Last week was all about headlines and the Fed's Jackson Hole speechmaking. This week will be quite different. There is a data deluge, culminating in Friday's employment situation report.
Everyone has low expectations for this week's economic news. So do I. An already sluggish economic recovery was thrown off course by the earthquake and tsunami in Japan. Just as that effect was declining, we had the highly-publicized debt ceiling debate. The political process undermined confidence on the part of consumers, businesses, and one misguided ratings agency.
There are now two distinct interpretations --- a worldwide economy that is spiraling into recession or an extension of the "soft patch."
The coming week's data will not resolve the debate, since everyone expects more weakness in the numbers. I'll offer my own forecast in the conclusion, but first let us do our regular review of the week's events.
Background on "Weighing the Week Ahead"
There are many good sources for a comprehensive weekly review. I always check out the articles from Steven Hansen at Global Economic Intersection and Calculated Risk. My mission is different. I single out what will be most important in the coming week. 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.
Unlike my other articles at "A Dash" I am not trying to develop a focused, logical argument with supporting data on a single theme. I am sharing conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am trying to put the news in context.
Readers often disagree with my conclusions. (A commenter recently suggested that was proof that I was wrong -- an amazing interpretation!) Do not be bashful. Join in and comment about what we should expect. 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
In a light week for data, the sluggish growth story still reflects the totality of the evidence.
There were a few bright spots.
- Durable goods orders were up 4%, much better than expected. This was a July number, and it did reflect some rebound in auto production.
- Initial jobless claims clocked in a bit higher, but still in the 400K range when you take the Verizon strike into account. This is still not what we need, but it is better than recent levels and much better than many were forecasting a few weeks ago. It is not a recessionary level, nor a sign of robust growth.
- The money supply rebound continues. This is a major forward-looking indicator that is widely ignored. It is a leading indicator, giving it extra significance. I have been writing about this for several weeks. It is ignored in the trading community. If you understand this point you will realize that the QE II effects are just starting. This interview featuring Bob McTeer, one of our favorite sources, explains the point in a way that anyone can understand.
- More hints of compromise on the Supercommittee. No one is paying much attention to this, nor are they expecting much. It is a source of edge for savvy investors. There are encouraging background reports on committee progress. No one expects much from the debt limit compromise. My contrarian estimate for success is 2-1. We now have one GOP member who does not want to cut entitlements. This is going to be a big story over the next three months, so read this article to prepare yourself for breaking news.
There was some important negative news.
- The Michigan sentiment index is at recession levels. Check out Doug Short for his great historical chart. We already knew this would be terrible based on the preliminary reading. The question is whether it is a reflection of the Washington politics from the debt ceiling or something with a lasting effect.
- The ECRI growth index dropped further into negative territory. The ECRI warns against over-reacting without a persistent change in this indicator, but we are watching with interest.
- Further European Confusion. There was mysterious selling on Thursday, at first linked to various rumors about European stocks. The rumors of a downgrade of German debt or French debt were both denied. Rumors about a change in the European short-selling ban were denied. The only remaining rumor was the ongoing debate about Finland's demand for collateral on Greek debt. US investors had better get used to this rumor-driven trading, since the European story is more than a year away from a resolution.
By the end of the week, few were expecting any big announcements from Jackson Hole. I suspect that many still anticipate some new "QE" before the year ends. As we noted on two occasions last week, the emphasis and expectations for action were overstated.
Everyone in the business community has respect for Steve Jobs. Here at "A Dash" we acknowledge the challenge of his competing demands -- his failing health and his continuing desire for excellence. He has been an inspirational leader and created value for customers, employees, and shareholders. Few seem to understand that a great company does all of the above.
Our team hopes that Mr. Jobs finds satisfaction from every day. He deserves it.
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.
As I have often noted in the past, the ECRI and the SLFSI report with a one-week lag. This means that the reported values do not include last week's market action. In my research, I take account of this lag. In my daily monitoring of the market I look at the underlying elements in the SLFSI. I cannot do this with reliability for the ECRI since the indicators are secret. The SLFSI will increase next week, but not to the level that would trigger the "risk alarm."
There will soon be at least one new indicator, and the current choices are under review. In particular, I am considering replacing the ECRI method with the equally effective and more transparent approach from Bob Dieli. The ECRI has a "long leading" series that is available only to subscribers, which they refer to in media appearances.
The indicators show continuing modest economic growth, but the rate of growth is getting weaker. Two weeks ago there was an increase in the SLFSI, generated by a slight increase in LIBOR rates and a big jump in the VIX. The SLFSI declined slightly this week. I have been doing extensive research on this indicator. It was not designed to predict the stock market. It is a reflection of actual risk. I believe that it will prove valuable as a tool for investors who prefer data to story telling. This article helps to explain how to interpret the values and also provides historical context.
Our "Felix" model 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.
A more accurate vote for this week would be "abstain" rather than neutral. Felix sees too much confusion for accurate forecasting, which is why everything is in the Penalty Box.
[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 a number of big reports this week featuring the employment situation report on Friday, just before Labor Day. President Obama will follow the news with a major address on jobs and the economy.
This week may well prove to be a turning point for data. It will reflect the worst of the "soft patch" if that is a solid explanation.
We can look forward to personal income data, Case-Shiller housing data, Conference Board consumer confidence and Fed minutes. And that is all before Wednesday!
On Wednesday the focus will turn to jobs with the ADP private employment report and Thursday's initial jobless claims. Thursday will also mark the ISM manufacturing report, which everyone expects to be below 50. There is a lot of emphasis that a below-50 reading signals contraction, which it does for manufacturing. Because manufacturing is in a secular decline in the US, the break-even level for GDP is actually 42.5. No one seems to note this. GDP growth of 1.5% to 2% is consistent with an ISM reading below 50.
Friday is the big day. Forecasts are for net job growth of 67,000 or so. Our model implies even less, but the consumer confidence input has been unduly influenced by non-employment factors.
Trading Time Frame
In trading accounts we were out of the market all week, after a well-timed close of short positions three weeks ago. Our Felix model is not calling a market bottom, but is reacting to volatility. When sectors go into our Penalty Box it indicates reduced confidence in short-term predictions.
While our official vote this week is "bearish," it would be more accurate to say that we are abstaining. The power ratings are actually quite solid, so we will be buying aggressively as sectors emerge from the Penalty Box. I do not see any short-term buying this week, but we are getting close to the chance for aggressie trading.
Investor Time Frame
In our ETF-based Dynamic Asset Allocation program, the portfolio is also very conservative. This cautionary posture includes bonds, gold ETFs, and utilities. The DAA now also includes one inverse ETF, and might add more if adverse conditions persist.
For long-term investors little has changed. The market is pricing in a high level of systemic risk and recession potential, even though these outcomes are not suggested by quantitative indicators.
The base case is for continued sluggish growth, an environment that has worked well for corporate earnings and created strong balance sheets. Meanwhile, stock prices reflect expectations for a major decline in earnings, something that has not even started.
While there is always some guesswork in timing entry points, there are some promising signs. Many of our favorite names, including Apple (which we highlighted once again last week -- see our history on this stock), are trading at very attractive prices.
Doug Kass thinks the "selling storm" might be ending:
Last month, individual investors fled equity funds in a massive move toward the flight-to-safety trade. In July, over $25 billion was redeemed. A week ago, over $20 billion was pulled. Surprisingly, assets were taken out of every mutual fund asset class (equities, taxable and nontaxable bond funds) and went into money market funds. I estimate that individual investors will pull out at least $35 billion in August, representing the second-highest liquidation on record since the series of data began to be accumulated in 1979. It is almost a certainty that 2011 will represent the fifth consecutive year of liquidations -- something that has never happened in mutual fund history.
This is a big contrarian indicator.
As usual, we are not making a recommendation for new investors to go "all in." It is also not a time to be all out! Most long-term investors need a solid plan that right-sizes their holdings in strong equities, balancing yield and growth.