have a positive rating, down sharply from 80% last week.
• 66% of our 56 sectors are in our "penalty box,"  up from 50% last week.  This is an indication of moderate short-term risk, but the picture is deteriorating.
• Our universe has a median strength of -5, down significantly from +23 last week.

The overall picture is much weaker than last week, and I could easily have called "neutral" on our official posture.  Felix is positive on the Dow and the QQQ's, but SPY is in the penalty box.  Our positions could easily change during the coming week.

[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

The big stories this week will relate to housing data.  Regular readers know that I like to follow buidling permits (which have been very weak) as an early indicator of a change.

I do not expect anything new from the Fed minutes.  I do not use the "leading" economic indicators and the regional Fed surveys are important only when there is a huge move.

It is also options expiration week, so any moves might be extended.

Investment Implications

David Altig has an alternative viewpoint on housing, suggesting that we may be near a bottom.  He is not pounding the table, but merely trying to illustrate all sides.

As I have frequently noted, the housing and employment problems are linked in a very bad way.  Job applicants cannot easily move to take advantage of new opportunities.  Falling housing prices hurt consumer confidence and overall business conditions.  It is not a typical macroeconomic problem.

There are a lot of reasons to be cautious right now.  I still like the prospects for the remainder of 2011, but there is a lot of uncertainty to get through in the next month or so.

 

Investors' Guide to the Debt Ceiling Debate

As a professional analyst of public policy issues, the forecasting of political events is a favorite topic.  My record has been good.

Despite this, whenever I write on these issues there is a danger.  I explain that this is analysis, but there is always a temptation to view the explanation as a politcal opinion.  It is not.  I can admire political strategy by skillful leaders who represent a different political viewpoint.  You should be able to do the same.  With this in mind, here is my summary of the current debt ceiling debate.

Background

Congress has a (mostly symbolic) celing on the national debt.  Through decisions on appropriations and revenues the Congress participates in setting a budget that has regular deficits.  The debt limit is something of a fig leaf, but it does have the force of law.

No responsible official thinks that defaulting on debt is desirable.

• Bernanke stated, "I think using the debt limit as a bargaining chip is quite risky."
• Business leaders join in warning on the economic consequences.
• Speaker Boehner drew sharp questions in his "tough" speech about the deficit problem.

Tea Party Influence

There is a significant effect from the "tea party" voters, and those elected by them.  Even the aggressive Republicans cannot do enough to satisfy this group. Here is a Fox News story explaining what is expected:

We're telling Boehner and all of the House Republicans, they came into office with Tea Party help. We now expect them to keep their promises and hold the ceiling on the national debt," said William Temple, head of this fall's Tea Party National Convention. "The Tea Party will not be in a very forgiving mood this fall, nor as the GOP primary season opens, if House freshmen and others elected by the Tea Party cave to Obama. We will find replacements for them this fall.

What it All Means (and how to profit)

The typical pundit commentary on Congress is fun to write and resonates strongly with readers.  The theory is that every representative should be like Jimmy Stewart in Mr. Smith Goes to Washington, acting on principle and ignoring political pressure.

The problem is that one person's principle is another one's poison!

The debt limit saga will play out according to the following playbook:

1. The debt limit will be raised;
2. All participants will play out the string, demonstrating to supporters that they did their best;
3. The final resolution will include a commitment to deficit reduction, with some combination of tax increases and spending cuts .

Any scares based upon the debt ceiling issue are buying opportunities for long-term investors.  I see the discussion as a predictable political sideshow.  It is really business as usual.

[Update: slip on "tax cuts" fixed.]

Baffled by Demand Destruction?

The latest pundit folly is the two-way interpretation of commodity price moves.

• When prices were spiking, it was a signal of impending doom:  spiraling inflation and eventual stagflation.  It showed that Ben Bernanke was clueless and that it would all end badly.

• With prices plumeting, it shows that we have "demand destruction," a signal of impending doom.  It shows that Ben Bernanke has been clueless, and it will all end badly.

No wonder the average investor is confused!

An Easy Guide to Demand Destruction

Normal Changes in Price and Quantity.  For any good there is a supply curve and a demand curve.  Let me consider the demand curve for gasoline.  Any specific  consumer will adjust the quantity purchased based upon the price.  If prices move higher, I might choose not to take a trip or to take other transportation -- even if less convenient.  If you total all of the individual decisions about fuel consumption, you get the demand curve.  If it changes a lot with changes in price, it is said to be elastic.

This is not demand destruction, but a normal (and perhaps temporary) market reaction to finding a clearing price where supply and demand intersect.  The behavior is movement along the existing demand curve.

Sustained Price Moves.  Sometimes there is a price move that has more than a temporary effect.  If, for example, people thought that we were moving into an era of higher gasoline prices, there would be a very different response.  The specific consumer might make permanent lifestyle changes -- trading in for a higher gas mileage car, selling a vehicle and switching to mass transit, or changing jobs to a location closer to home.  These permanent changes are very different from the first case.

These changes represent a shift in the demand curve, not movement along it.  The clearing price and quantity change, because the aggregate of individual preferences have changed.

We can say there has been demand destruction because there is a lower market clearing price at any given point on the supply curve.  The demand curve has shifted.

Illustrating the Point

There is some nice software to help in illustrating these problems.  Maybe I will do another version.  Meanwhile, I face my daily question.  This is an important issue which I will try to revisit with some cool graphs.

Investment Implications

Here is the biggest takeaway, one that I use daily in my investment management:

Higher energy prices are bad.  Lower prices are good.

Higher energy prices are a tax on the consumer.  Unlike most taxes, there is no public service benefit.

I am well aware of the (temporary) correlation between commodity prices and stock prices.  There are many reasons for this, not involving causation.  One of the first things taught in the class on causal modeling was to think.  There needs to be some plausible relationship before correlation implies causation.

In the richness of time we will see the following:

1. Stock prices will move higher with dollar strength, the normal long-term relationship.
2. Stock prices will move higher with lower oil prices, the normal logical relationship.

Spotting Bogus Advice

I had a long list of links with bad advice, but what is the point?  You need to learn to spot these on your own.  Feel free to add examples in the comments!

Any pundit that uses the term "demand destruction" to apply to the effect of higher gas prices on overall consumer activity is just being sloppy.  It is a tax, but the source does not understand what is happening.

Any pundit that talks about "demand destruction" based upon a change in gasoline or oil inventories is clearly mistaken.  This is movement along the curve, not a shift in the curve.

I have another indicator for which I invite reader commentary.  My hunch is that anyone citing "Econ 101" either did not take the class or does not remember it.  I cannot remember a helpful article that had that phrase.

I also did a search for "demand destruction" on the blogs that I regularly follow.  This includes a wide range of economists and pundits.  This term was used in a technically correct sense on only a handful of occasions.

Investment Conclusion

I understand that many people will see this article as technical, wonkish, and pedantic.  They will miss the point.

How can I explain?  If you are willing to let a bunch of pop economists sling around terminology that means nothing, you will never succeed as an investor!

The most popular "economic" blogs tell you things that you think you already know, reinforcing your beliefs.  It is possible to gain some investment advantage from real economists, but you need to have an open mind.

This means that on a day like today, you could use the lower energy prices to look for bargains in cyclical stocks, tech stocks, and financials.

 

Getting the Most from Economic Bloggers

In the Internet age we are not troubled by a lack of information, but by too much.  Successful decision making has become a matter of figuring out whom to trust and on what topics.

My original mission statement at 'A Dash' was to take an eclectic approach -- finding the best sources, information, and methods.  It has been a common theme for me.

Regular readers know that I have enjoyed and learned from my association with the Kauffman Foundation.  Their support of economic bloggers helps many of us convene annually.  There is no substitute for meeting people in person.  The assembled group at the conference includes academic economists, leading economists from think tanks, entrepreneurs, economic journalists, and a group that I'll call "pop economists."  Each plays a certain role.  All are intelligent and hard-working.  There are no slackers among the economic bloggers!

My sense is that the group is a bit conservative, but that does not trouble me.

There are many criticisms of Wall Street economists.  They are not represented.  Academic economists are also a popular target for those who never took a class or don't remember it.  This group is a distinct minority.  If you are skeptical of traditional economic reporting, this is the source for you.

Here is the opportunity:

We can learn from the wisdom of a special crowd -- the economic blogging community.

The Current Findings

The Q211 results are out.  A big story is the accurate perception of a growing economy, but one with less certainty.  More bloggers see the economic potential as mixed than did a quarter ago.  Poll leader Tim Kane has an innvoative pictoral method for conveying the message.  He asks us to provide five terms to describe the economy and then creates a word cloud.  Here is the current result:

This is a very realistic picture.  With this in mind, I urge careful consideration to the next chart.

There is a lot of skepticism about the economy.  It includes average folks, business leaders, and individual investors.  The pessimism is excessive, sometimes generated by political sentiment.

Take a look at the assessment from this hard-headed group of bloggers.  The expectations for economic growth, employment, and the stock market are all pretty solid.  The budget deficit is expected to decline, and some think it will decline a lot.

These findings are only scratching the surface.  Anyone who thinks that economic prospects are relevant to investment decisions (and that should be everyone) should take a deeper look at these results.  There are many interesting results related to specific policy ideas.

 

Weighing the Week Ahead: Another Soft Patch?

When stocks have had a big rally, it can lead to nervous longs.  How much of the ownership is in "weak hands" or with short-term traders, people ready to sell at the first sign of bad news?

So far, any selling has been limited -- evidence of waiting buyers.  Will this change?

The Bonddad Blog, as I have noted in some past weekly reports, has warned about some economic weakness.  The team there does a nice job of sticking to the data.  This week they summarize prospects as follows:

...I sincerely hope that readers of this blog were not surprised by the several suddenly punk reports this past week. Back in January I said that I expected the economy to stall in the second and third quarters due to Oil and Austerian stupidity. Week after week for at least three months in this column I have been reporting the slowly deteriorating YoY numbers in many indices. This week the MSM's complacency was finally broken. So was the speculative surge in several commodities, most especially silver - which caused Oil to back off 10% in a single week. For the next several months I expect to be chronicling the coincident damage, while we wait to see how long it takes high prices to cure high prices, and how much Austerian stupidity emanates from Versailles.

Read the entire article for a nice look at "high frequency data."

I  will evaluate this further in my own weekly conclusion.  First, let us do our weekly summary of the most important 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.

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 somewhat negative, saved mostly by Friday's employment report.

The Good

Most major economic indicators show that the US economy has returned to its normal state, self-sustaining growth.  Many seem to have forgotten that economic growth is normal, including the use of slack resources to expand and to build new businesses. 

• The death of Osama bin Laden.  The evidence shows that this was a blow against global terrorism.  I realize that some who are determined to find a negative in anything that happens are even spinning this event.  In this weekly column I just state my conclusions rather than arguing them.  I have been monitoring factual news sources and interpretation all week.  The data show that there will be a loss of leadership and some operational control.
• Payroll employment gains were 244,000, better than most pundits expected, and much better than my own estimate.  Check out Steven Hansen's excellent review of the  entire report.  My method compares these job gains with other economic data.  A fair way to summarize what is happening would be to say that employment is actually running a little ahead of other indicators.  It may be that businesses are finally reaching the limits of what they can squeeze out of existing workers, something that I have been predicting for months.  Colin Barr has a nice article on this topic. 
• Falling commodity prices reduce inflation fears.  The WSJ suggests that this lends credence to the Bernanke viewpoint.  The Fed was not watching commodities, but the FOMC does pay attention to market expectations.
• Mortgage rates hit a new low -- the lowest since January and down nicely from last year.  This is in sharp contrast to the forecasts of some leading bond pundits like Bill Gross.  In case you missed it, check out the forecast from Jeffrey Gundlach, who has done even better than Gross over the last ten years.
• Economic growth forecasts improved.  The ECRI Weekly Leading Index decreased from 129.2 to 128.7, but remains at solid levels.  The growth index, a widely-misinterpreted acceleration term, also move a little lower.
• Risk as measured by the St. Louis Fed Stress Index, remains very low.  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 -0.174, a bit lower than  last week's -0.166 (adjusted).  These are completely normal readings for a scale measured in standard deviations from the norm.  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.  The scale is in standard deviations, so anything short of 1.0 or so is neutral territory.  I am doing more extensive research on this indicator. 

NB:  The ECRI and SLFSI are actually readings from week-old data.

The Bad

There was a lot of disappointing news -- all qualifying as "bad" in terms of my weekly update.  I look for things that are fresh -- unexpected.  I would characterize the data as a slowing in the rate of growth. 

• The ISM service index was only 52.8, much lower than the expected 57.  Cullen Roche has a good summary. 
• Initial jobless claims spiked much higher.  We are continuing with the 4-handle, now for four weeks.  It is important not to read too much into a single week, but this series is important.  While it is only one part of the employment story, everyone agrees on the significance.  It is a real-time data series from a good source.  I follow it closely, and the story has not been good.
• The earnings "beat rate" declined to 60%.  This is a weaker record than accomplished over the last few quarters.  Check out the Bespoke Investment Group chart for the full story.
• Unemployment moved higher, to 9%.  This was in contrast to the payroll report, something that happens as a result of two different surveys.  However you measure it, we are not adding enough jobs, as noted by the NYT.  Dean Baker explains why, and corrects the Washington Post editorial writers.

The Ugly

Memories of the Flash Crash.  This gets combined with those who want to "sell in May."

Mark Hulbert finds a source who tells us that we should expect another such episode.

The first line of defense on the flash crash problem is to avoid sell stops that turn into market orders.  The stop always sounds like a good idea when it is presented.  It is seductively attractive to those who are not actively managing their accounts.  There really is no substitute for paying attention.  The flash crash was not too important for those who did not attempt to trade during the most volatile hour.

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 much more cautious.  We shifted from our neutral posture to bullish four weeks ago, and we continue that posture in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close.  This is based on improved ratings in the various index ETFs, as well as the general trend.  Here is what we see:

• 80% of our 56 ETF's have a positive rating, up nicely from 73% last week.
• Only 50% of our 56 sectors are in our "penalty box,"  the same as 50% last week.  This is an indication of moderate short-term risk, and the picture is improving.
• Our universe has a median strength of only +23, up nicely from +11 last week.

The overall picture is a little better than last week.  We are still 100% invested in trading accounts, since there are many attractive sectors.

[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

The coming week will feature the PPI and CPI, but the data will be viewed as irrelevant if the commodity volatility continues.

Thursday's initial claims will attract more than normal attention because of last week's spike.

News on the debt limit, European aid packages, and commodity prices will be more significant than the economic reports.

Earnings season is winding down, but there are still some important reports left.

Investment Implications

This is a tricky time for both traders and investors.  We seem to have a wide trading range.  Charles Kirk, after a couple of weeks off, is back with his weekly chart show.  (Some have pointed out that my link is to a paid site, and that is true.  Charles has a modest charge that goes only for expenses and then to charity.  He has many satisfied followers, both for his weekly take and his various stock screens).  It is impossible to do justice to this in a summary.  He is essentially neutral, looking to get long, but willing to respect the tape in either direction.  He sees the programs as more important than fundamentals right now.

My own viewpoint is a bit more positive for long-term investors.  The 60% earnings beat rate cited above is viewed as negative by most observers!  Think about that for a moment.  These are pundits who claim that analyst estimates are too high and then celebrate when most of the estimates are actually too low.  I track the one-year forward earnings closely, and those estimates continue to march higher while interest rates hold at low levels.  The earnings story remains positive, with many attractive stocks.

While I watch economic data closely, small changes are not that important for earnings.  We are nowhere close to a recession risk, and the SLFSI shows a high comfort level on the financial side.

I understand that everyone wants to avoid risk.  There are many ways to construct a very safe program that still allows the investor to share in stock gains and fight inflation.