A Dash of Insight

Weighing the Week Ahead: Back to Work!

The investing community goes back to work on Tuesday for a short week that could see plenty of action.

Everyone is doing a review of 2011, so I tried to do something really different -- The Year that Wasn't!  Please take a look at what might have happened (but didn't) and offer your own take.  I think the theme is worth consideration, so I might do it again if there is interest.

I will have more traditional "year ahead" pieces next week, including some specific ideas for the coming year.

Today's focus is shorter -- the week ahead.  The key question is whether America is also going back to work.  This week will be all about jobs, culminating with the monthly employment situation report on Friday.

Felix remains bullish for the near-term.  While I was skeptical last week, I am more inclined to agree this week.  I'll explain further in the conclusion, but first, a review of a week that was pretty light on real news.

Background on "Weighing the Week Ahead"

There are many good sources for a comprehensive weekly review.  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.  Do not be bashful.  Join in and comment about what we should expect in the days ahead.  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

There was little on the data front last week, so the temptation was to draw inferences that were not really there.

I'll just stick to the facts:)  I discuss important data releases, ETF updates, and trading ideas in real time on my new investment diary, but there was not much meat last week from the economic data.

The Good

The Chicago purchasing managers report at 62.5 handily beat expectations.  That is thought to be a good indicator for the widely-followed ISM report.

Consumer confidence was better than expected.  This is important, as is clear from my conclusion.  The improvement must be kept in perspective.  Doug Short's fine chart tells the story -- better, but not good enough.

The Notable

There was nothing really bad or ugly, but several events worth noting.

• Forward earnings are still lagging.  This is a story covered in excellent fashion by my WSAS colleague Brian Gilmartin.  For many years he has carefully tracked the data and monitored the trends.  Earnings estimates have stalled, but are not in a decline.  It is something to watch very carefully.
• The Italians were selling bonds all week, and we are all watching the 10-year yield.  The early auctions for short-term paper went well.  The longer-term bonds had a mediocre reception.  We are still waiting for the ECB.
• The Obama approval ratings moved up 4 points.  Most will react to this based upon whether or not they favor Obama.  This is superficial.  From a market perspective, the election is in the distant future.  What I like about this is the warning shot to those who refuse to compromise.  It is pretty obvious that gridlock is not market friendly.  Those of us who want to have successful investments should be paying attention.  We can hope that our legislators are doing the same.
• Initial jobless claims moved a little higher, but within the noise level.
• Housing data showed some improvement, but there is so much noise that inferences are difficult.

To summarize, there was little in the way of fresh data last week, but we are at full attention for next week.

The Silver Bullet

A few weeks ago I initiated what I am calling the "Silver Bullet" award.  The basic concept is the willingness to do a careful and thoughtful analysis in difficult circumstances.

Often this means direct engagement, which is difficult to do effectively in the blogosphere.  It also means the willingness to take the unpopular side of the issue.

When you embark on such a story, you are like the Lone Ranger.  In the spirit of encouraging this type of work I hope to mention a "silver bullet" story each week.  I invite readers to send suggestions.  I expect that this will only be an occasional topic.

This week I want to recognize Joe Weisenthal and congratulate him as Talking Biz News’ Business Journalist of the Year for 2011.  Read their entire citation and you will learn what many of us knew about Joe from his early blogger days as "The Stalwart."

He had so many important stories this year, that picking a single one is a challenge.  Undaunted, here is my suggestion, which I actually tweeted about a few days before his selection.  The big policy and market question of the year is about government debt.

Many conveniently cite a book that they have not read, covering data that they have not reviewed, employing methodology that they do not understand, and reaching a conclusion that is not shared by many peers.  This happens because the conclusions support a viewpoint that they already hold -- quite fervently.  As a result, people are willing to bet real money.

Joe is willing to tweak us all on this subject, so I especially liked his article,  Meet the Two Most Dangerous Economists in the World Right Now.

It is merely an example of something that he does all of the time.

The Indicator Snapshot

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

• An Economic/Recession Indicator.  I am evaluating several candidates.  None confirm the ECRI forecast of an inevitable and imminent recession.  These are sources that have a similar track record, greater transparency, but less PR.  I realize that I am (long) overdue for making the choice for a new indicator.  It has been a careful research process, and I expect the explanation to require multiple articles.  Meanwhile, if something really bad were taking place, I would make it clear in the weekly updates.  From the strongest candidates, I see the recession odds over the next nine months as being less than 25%.  Barring a market surprise, I expect to start covering this next week.
• The St. Louis Financial Stress Index.
• The key measures from our "Felix" ETF model.

The SLFSI reports with a one-week lag.  This means that the reported values do not include last week's market action.  The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm.  This is an excellent tool for managing risk objectively, and it has suggested the need for more caution.  Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect.  We identified a reading of 1.1 or higher as a place to consider reducing positions.

 

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions.  We voted "Bullish" this 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

This is a big week for data -- mostly about jobs.

I am interested in the ISM report on Tuesday because it correlates with job creation, and it is from the same time frame as the payroll survey.  Thursday's ADP report seeks the same answers with a different measurement approach.  We also get initial jobless claims on Thursday, which many will incorrectly view as related to the Friday report.

I do not expect much in the way of fresh news from the FOMC minutes on Tuesday, or the other lesser reports.

So --  Tuesday ISM, Thursday ADP and initial claims, and Friday -- the big day.

Tuesday also has the Iowa caucuses -- the first real voting in the 2012 election.  It also features the Sugar Bowl where the resurgent University of Michigan Wolverines take on the Virginia Tech Hokies.  Tough choice!!  I might manage a tweet or two on the caucus, but what is the rush?

When the choice is Hoke or the Hokies, it is easy for me:)

The WSJ has a nice calendar of upcoming events in Europe -- not too much this week.

Trading Time Frame

Our trading accounts were fully invested last week, as indicated from our ratings.   Felix has actually done a little better than the weekly update shows, since the first "bullish" week -- a loser -- had no trading positions since everything was in the PB.  The entry for this cycle has been very good.

This program has a three-week time horizon for initial purchases, but we run the model every day and change positions when indicated.

Investor Time Frame

Long-term investors should continue to watch the SLFSI.  Even for those of us who see many attractive stocks, it is important to pay attention to risk.  In early October we reduced position sizes because of the elevated SLFSI.  The index has now pulled back out of our "trigger range," but it is still high.  For investors desiring this risk management approach we raised cash when the trigger  hit the range.  We have also been cautious with new accounts.  We still do not have an "all clear" signal, but I expect the SLFSI to decline next week.

A reader recently suggested that this method reduced position size at a market bottom in October.  This really misses the point.  When the volatility gets too large, you step back a bit.  Those who do not wind up bailing out on the entire position.  Even if stocks have a big rally from that point, it is better to enjoy it with 70% than to bail out completely, as many did, because the size was too great.  Meanwhile, we are on the verge of increasing size.

This is not about market timing.  It is about risk management.

Our Dynamic Asset Allocation model maintains a very conservative posture, featuring bonds and other defensive holdings.  This method reduces overall volatility, so we expect it to be a little slow at the bottom.

To summarize, we have a very conservative approach in most of our programs, recognizing the uncertainty and volatility.  For new accounts we are establishing partial positions, using volatility to buy favored names and selling calls for those in our Enhanced Yield program.  We have high volatility, and that is a source of opportunity.

Take what the market is giving you.

[Interested readers can get information which you can use for your own investing and/or consider us for some help -- our approach to limiting risk, coaxing out more yield, and exploiting the current opportunities.  This includes a description of how to do a  year-end tuneup.  Write to main at newarc dot com -- no charge, no obligation, and respect for your email privacy.]

Conclusion

Each week I try to find a helpful perspective that is worth consideration.  Zach Karabell has a thoughtful article where he acknowledges all of the main market worries, and then notes the result.

His conclusion is worthy of attention:

We are not in desperate economic times. But we believe that we are, and that is as paralyzing today as it was when Franklin Roosevelt famously intoned on his inauguration that fear itself is the biggest obstacle. In 2012, the American economy will do better than muddle and less than soar. Let’s hope for the new year that Americans can adjust to that reality without succumbing to despair.

This matches my own concept of cautious optimism.

A Unique Review of 2011: The Year that Wasn't!

The "year in review" market is another crowded trade.  Either you have a special angle, or why bother?  I hope readers enjoy playing along with my idea for the year that wasn't.

My approach involves an essential analytical skill.  You need to have a basis for comparison -- often called the "counterfactual."  Regular readers know that this is a frequent theme at "A Dash."  If you want to evaluate the stimulus legislation, or the Bush-era tax cuts, or the effect of the Iraq war -- you cannot just ask where we are, but also where we would have been in the absence of that policy.

What was at the end of the road not taken?

With that in mind, I offer six events/decisions for your consideration.  In each case our question is:  What would have happened in the absence of the event in question?

I have done my own speculating, but I invite comments and other nominations.  I am focusing on US equities, but the impact on other markets and sectors might have been highly correlated.  Please note that I am not offering an opinion on whether the event or decision was good or bad.  The question is whether it was market-friendly.  (See here if you want more insight into why this is important).

Three Bullish Events

Here are three things that happened that improved market performance in 2011.

1. Fed policy. We saw QE II which everyone believed was important -- so it was, whether the effects were substantive or psychological.  We also got Operation Twist.  The Fed is on a mission, and it has increased the monetary base, although with a smaller effect on M2.
2. The Greek Leadership Debate.  The market went into a tailspin when Greece questioned the bailout terms and suggested that they might invoke -- (drum roll) ---  DEMOCRACY.  This had the potential to unravel the entire European story, but the Greek leadership change kept the incremental rescue process on course.  (runner up to Italy and Spain).
3. The NATO involvement in Libya.  In the absence of this decision, the rebels would probably have been crushed.  Oil prices might well be significantly higher.  The course of Arab Spring would have changed.  (runner up to the Osama bin Laden 'excecution').

I suggest that in the absence of any of these events, the US stock market might have declined significantly this year.  What do you think?

Three Bearish Events

Here are three things that happened that hurt market performance in 2011.

1. The Japanese earthquake/tsunami.  When this occurred the world economy seemed to be on the mend.  What started with a tragedy for the Japanese had a global effect.  There was a hit both to consumption and to production.  US companies could not build things because of supply chain problems.   Most ironic outcome?  Ford could not supply cars painted black!  What would Henry have thought?
2. The debt ceiling debate.  While the parties reached an agreement in the nick of time, no one appreciated the inside view of the sausage factory!  China expressed alarm.  The S&P downgraded the US.  Europe did not understand, so US leaders lost whatever moral authority they might have had.  Consumer confidence plummeted in a fashion that equaled the major crises of the century.  This turned out to be a really big deal, even though all of the professionals never doubted that the limit would be extended.  There is a lesson here, but no sign that it is being learned in the right places.
3. The Dominique Strauss-Kahn story.  This is my "surprise" nomination, but the logic is clear.  The WSJ now says that "dithering" turned the European problems into a global threat.  If DSK had been on the job in May, the organization and response would have been stronger.  It took many weeks to recover.  This is true regardless of the cause of the incident, but the conspiracy theories are now afoot.  So far the speculation has focused on DSK's political enemies in France.  Will the Oliver Stone movie version feature them, or a band of happy Wall Street short sellers?

I suggest that in the absence of any of these events, the US stock market might have rallied significantly this year.  What do you think?

Conclusion

Sometimes events have a temporary market effect.  If the economy or the market is already at a tipping point, the impact of stories that originally seem minor can be magnified significantly.  Especially if it is a slow news day!

Nature Abhors a Vacuum -- and so do Financial Journalists!

In most aspects of life, gaining information is helpful.  Smart people learn how to learn, and use the skill in everyday life.

There is a cruel twist of fate:

When it comes to investing, a little knowledge can be a very dangerous thing!

If you read the headlines, you are assured of being at least one step behind.  In the case of many headlines, it may even be a step backward.

Today is a great case in point.  Essentially, there was no fresh news except for an Italian bond auction (of short-term paper) that went very well, sending overseas markets and US stock index futures higher in pre-opening trading.  Everyone knew that the more important test would come tomorrow, when Italy auctioned off longer maturities, stretching out to ten years. 

This was the only fresh information, and I reported as much in my diary.

What Happened?

We then saw the same correlated trade that has been the staple of the past year:  Lower Euro, Higher dollar, lower commodities (oil and gold for sure), and lower stocks.  Traders love simple heuristics, so it was "risk off."

Notice that there is no explanatory power involved in this statement.  The Italian auction went well, and the initial reaction was positive for longer maturities.  Any other stories about the ECB balance sheet were "old news" since that program has been sliced and diced for a few days.

Two Competing Headlines

Tomorrow morning's papers will have many competing headlines offering explanations for today's trading.

Here are two choices, ironicalliy from the same source:

Stocks End Lower as Investors Take Dim View of ECB Lending

or this one

Year-End Caution Takes Over

The second headline is followed with this explanation:  Investors get bearish on Wednesday despite an okay debt auction in Italy as eurozone fears never fail to haunt the market.

This is refreshing honesty from reporter Chao Deng, for whom I predict great things!  She understands some key principles:

1. Not every move needs an explanation;
2. There are no delayed reactions;
3. There is a never-ending quest to explain every move;
4. Some moves are basically random and/or unexplainable.

This is consistent with her basic professionalism and her article in the Columbia Journalism Review.  (I had a minor inspirational role in this, but it is 99% hers).  Here is a brief quote:

When reading a typical stock-market story, one that says something like, “Futures Gain Ahead of Obama Jobs Plan,” did you ever think to yourself: “How do we really know the market move had anything to do with the president’s jobs plan? Says who?”

Says me.

I’m a markets reporter. It’s what I do.

Read the whole article.  She explains the problem in interpreting the news.

The Sign of the Apocalypse in Financial News

To understand this, you need to get the context of today's trading.

Let us suppose that the Dow is down a buck thirty.  There are only a few stocks fighting the market.  The "B team" is on the job at CNBC.  One of the pretty ladies has to point to each of the winners and say something.  What should she say?

One of the winning stocks was Weyerhauser (WY), fighting the "risk off" tide.  The CNBC anchor noted that Seeking Alpha featured an article explaining five reasons that Weyerhauser might move higher.

I was intrigued.  As a long-time contributor to Seeking Alpha I was delighted to see that CNBC was showing some respect.  I looked for the article and found something that was published the prior day.  It was written by an anonymous author.  I hope that CNBC continues to feature Seeking Alpha, but the process should be more disciplined.

I have no opinion on the merits of the article, but it is obvious that it had nothing to do with the stock strength today.  My point is that even the biggest media sources will reach deep to find an explanation for an unusual stock move.

And finally -- if something good happens for the company at some point, there will be a technical analyst who will tell you that today's trading signaled something big!

Investment Implications

I have been advocating the approach favored by NFL offensive coaches -- Take what the market is giving you!

For new accounts I spent today buying great dividend stocks at low prices and selling calls with inflated premiums.  There are many such examples, but don't start with a list of the highest yields.  Look for good yields, good earnings growth and reasonable payout ratios.  I recently mentioned Abbot Labs (ABT), Johnson and Johnson (JNJ), Intel (INTC), and Microsoft (MSFT) as candidates.  There were some excellent new choices today, but I am still shopping for clients.  This is a happy hunting ground for yield-oriented investors.

 [long all named stocks]

Weighing the Week Ahead: A Respite from European Concerns?

In the absence of fresh bad news from Europe, stocks managed some solid gains last week.  Our trading model, Felix, reflected greater confidence than most traders and investors (including me).

As noted last week I plan to focus on year-end matters, as well as enjoying time with family and friends.  This is a somewhat abbreviated version of the regular weekly update.  I want to provide continuity on the indicator updates, as well as capture important events in real time.

There was plenty of news, but I will highlight only a few items.

Background on "Weighing the Week Ahead"

There are many good sources for a comprehensive weekly review.  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.  Do not be bashful.  Join in and comment about what we should expect in the days ahead.  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

The economic data was mixed, but the most important were positive. Initial jobless claims continued the downward trend, covering the period that will be part of the monthly employment survey.  GDP was revised lower, but the third quarter now seems like ancient history.  Personal income and spending were weaker than the recent trend.

There was great coverage of these stories from my favorite sources, and I'll get back to highlighting that in two weeks.

Europe

Europe remains the big story, dominating everything else.  This is the single most important thing to understand, for both traders and investors.  It might start to be a case of the "dog not barking" for those who know their Sherlock Holmes.  In the absence of fresh bad news, the market seems to have an upward tilt.

There was a developing story this week that is still given short shrift by many observers: the recognition that the European "solution" will be incremental in nature.  Regular readers know that I have been a lonely advocate for this position for many months (as noted in this new summary of articles).  I forecast that there will be no magic bullet and no single meeting with a comprehensive plan.  I anticipate that we will observe a gradual process of compromise and negotiation. Eventually this will include many programs and participants.  The result will be messy and will not please everyone.  My time frame for general recognition that this is "working" is mid-2o12.  I put "working" in quotes because the underlying problems will linger for years after the situation is no longer viewed as a crisis.

This type of policymaking is viewed disparagingly by the current market punditry.  It is actually a classic and respected approach, dating back to Charles Lindblom's 1959 article, The Science of Muddling Through.

This week there were several new members in what I am going to call the "Lindblom Club."

• Mark Mobius says that the Euro crisis could be over by June and that it is easier because the UK will not be involved.  There were widely publicized articles quoting Mobius as predicting a disaster from derivatives.  Joe Kernen does a nice job, going right to the heart of the story with his questions.  The entire video is worth watching.

 

•  Joe Weisenthal asks whether the crisis might not already be over?
• Doug Kass, also giving credit to Steve Liesman, writes as follows:

Despite the anxiety in the markets and the downside risk to the world's economic growth entwined in the European debt crisis, I remain of the view that a credible plan to stem the debt crisis in Europe has just begun and that European and global leaders and central bankers will all come to their senses and intervene in a massive way.

 I expect more members in the Lindblom Club as the weeks go by.  There may never be a magic moment, but the story will gradually shift.

 The Indicator Snapshot

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

• An Economic/Recession Indicator.  I am evaluating several candidates.  None confirm the ECRI forecast of an inevitable and imminent recession.  These are sources that have a similar track record, greater transparency, but less PR.  I realize that I am (long) overdue for making the choice for a new indicator.  It has been a careful research process, and I expect the explanation to require multiple articles.  Meanwhile, if something really bad were taking place, I would make it clear in the weekly updates.  From the strongest candidates, I see the recession odds over the next nine months as being less than 25%.
• The St. Louis Financial Stress Index.
• The key measures from our "Felix" ETF model.

The SLFSI reports with a one-week lag.  This means that the reported values do not include last week's market action.  The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm.  This is an excellent tool for managing risk objectively, and it has suggested the need for more caution.  Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect.  We identified a reading of 1.1 or higher as a place to consider reducing positions.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions.  We voted "Bullish" this 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

There are few important reports this week.  I am mostly interested in initial jobless claims and the Chicago purchasing managers index (as a hint about the ISM report).  For anyone who is interested in real-time commentary on these reports you can check out my new "investment diary" at the Wall Street All-Stars site.  Some readers informed me that there was some kind of hacker attack leading to a virus warning.  The team there has cleaned up the problem, so please check it out again.

Trading Time Frame

Our trading accounts were fully invested last week, starting with a partial position on Monday afternoon. Before that Felix had high ratings, but also high uncertainty which relegated everything to the penalty box.  As I predicted in last week's update, this led to new trading positions and we were fully invested by Wednesday.  This program has a three-week time horizon for initial purchases, but we run the model every day and change positions when indicated.

Investor Time Frame

Long-term investors should continue to watch the SLFSI.  Even for those of us who see many attractive stocks, it is important to pay attention to risk.  In early October we reduced position sizes because of the elevated SLFSI.  The index has now pulled back out of our "trigger range," but it is still high.  For investors desiring this risk management approach we raised cash when the trigger  hit the range.  We have also been cautious with new accounts.  We still do not have an "all clear" signal, but I expect the SLFSI to decline next week.

Our Dynamic Asset Allocation model maintains a very conservative posture, featuring bonds and other defensive holdings.

To summarize, we have a very conservative approach in most of our programs, recognizing the uncertainty and volatility.  For new accounts we are establishing partial positions, using volatility to buy favored names and selling calls for those in our Enhanced Yield program.

Take what the market is giving you.

[Interested readers can get information which you can use for your own investing and/or consider us for some help -- our approach to limiting risk, coaxing out more yield, and exploiting the current opportunities.  This includes a description of how to do a  year-end tuneup.  Write to main at newarc dot com -- no charge, no obligation, and respect for your email privacy.]

 Conclusion

Repeating my prediction from last week:

• Trading volume will be lower
• There will be less political activity and speech-making

The reduced volume sometimes exacerbates big moves, so I make no guesses about volatility.

A Final Investment Thought

When I talk with individual investors, most of them are struggling with headline risk.  They also are bombarded with stories about how the market is overvalued, earnings estimates are wrong, and the world is in a permanent state of disarray, led by poor leadership everywhere.

As someone who lived through Nixon, Vietnam, a cold war where nuclear destruction was a daily possibility, interest rates in the high double-digits, and many other challenges, I am shaking my head in disbelief.

By my standards, the world is a better and safer place.  Opportunities are greater in both work and entertainment.  The potential for personal productivity is huge.  The comical Washington scene is no worse than it has ever been.  Hasn't anyone ever heard of Will Rogers?

 "A fool and his money are soon elected."

....and too many others to count.  This is nothing new.

What has changed is the way we observe and parse news, and the link between that and our investment decisions.  If you want to read one thing during the holidays, check out this article by Chuck Carnevale, who shares my relentless focus on fundamentals.  While the article provides a nice uplifting message, it also includes a shopping list of 100 cheap stocks -- a nice Christmas gift from Chuck.

Here are the first ten (alphabetical) stocks on the list, just to illustrate the valuable information in the table.

I own two of these names for different programs (ABT and AFL) and many others from the rest of the list.

 

Want to make money? Take off your ideological blinders!

Suppose that your objective is to find good investments.  You start by looking at the most popular sources, and what do you find?

Most of the comments have a strong viewpoint -- either political or ideological.  This has an effect on the writers, since stimulating page views drives advertising, measures of popularity (which are confused with quality, even by experts), and face time on TV.

If you want to be a writer for any  big-time site they expect you to have a viewpoint and to be provocative.

Am I alone in seeing the irony here?  If you just take a list of the biggest "investment blogs" the ideological bias is apparent.  There are only a couple of exceptions.

Today's Example

This week provided an excellent example of how the savvy investor can profit by putting aside his/her political views.  I have in mind the ongoing Washington farce, this week emphasizing the extension of the payroll tax cuts and unemployment benefits (along with a few other elements of contention).

• As public policy, you could question whether it was appropriate to extend benefits.  Was this sending the right message to the unemployed?  Should public policy be nudging the long-term unemployed into more aggressive job searches?

• You could also question the payroll tax cut extension.  Should we  be digging a deeper hole on the entitlement balance sheet, deferring the costs until later?

• You could emphasize the political horse race -- the main theme of most stories.  This is what everyone wants to read.  Did the Democrats gain from this showdown?  Did Boehner really "cave?"  What does this mean for the election.  It is all a game to most people.

The Trading and Investment Edge

It is easy to take advantage of this political, partisan, and ideological bias.  Just ask the following question about what is happening:

Is it market-friendly?

The tax-cut/unemployment decision meets the market friendly test because it helps to stimulate the current economy.  I understand that many people believe it is wrong to spend now and pay later, but that is not the market test.

Those who wear this ideology on their sleeves and invest accordingly are losers.

Every macro-economic model used on The Street takes a different view.  Whether Keynesian policies will work in the long run is a matter for debate.  Whether Wall Street forecasts, mainstream viewpoints, and the actions of big pension funds follow this approach is not debatable.  This is what they do, and today's market underscores the point, as you will see from tomorrow's news headlines.

How to Profit

There was actually plenty of time to profit from this.  The news came out on Thursday afternoon, and there was little movement in futures.  Here is what I commented at the new Wall Street All Stars Site:

December 22, 2011 - 4:24 pm

There are reports from various sources that the House GOP will accede to the two-month payroll tax cut extension. Since the House already acted on the Senate bill, calling for a conference committee (SOP) this is going to take some fancy footwork.

jeffmiller

December 22, 2011 - 4:26 pm

Whatever one thinks of the merits of this issue, I regard this as market-friendly news.

There was plenty of time to act.  This afternoon I noted the reaction from one major firm.  I expect more to follow:

As I said yesterday afternoon, the payroll tax cut extension is market friendly. JP Morgan raised their Q1 GDP forecast from 1% to 2.5% partly on this basis. The assumption in their report is that it will be extended for the rest of the year as well. I think that is a near certainty. Here is a link to a story describing the report: http://www.businessinsider.com/jp-morgan-raises-2012-us-gdp-growth-forecast-2011-12

A Guideline that will Pay Off

Here is the rule that is working:  Anything that provides current stimulus, even if it has a later cost, is market friendly.  Expect a rally.

This goes double in Europe.  Any measure that  delays a day of reckoning and buys time for a solution will be viewed as market friendly.

Are you trying to win a debate, or would you rather get returns on your investments?

 

What can we learn from jokes?

I must present the joke first, with no lead.  I have shamelessly ripped it off from email, so some readers may have seen the joke.  Plunging ahead anyway ----

Hans, a middle-aged German tourist on his first visit to Orlando, Florida, finds the red light district and enters a large brothel. The madam asks him to be seated and sends over a young lady to entertain him.

They sit and talk, frolic a little, giggle a bit, drink a bit, and she sits on his lap. He whispers in her ear and she gasps and runs away! Seeing this, the madam sends over a more experienced lady to entertain the gentleman.

They sit and talk, frolic a little, giggle a bit, drink a bit, and she sits on his lap. He whispers in her ear, and she too screams, "No!" and walks quickly away.

The madam is surprised that this ordinary looking man has asked for something so outrageous that her two girls will have nothing to do with him. She decides that only her most experienced lady, Lola, will do. Lola has never said no, and it's not likely anything would surprise her. So the madam sends her over to Hans. They sit and talk, frolic a little, giggle a bit, drink a bit, and she sits on his lap. He whispers in her ear and she screams, "NO WAY, BUDDY!" and smacks him as hard as she can and leaves.

Madam is by now absolutely intrigued, having seen nothing like this in all her years of operating a brothel. She hasn't done the bedroom work herself for a long time, but she's sure she has said yes to everything a man could possibly ask for. She just has to find out what this man wants that has made her girls so angry. Besides she sees a chance to teach her employees a lesson.

So she goes over to Hans and says that she's the best in the house and is available. She sits and talks with him. They frolic, giggle, drink and then she sits in his lap.

Hans leans forwards and whispers in her ear, "Can I pay in Euros?"

The Lesson?

This is like the magazine cover indicator or the taxi driver/shoeshine boy with stock tips.

When something hits the mainstream media, the trade is crowded.

This joke is too long for Jay Leno, but the concept is clear.  I hope you enjoyed a chuckle.

Meanwhile, the ads on financial TV are shifting from selling gold to selling currencies.  This might be a warning that there is a crowded trade out there......

 

Weighing the Week Ahead: What should we expect from Santa?

Market forecasts are made for many different time frames.  Peter Lynch focused on the long term, famously saying that he could not tell you the direction of the next 1000 point move in the market, but he could for the next 10,000 points.  Our Felix model makes a three-week forecast, although we take a fresh look and adjust positions (if needed) every day.  That is long-term thinking for the day trader, and an eternity for the high frequency trading operations.

Each time period is a different battleground.  Somehow everything changes at this time of year as you hear the question:  Will there be a Santa Claus Rally?

Even those who would not normally make a tw0-week prediction enjoy playing this game.  There are plenty of year-end shenanigans, window dressing, tax selling, and the like.

Felix is bullish, but with low confidence, for the year-end period.  I am not convinced, as I will explain in my conclusion.  First, let us take our regular look at last week's events.

Background on "Weighing the Week Ahead"

There are many good sources for a comprehensive weekly review.  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.  Do not be bashful.  Join in and comment about what we should expect in the days ahead.  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

The data from last week was mixed, but encouraging on balance.  As has been the case US news was trumped by anything from Europe.

The Good

The economic story was mixed, but there is still no indication of a current recession.

• The last US troops have left Iraq.
• Initial jobless claims fell to 366K, the best level offsetting last week's +400K result.  The seasonal adjustments can be difficult at this time of year, so everyone watches the four-week moving average, which is also improving.  Matt Busigin explains the significance of this improvement with four great charts.  Here is the first, which he suggests shows the relationship between stocks and this economic indicator, implying higher stock prices to come.  Check out the other three relationships as well.

 

• Exports are strong, as measured by container data from Los Angeles reported by one of our favorite sources, Scott Grannis.
• As expected, inflation as measured by the CPI remained tame.  The year-over-year core rate is slightly higher than the Fed's target.

The Bad

The negative news reflects diverse fronts.

• Chinese manufacturing growth is slowing, although not quite as much as the original "flash" indexes suggested.
• Tax withholding is lower, even after adjusting for changes in the law.  This is a broader measure than the income tax data I cited last week.  The Bonddad blog covers this and a mixed bag of other high-frequency data.
• CEO's are still worried about the economy, according to the Business Roundtable.  They read the same newspapers we do.  This is bad news, since the economy would be helped if they would start investing some of that mountain of cash they have built up -- over $2 trillion in non-financial companies.  See Josh Brown's colorful exhortation for these leaders.
• Trade is weak, as measured by container data from Los Angeles and Long Beach.  In sharp contrast to the Scott Grannis take above, Steven Hansen (another favorite source) takes a deep look into both import and export data.
• Job openings declined very slightly, as did the "quit rate."  The number of openings is around 3.3 million which is 1.2 million higher than the recent low, but still behind the 4.4 million from before the recession.  More people quit their jobs than are laid off or fired.  In summary, we need a lot more job openings.  Good discussion and a helpful chart at Calculated Risk.

The Ugly

This week's "ugly" award goes to the MF Global story.  It is tough to beat out the Washington contenders in their struggle to finish business before going on vacation, but John Corzine has done it.

The disappearance of $1.2 billion, the questionable transfers of funds, and the unconvincing Congressional testimony of Corzine himself have all helped to keep the story alive.  It is especially ugly, since it raises investor concern about the safety of their money.  Which accounts are really safe, carrying the proper controls and insurance?

Europe

For now I am going to monitor developments in Europe in a separate section.  My general approach, which is based upon my experience in the messy process of policymaking in democracies, is that the eventual solution will include a combination of many programs and participants, some of which we do not yet know.  I have been doing a separate series of articles on this theme.  So far I have the following:

How Investors Should Think about Europe  -- an overview with a general conclusion.

How to Predict Policy Decisions -- Focusing on Europe  -- comments on the players and motives.

In future installments I will discuss further the behavior of individual decision makers, try to define what constitutes progress and how we can measure it, and finally, venture some ideas about how and when it will all play out.

In the weekly updates I will highlight events that are important in the context of my thesis -- a combination of political, institutional and policy changes that will take time.  Reaching back through the much-maligned Summit of ten days ago, here are the key developments:

• Progress toward EU treaty changes and some bilateral agreements for enforcement of budget discipline.  It would have been better to have unanimity, but this progress will provide some comfort for the ECB.
• The EU will provide more funds to expand the existing EFSF facility.  No one thinks that the amount is enough --so far -- but the point is to measure progress.
  
• ECB changes in bank lending terms -- longer times and weaker collateral requirements.  This is positive since it helps strengthen the banks, reduces the problem, and buys time.
• The Fed is not going to join in any bailouts, Bernanke explains to Republicans.  I think we all knew that, but some reassurance was required.  This is not market-friendly, so a negative on my scorecard.  [Please note the distinction between market friendly and good public policy.]
• IMF head Lagarde warns (along with dozens of others) that there will be a disaster if nothing is done.  The market sold off on this story, but we should get used to it.  The IMF wants cooperation on all fronts.
• Ratings agencies are downgrading again.  This time it is Belgium, but plenty of other governments are on warning.  Once again, we had better get used to this.

This is a race.  Merkel calls it a marathon and the market thinks it is a sprint.  The impending test is the rollover of Italian debt.  For the moment, our progress indicator is the yield on Italian bonds.  There has been some progress, but the cost is still too high.

The Most Fun

I really enjoyed Josh Brown's story on the ten biggest market moments of 2011.  Everyone can quibble with the exact nominees, but that is part of the fun.  If you missed the post, take a look.

The Silver Bullet

Last week I recognized the leadership of several sources -- Barry Ritholtz, The Bonddad Blog, and Prof. James Hamilton.  Each provided a careful and thoughtful analysis of some poor data analysis.  This is a difficult and thankless task, but it is necessary.  The blogosphere is loosely peer-reviewed, but there are no real incentives for active engagement and discussion.

When you embark on such a story, you are like the Lone Ranger.  In the spirit of encouraging this type of work I hope to mention a "silver bullet" story each week.  I invite readers to send suggestions.  I expect that this will only be an occasional topic.

Meanwhile, this week's Silver Bullet goes to Rex Nutting for his story,  Is the government lying to us about the economy?  He takes on some widespread perceptions with allusions to Shadow Stats, Rush Limbaugh, and a closer look at Richard Nixon and the BLS.  He makes an interesting case concerning current data.  Whether you agree with him or not (and I do), we should all encourage this kind of article.

The Indicator Snapshot

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

• An Economic/Recession Indicator.  I am evaluating several candidates.  None confirm the ECRI forecast of an inevitable and imminent recession.  These are sources that have a similar track record, greater transparency, but less PR.  I realize that I am (long) overdue for making the choice for a new indicator.  It has been a careful research process, and I expect the explanation to require multiple articles.  Meanwhile, if something really bad were taking place, I would make it clear in the weekly updates.  From the strongest candidates, I see the recession odds over the next nine months as being less than 25%.
• The St. Louis Financial Stress Index.
• The key measures from our "Felix" ETF model.

The SLFSI reports with a one-week lag.  This means that the reported values do not include last week's market action.  The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm.  This is an excellent tool for managing risk objectively, and it has suggested the need for more caution.  Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect.  We identified a reading of 1.1 or higher as a place to consider reducing positions.

 

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions.  We voted "Bullish" this 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

There are many interesting economic reports this week.

We'll get several reports on housing, starting with the NAHB index and ending with new home sales on Thursday.  My personal favorite is building permits (a Tuesday release) which has actual status as a leading indicator.  No one is expecting much from housing right now, especially at this time of year.

Wednesday brings the Leading Economic Indicators, which many see as an important recession gauge.

Thursday's initial jobless claims have a special significance, for the reasons described above.

Friday's report on personal income and spending is of special interest.  Consumer spending continues apace, even as debts are reduced.

I am not expecting much impact from industrial production or the revisions in the Michigan sentiment index.

As usual, Mark Gongloff has the comprehensive data/earnings/speechifying calendar which we should all put on the bulletin board.

Trading Time Frame

Our trading accounts have not had any US equity exposure for several weeks.  Felix has relegated everything to the penalty box.  This suggests that a vote of "abstain" is more accurate, but the general ratings picture is quite positive.  I expect new trading positions this week.  This program has a three-week time horizon for initial purchases, but we run the model every day and change positions when indicated.

Investor Time Frame

Long-term investors should continue to watch the SLFSI.  Even for those of us who see many attractive stocks, it is important to pay attention to risk.  Six weeks ago we reduced position sizes because of the elevated SLFSI.  The index has now pulled back out of our "trigger range," but it is still high.  For investors desiring this risk management approach we raised cash when the trigger  hit the range.  We have also been cautious with new accounts.  We still do not have an "all clear" signal, but I expect the SLFSI to decline next week.

Our Dynamic Asset Allocation model is also very conservative, featuring bonds and other defensive holdings.

To summarize, we have a very conservative posture in most of our programs, recognizing the uncertainty and volatility.  For new accounts we are establishing partial positions, using volatility to buy favored names and selling calls for those in the Enhanced Yield program.

Take what the market is giving you.

Conclusion

We can forecast some elements for the next two weeks:

• Trading volume will be lower
• There will be less political activity and speech-making

The reduced volume sometimes exacerbates big moves, so I make no guesses about volatility.

There are indications that the stock market would move higher without the daily pressure from Europe.  The best measure of sentiment is the flight to bonds, shown in this chart from Scott Grannis.

 

Read the entire article for more charts and a full discussion, but here is the key takeaway:

This is a highly unusual circumstance that can only have highly unusual roots. I think those roots are most likely to be found in the Eurozone. Such is the fear that the PIIGS defaults will destroy the Eurozone banking system and ultimately lead to a global depression and a financial market collapse, that investors are willing to pay exorbitant prices for Treasuries in view of their safe-haven status. The risk-free status of Treasuries seems paramount, far more important than possible concerns about inflation.

If there is a message here for investors, it's that fear has reached extraordinary levels, artificially inflating the prices of Treasuries. And it's not a stretch to go from that conclusion to the belief that fear is also artificially depressing the prices of equities.

 

Eventually this picture must change, but it will take more time than the remaining two weeks of 2011.

Note to Readers:  I am working on some year-end pieces with broader themes, so I may suspend or abbreviate the WTWA series during the holidays.

How to Predict Policy Decisions -- Focusing on Europe

One way for investors to gain an edge is through accurate forecasting of policy decisions. The edge is great because the investing community -- traders, bloggers, pundits and TV talking heads -- emphasize problems and ignore solutions.

There are many reasons for this, including the following:

1. Problems are more obvious
2. Problems make a better story - -more page views, more comments
3. Repeating information about problems caters to reader preconceptions. Reinforcing this makes the writer seem smart. Both writer and reader are happy.
4. There is an active market for bad news and criticism. If you are tempted to disagree, watch some ads on financial TV--the single best measure of what is working. Or try this thought experiment about two headlines:

Bernanke's Crisis Leadership

Bernanke's Failed Legacy

Putting aside the merits, which do you think would get more attention?

Applying this to Europe

For investors to get an edge, you need to have information or analysis that is not widely known. The European problems and attendant stories occupy hundreds of columns each week in the financial press and even more blog posts. There is a general consensus about what will happen if there are no policy changes.

The media highlights pundits who predicted something or other in the multiple years before 2008, implying that there is some special skill in the hunting of black swans.

One of the many differences between now and 2008 is that this problem is vastly more analyzed and understood. There is not an unknown market in synthetic securities, rated AAA, that dwarfed the underlying market.

To get an edge this time requires a different skill. You need to think not about the problem, but about the solution. To do this, let us look for the best source on solutions in 2008. Who accurately predicted the alphabet collection of programs? The determination to avoid disaster? The willingness of doctrinaire Republicans to intervene? The willingness of the Fed and the Bush Administration to stretch the law to aid financial institutions? The extension of this by the Obama Administration to non-banks?

Was there such a source? If so, let me know.

The Winning Perspective

In this series about Europe I do not expect to provide a complete answer in any single article. I do hope to nudge thinking in the right direction.

I suggest that we view the various political leaders as intelligent, informed, and acting in the interest of their constituents. I'll go into this in more detail in the next installment, but here are some examples.

Merkel -- understanding the value of the eurozone to Germany and eventually supportive. Meanwhile extracting every concession possible.

Draghi -- cognizant of the problems. Under no pressure from the single mandate of price stability. Unwilling to be pressured into abandoning long-term principles. Stumbling a little in conflicting statements. Requiring institutional change before any commitments.

Lagarde -- posturing for an international constituency. Highlighting the risks. Willing to be part of the solution, but pressing for cooperation.

Geithner/Bernanke -- emphasizing the risks, but limited in policy alternatives. Operating from a perceived "glass house."

Chinese leaders -- enjoying the bully pulpit and the ability to lecture the West. Unwilling to take the lead role in a bailout. Understanding that Europe is their biggest export market. Knowing that a European recession is against the Chinese self-interest. Willing to join in a solid investment program that is not a pure bailout.

And many other participants, creating ideas that have not even been discussed.

Here is another question. The latest European Summit suggested avoiding the problems of a full treaty via various bi-lateral agreements. Which of the political science or legal amateurs -- hedge fund managers who are reading treaties and deciding what can be done -- even considered this possibility? That would be no one. Just as they did not consider TARP, TALF or any other such program in 2008.

Investment Conclusion

My working hypothesis is that there will be a messy negotiated compromise to the European problem. It will include many participants and some leverage. Austerity. Sale of public assets. Haircuts on debt. Eurobonds. ECB bond buying. It will include everything that has already been mentioned and some things we have not yet heard about.

European bank capital will increase. Confidence will gradually be improved and interest rates on sovereign debt will fall. It may take years to accomplish in full.

There will be no single meeting with a final plan announcement. Each incremental step will be met with skepticism from the usual suspects, beginning with the fact that it is not comprehensive.

If you wait to invest until this is all solved, you will be buying Dow 20K.

Investors need to learn how to measure progress and risk. It must be a measure, not a binary choice influenced by headlines.

 

Next installment: Why leaders seem dumb -- start by calling them politicians.

 

 

How Investors Should Think about Europe

The right way to approach macro investment themes depends upon your time frame.  For traders, you need to find the rhythm of the current market.  What do the active participants expect?  When do they expect it?

The problem for investors is much different.  The investor should hope for wild gyrations and mispricing of asset classes.  That is the source of opportunity.

As we prepare to turn the page on the calendar, everyone will focus on what is important for 2012.  Everyone will write about Europe, since nothing else has mattered for several months.  With that in mind, I want to do a more comprehensive analysis.  I have frequently written about the European debt crisis, but more often stating my current posture and conclusions.  Since my chosen airline does not have Internet access, I have the joy of isolation during flying time.  This sensory deprivation is valuable and can also be achieved by turning everything off!

The key conclusion I reached is that for many weeks, documented in my WTWA series, nothing much matters except Europe.  Why is this?

• It is the message of the market.  US economic news has been irrelevant.  The US economy is showing solid progress.  Corporate earnings have slowed, but still show significant growth.
• The volatility.  Wild market swings distort perceptions.  When the Dow has 300 point swings in a day, why play for an expected annual gain of 8% or so?
• Counter-party risk contagion.  This is the disaster scenario for US investors.  What is the exposure for US banks?
• Recession contagion.  Will a European recession drag down the rest of the world?
• Earnings outlook.  The gloomy forecasts have already had an effect. Why would any company give an upbeat outlook?  Why not keep the bar low by citing uncertainty.

These factors all combine to create a negative outlook for US equities.

What to Expect

A mainstream article from William J. Watts of MarketWatch captures the current sentiment.

Think 2012 will be the year when investors learn once and for all whether Europe’s leaders can come up with a plan to once and for all address the euro-zone debt crisis?

Think again.

The volatility and market turmoil that accompanied the 2011 realization that the euro could conceivably come apart is unlikely to be fully dispelled. Instead, top politicians and policy makers appear likely to continue relying on the potential for imminent disaster to push through otherwise politically unpalatable changes, economists said.

Does this make sense?

Regular readers know that my conclusion is that the impact on US equities is overstated.  As I prepared for this article (thanks United Airlines for the sensory deprivation) I saw the issues more clearly.  It is my plan to expand on each of these themes, but I invite comments on which is most important.

• Timing.  This will not play out quickly.  I have described a process of incremental compromise and adjustment.  Eventually everyone will agree with me.  Watts is among the first.
• Economists are not the best sources.  I am one of the chief defenders of economists on many fronts, as regular readers know.  Forecasting political events is not their forte.  Why rely on them to predict what Europe will do?
• Doomsayers.  Old idea, new situation.  So many economists and bloggers who claim credit for "calling the housing crisis" are going for a repeat performance.  These credentials should be carefully examined.

The Blog Agenda

There are many facets to this problem, and each deserves careful consideration.  The problem of sources is paramount.  Most people writing on this topic have no special expertise.  We tend to look to journalists, who have the skill of taking technical problems and explaining them.  For this translation to work, the journalist must have an adequate grasp of the technical problem.

In the case of Europe, there is a very poor grasp of the problem faced by the various leaders.  To summarize -- and to do so far too briefly -- the many critics suggest that the leadership is  stupid, ill-informed, and made up of people who "just don't get it."

My perspective is quite different.  Any blogger who thinks that he or she knows more than Merkel or Sarkozy or Braghi (or Bernanke) is posturing for an audience.  World leaders are intelligent, well-informed, and aware of the market implications.  Market pundits are wrong to underestimate their abilities.

As one who has moved freely in both the government leadership and trading groups, I want to sharpen the focus.

Ask not what some pundit thinks should happen.  Ask instead what is most likely to happen.

Taking this approach will lead to a significant investment advantage over the doctrinaire and often political viewpoints of the popular market pundits.

Current Investment Implications

There are many stocks that fit the current theme for investors, but here are two favorites.

Oracle (ORCL) has been trading  lower for no particular reason in front of earnings.  This is one of many stocks that has been slammed on Europe news.  Cheap on earnings (next week), channel checks solid.

JP Morgan Chase (JPM) is the strongest US financial stock.  It is not necessary to make a big statement on Europe to buy this stock.  You only need to understand that the exposure is limited.

For participants in my enhanced yield program I write calls against both positions.

 

Weighing the Week Ahead: Central Bankers take the Spotlight

Now that the political leaders in Europe have acted, we are all left to wonder whether anything has changed.

The framework is different, perhaps providing some comfort for the ECB if Draghi chooses to become more aggressive.  The initial market reaction was positive, but everyone is still very cautious.

You can still weigh in on which TV Series most resembles the European soap opera!

I will offer some suggestions in the conclusion.  First, let's take a look at the data and news from last week.

Background on "Weighing the Week Ahead"

There are many good sources for a comprehensive weekly review.  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.  Do not be bashful.  Join in and comment about what we should expect in the days ahead.  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

Last week was a bit light on data, and it was also a little soft.  This was in contrast to the heavy-duty reports from the week before, which were all solid.  It has not mattered for many weeks, with Europe-related headlines dominating over anything else.  Eventually the news and data will matter.  This week, as usual, we had mixed signals.

The Good

The economic story was mixed, but there is no indication of a current recession.

• Europe moves closer to the required policy changes.  I have encouraged readers to evaluate incremental progress rather than looking for a single bold solution.  This continues to be the story.  The concessions in national sovereignty related to budget control constitute significant progress.
• Initial jobless claims fell to 381K, offsetting last week's +400K result.  The seasonal adjustments can be difficult at this time of year, so everyone watches the four-week moving average, which is also improving.
• Consumer sentiment is recovering.  It is difficult to measure job creation, but sentiment helps.  The Michigan survey is strong, partly because it includes a continuing panel that changes over time.  The effect of the debt ceiling pseudo-crisis and gas prices have influenced sentiment, but it is still relevant.  Current levels remain poor, but the rebound is encouraging.  I especially like Doug Short's chart shows sentiment changes and recessions.

 

•  Income tax receipts are booming.  Scott Grannis reports with good analysis (worth reading) and a nice chart.

• Rail traffic -- however measured -- was higher.  (Calculated Risk).

The Bad

The negative news reflects diverse fronts.

• Forward earning estimates have stalled.  My WSAS colleague Brian Gilmartin has been all over this story for months.  Regular readers know that I think forward earnings provide a good valuation metric.  I accept the bad with the good, so a stall in earnings growth is bad news.  Brian does a great job of laying out the issues -- profit margins, PE multiples, and what is at stake.
• ISM Services was a bit light.  The US increasingly has a service economy, so this matters. Steven Hansen has a somewhat contrary take.  Steven has an effective and eccentric viewpoint on data, often finding angles that others miss.  His analysis is worthy of respect.
• The ECRI reaffirms the recession call.  About two months ago the ECRI stated that we were "tipping into recession" but no time frame was provided.  The ECRI has now (finally) provided a time frame for the prediction -- the middle of 2012.  The loud confirmation of their position is bad news (market unfriendly) for this week, but I regard it as questionable.  At least we now have a time frame for their 100% forecast.  My sources have a 25% or lower estimate for the same time period.  I am working on a comprehensive analysis.

The Beautiful

Instead of giving another "Ugly" award to politicians, this week I want to emphasize some real winners.  Here at "A Dash" I try to recognize strong data analysis and to expose hype.  This week there were three excellent stories that used sophisticated data analysis to debunk stories that got widespread attention.  We can only wish that as many people will read these great analytical articles as those who read the initial hype.

• Barry Ritholtz exposes the Black Friday surveys.  While the final Black Friday numbers were strong, the original data from surveys was overstated.  This is an annual pattern from the survey which Barry has identified and highlighted.  See the full story here.
• Bonddad corrects the WSJ and Mish on interpreting temporary employment.  This is an absolutely first-rate article, which I urge everyone to read.  It illustrates the problems in using year-over-year changes and trying to make sharp interpretations of monthly moves.  It is a testament to the difficulty of correcting superficial analysis, no matter how well-intended it might be.
• Prof. James Hamilton exposes the "secret Fed loan" myth.  The story about the secret Fed loans of $7.77 trillion suited politicians, Fed bashers, and perma-bears.  That trifecta sent the story into Internet overdrive with hundreds of links and a gazillion readers.  It is completely deceptive, including a questionable citation of Bloomberg.

I'll get back to the "ugly" next week.  It is much easier to find!

The Indicator Snapshot

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

• An Economic/Recession Indicator.  I am evaluating several candidates.  None confirm the ECRI forecast of an inevitable and imminent recession.  These are sources that have a similar track record, greater transparency, but less PR.  I realize that I am (long) overdue for making the choice for a new indicator.  It has been a careful research process, and I expect the explanation to require multiple articles.  Meanwhile, if something really bad were taking place, I would make it clear in the weekly updates.  I see the recession odds over the next nine months as being less than 25%.
• The St. Louis Financial Stress Index.
• The key measures from our "Felix" ETF model.

The SLFSI reports with a one-week lag.  This means that the reported values do not include last week's market action.  The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm.  This is an excellent tool for managing risk objectively, and it has suggested the need for more caution.  Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect.  We identified a reading of 1.1 or higher as a place to consider reducing positions.

 Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions.  We voted "Bullish" this 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

There are a number of economic reports this week, but I do not expect many surprises. Thursday's initial claims add another data point in an important series.

The inflation data (wholesale and retail) are unlikely to surprise.  Similarly, the Empire State Index is minor.  Thursday's capacity utilization will be significant when we reach capacity and see inflationary pressures.

Tuesday's retail sales data will be important.  The FOMC decision itself is not important, but the accompanying statement will be carefully parsed for any hint of a change in policy.  The market (incorrectly) sees weakness and craves more aggressive Fed policy.  The Fed disagrees, so I expect nothing.

In the aftermath of the FOMC announcement the Fed members are free to speak, so we will start hearing from them.  Draghi is also on tap on Friday.

As usual, Mark Gongloff has the comprehensive data/earnings/speechifying calendar which we should all put on the bulletin board.

Trading Time Frame

Our trading accounts have not had any US equity exposure for several weeks.  Felix has relegated everything to the penalty box.  This suggests that a vote of "abstain" is more accurate, but the general picture is quite postivie.  I expect new trading positions this week.  This program has a three-week time horizon for initial purchases, but we run the model every day and change positions when indicated.

Investor Time Frame

Long-term investors should continue to watch the SLFSI.  Even for those of us who see many attractive stocks, it is important to pay attention to risk.  Six weeks ago we reduced position sizes because of the elevated SLFSI.  The index has now pulled back out of our "trigger range," but it is still high.  For investors desiring this risk management approach we raised cash when the trigger  hit the range.  We have also been cautious with new accounts.  We still do not have an "all clear" signal, but I expect the SLFSI to decline next week.  I am doing some buying, especially in energy.

Our Dynamic Asset Allocation model is also very conservative, with holdings in bonds and gold.

To summarize, we have a very conservative posture in most of our programs, recognizing the uncertainty and volatility.  This week marks a more positive outlook.

A European Update

The story continues to play out as expected.  Traders and market pundits want an instant and comprehensive solution.  They think that government leaders are craven, stupid, or both.  Economists write about ideal solutions and the ignorance of leaders.

It is pretty easy for the punditry to criticize, since none of them have ever had the actual responsibility of leadership.  While it is not happening fast enough to suit traders, the leaders of European countries have been nudging their constituents toward a solution.

With the political commitment resolved, I expect more pieces to fall into place, including a leveraged EFSF and participation from China, the IMF, and sovereign wealth funds.

Investors who have played the volatility in line with my recommendations should be doing well.  The strategy of buying fear and selling calls is winning on both ends.

A Fond Farewell to Evelyn

This week's edition of WTWA will be the last one reviewed by my inspirational Seeking Alpha editor, Evelyn Roth.  She has worked with me for years, helping me to find my "voice" and influencing the definition of the Weighing the Week Ahead articles.  She improves both my titles and my work every time.  By focusing on what she has done for me personally, I am under-estimating  her impact at Seeking Alpha's fixed income group.  I can only imagine what she has done for emerging authors.

I wish Evelyn the very best.  Meanwhile, I am hoping that the deep bench at Seeking Alpha will continue in her footsteps.