A Dash of Insight

Stock Exchange: Technical or Fundamental?

Market participants split sharply on whether it is better to use technical or fundamental analysis. The question rivals "Ginger or Mary Ann" in popularity.

Technical experts are a rich source of new stock ideas. Our trading models each specialize in a different time frame and level of risk. Before their weekly poker game, they spend a few minutes trading ideas. They like to call this their "Stock Exchange." I am the only human and the only one using fundamental analysis.

The group had a winning call on energy two weeks ago, without clear support from the fundamentals. Just luck? Temporary? Time will tell.

The key difference between the approaches: The technical analyst thinks the market is describing the world. The fundamental analyst looks to the world, and then for mispricing in markets. This series expands upon this story, with interesting new ideas each week, as well as answers to reader questions.

This Week's Ideas

Our technical experts have varying ideas this week. As usual, I disagree with most of them. Let us have a word from each.

Felix

I look for long-term themes, and I have already shared several. Another good one is technology. One of my favorites is Hewlett Packard Enterprises (HPE).

[Jeff] Ahh! That is the portion Meg Whitman chose to run after the company split into two parts.

[Felix] Who is Meg Whitman?

[Jeff] She is the CEO of the original Hewlett Packard and now HPE.

[Felix] I only know that the market approves! Investors are applauding her. This is an excellent example of momentum in action. I expect more gains to come.

[Felix] We had some questions for this week's post! I thank my fans, and I am happy to answer.

Seeking Alpha's poorman#whocares asks: What does Felix think about RIO?

 

My response (via Jeff Miller):

I rank RIO in the top third of our stock universe, with a pretty solid hold/buy rating. In our own trading we stick to the top 20, so it is pretty exclusive.

Thanks for joining in!

 

Our second question comes from Seeking Alpha's 03FOSTER: How does Felix feel about UNH? It would seem to fit his personal presences.

 

My response:

I rate UNH in the middle of the rankings -- still a reasonable, positive rating. I do like the company, but I am not overly excited about the stock. Some human once said that a good company is not necessarily a good stock. This intelligent reader raised a very good question.

 

Oscar

I like the Diversified Utility sector (XLU). It is March Madness in action. It's been on a breakaway since the early spring, and it's still an easy layup. We may be off the yearly highs, but to me that seems like a buying opportunity more than anything else.

Looking closer, holding EXC (a part of XLU) is a near mirror image of that wider sector. You'd be opening yourself up to a bit more volatility there, though that may carry some extra upside along with it.

[Jeff] You got your nose out of the sports section long enough to spot EXC. I do not care for most of the sector, but Exelon is a good dividend stock especially if you write calls against it as I do for our Enhanced Yield program. The valuation is reasonable and the yield is 3.7%.

[Oscar] Thank you – I think…

Holmes

I like DuPont (DD) This giant Chemical company sold off pretty hard in the last 6 weeks, seems to have rested and consolidated, and is now ready to resume its long term bullish move. I expect new highs pretty soon.

[Jeff] I like a lot of industrial stocks, but this one is significantly overvalued.

[Holmes] I sniff out opportunities, deduce the risk and reward, and swiftly change course when I am occasionally mistaken. This pick fits my approach.

Athena

I have a great choice this week, but before I share it, what is this Ginger or Mary Ann question? Why not ask "Gilligan or the Professor?"

[Jeff] Hmm. That question has not caught on yet.

[Athena] Perhaps it will as wisdom improves. Turning to my excellent choice this week, if you had ever wondered what a textbook definition of "momentum" would look like, here it is. Intel (INTC). After climbing out of lows early in 2016, this stock has been red hot. Of course, I expect the gains to continue for some time. If something goes wrong with that plan, I'll drop the stock and find a stronger and wiser warrior.

[Jeff] This is a reasonable choice, but I do not see the explosive upside from current valuations. It is another stodgy holding suitable for writing calls.

[Athena] Are you going to fight with me every week? You shall learn my wisdom!

Questions

If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a special expertise. Who is your favorite? (You are allowed to choose me, although my feelings will not be hurt very much if you prefer one of the models).

Cast of Characters

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not usually announce new picks, but he will answer questions, saying what he thinks about specific stocks. He will also comment on favorite themes and sectors.

Oscar is naturally optimistic and a bit excitable. He definitely likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

Athena trades more frequently than the others, but still limits risk. Her inspiration helps to find good ideas. Her excellent quant skills find attractive risk/reward opportunities. Her wisdom leads her to exit trades that are not working. Athena will provide a new idea each week.

Jeff usually has some comments about stock or market fundamentals. Unlike the other witty participants, he sounds like an old prof.

An Important Note to Readers – from Jeff

All of the characters (except me!) are models, carefully engineered and tested by one of the leading developers of the last thirty years. They are highly-modified momentum models, with different time frames and features.

I humanize them to make it easier to understand the characteristics in their design. I always remind readers that my posts are informational, not investment advice, and that is especially true here. While we are trading based upon all four models, we are always watching and can act quickly when necessary. The models are not suitable for all investors. If you like the approach, reach out to us and I will see if you qualify for one of the programs.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned.

Finding great stock picks can be fun! I hope readers will join in making it so.

Weighing the Week Ahead: Will Election News Cause Markets to Change Course?

The calendar has a lot of data, but the FOMC meeting is over. The market waits for the next big event. We will soon have another jobs report, but Monday's presidential debate overshadows the other news. The news cycles this week will be all about the election, and the financial press will be no different. Should investors use this news to change course?

Last Week

There was plenty of economic news, and it was another mixed picture. The FOMC decision dominated.

Theme Recap

In my last WTWA, I predicted a focus on bonds, especially at the long end. That proved to be one of my worst theme forecasts. While interest rates figured prominently in the discussions, the Fed commentary quashed the selloff in the long bond. The ten-year note rates finished a bit lower than last week.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. Stocks had a good, three-day rally. Doug attributes this to central bank policy – no rate increase from the Fed and the B of J.

Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis grounded in data and several more charts providing long-term perspective.

 

The News

Each week I break down events into good and bad. Often there is an "ugly" and on rare occasion something really good. My working definition of "good" has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The Good

• FOMC held rates constant with a hint of increases to come. Whether or not you agree with the decision, the market seemed to celebrate. This is despite the reduction by the Fed in estimates for the long-term growth rate. The market continues to applaud stimulus over results.

• Earnings prospects improved. Brian Gilmartin continues to track the pace of estimate reductions, overlooked by many. He also emphasizes the rebound in technology estimates.
• Trucking improved, gaining 5.9%, although varying sources have something of a mixed picture. Steven Hansen provides a complete analysis.

• Building permits increased by 3.7%. This is a good leading indicator for housing.
• Global steel production is again positive.

The Bad

• Saudi's disappoint on oil. Even before the start of the OPEC meeting, they warned not to expect any solid conclusion. Matt Smith of OilPrice.com has the story.
• Congress and the Budget. There is only a week left before the October recess, and there is no deal in sight (NPR).
• Leading Indicators declined by 0.2%, missing expectations of a small gain.
• Architectural billings declined. This is a leading indicator for commercial real estate, interesting to some REIT investors. (Calculated Risk)
• Housing starts missed estimates by almost 6%. Calculated Risk sees the 6.1% YTD increase as consistent with the predicted "wide bottom" in single family construction, with several years of expansion coming in both starts and completions. "Davidson" is concerned about the difficulty young people have getting mortgages because of tightened rules. He sees a possible rental bubble. (Post via Todd Sullivan, who notes that he is not completely convinced).
• Existing home sales declined and missed expectations. (KWWL)

 

The Ugly

More violence. Talks have broken down in Syria, leaving the two million residents of Aleppo without water (The Guardian). Continuing incidents, tensions, and protests involving U.S. police and assorted bombings. It is not as if leaders were not trying. The U.S. and Russia have joined to back talks in Syria.

Chicago's homicide rate is much higher.

 

The TSA, much maligned last summer, collects hundreds of weapons each week, before they get into the aircraft cabin. Here is a typical haul of firearms. Read the entire post to see the other creative weapons.

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week. Nominations are always welcome.

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have a big week for economic data, setting up for some important reports at the start of October. While personally I watch everything on the calendar, you do not need to! I highlight only the most important items in WTWA. Focus is essential.

The "A" List

• Personal income and spending (F). Can the recent strength continue?
• New home sales (M). A decrease is expected, but how much?
• Michigan sentiment (F). An important concurrent indicator for employment and spending. Is there an election effect?
• Consumer confidence (M). See Michigan sentiment. This is almost as good and usually correlated.
• Initial claims (Th). The best concurrent indicator for employment trends.

The "B" List

• Pending home sales (Th). Not as important for the economy as new homes, but still a good read on the market.
• Chicago PMI (F). The most important of the regional indexes, especially when released on the Friday before the ISM index.
• Durable goods orders (W). Highly volatile August data with a big monthly decline expected. Any chance of an upside surprise?
• Core PCE prices (F). The Fed's favorite inflation indicator, so it is worth watching.
• GDP third estimate (Th). Few are interested in the final revision (before later benchmarking) of Q2 GDP, but this is what goes into the books.
• Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

The first Presidential debate will be a news highlight with markets paying attention. FedSpeak is back in full swing. Chair Yellen testifies on Wednesday before a House committee on bank supervision.

Next Week's Theme

Most investors would prefer to tune this out, but we can no longer avoid it. The polls have tightened. We are on the eve of the first of three Presidential debates. It is expected to attract more viewers than the Super Bowl. Debates are always important, but this time is really special. The debate will provide a focus for the news cycle, including the financial media. I expect that everyone will be asking: Should the election news cause investors to change course?

Please note that this is not a post with political advocacy. Everyone should vote as they choose, and for whatever reason. That said, it is important for investors to understand what is anticipated by markets, and the likely result if things change. I have worked to find articles that reflect a mainstream viewpoint. As always, I welcome alternative suggestions.

We have three key questions. Out of hundreds of posts on these topics, here are a few that are good. Think of it as a starting point.

1. Who will win? Nate Silver, whose methods have done well, gives Clinton a chance of about 60%. Larry J. Sabato now has Trump leading in the Electoral College.
2. What actions might result?
   1. Paul Ryan should know. He sees changes in tax policy, regulation, entitlements, and anti-poverty programs.
   2. Economist Mark Thoma warns about problems in taxes, spending and economic growth.
   3. Niall McCarthy (via GEI and Statista) has something of a mainstream viewpoint, citing Moody's. Whether you agree with these conclusions or not, it probably reflects the current street expectations. Also see Nanette Jacobson of the Hartford Funds.
3. Will Congress agree? Important, but little good work.

As always, I'll have a few ideas of my own in the conclusion.

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 

The Featured Sources:

 

Bob Dieli: The "C Score" which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.

The recession odds (in nine months) have nudged closer to 10%.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli's enhanced aggregate spread, considering when it might first give a recession signal. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score.

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies.

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has a number of interesting approaches to asset allocation. This week Dwaine does a detailed indicator review, concluding:

These are just a few indicators in a battery of twenty-one that we examine, and whilst there are no alarm bells yet, the aggregate composite of all 21 indicators shows the US economy the most vulnerable to exogenous shock since this expansion started:

 

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. Most readers can just "listen in." If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

• Understanding Risk – what we all should know.
• Income investing – better yield than the standard dividend portfolio, and also less risk.
• Holmes – the top artificial intelligence techniques in action.
• Why it is a great time to own for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions. What scares you?)

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar holds several aggressive sectors. The more cautious Holmes also remains fully invested. They now have a regular Thursday night discussion, which they call the "Stock Exchange." This is the place to get some ideas from the best technical analysis – and you can ask questions!

Top Trading Advice

Brett Steenbarger continues to provide a great piece of trading advice every day. Do you have a regular performance review? What does it include? Dr. Brett explains how to improve your trading from this process. He also has a great post on why creativity is important for traders. My guess is that most traders have not even thought about this question. Here's why you should:

I recall speaking with a successful trader who told me that he was excited about the opportunity in the marketplace.  I responded by saying that he was the first person I'd spoken with to tell me that.  Everyone else was lamenting the lack of opportunity in markets.  He said, "That's right.  I've always made my money going against the consensus!"  That was shortly before the events of Brexit.  That trader was able to capitalize on opportunity because he not only saw the world differently, but experienced it differently.

Adam H. Grimes also takes up the need for creativity and how to accomplish it. He draws upon his experience as a musician, and includes some other great examples for his proposed five steps.

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week it would be this analysis of risk by Michael Kitces. His informative blog is aimed at financial advisors and most of us read it religiously. A look at what your advisor is (or should be) thinking about is information you might not normally see. If you manage your own investments, it will give you some helpful ideas. Michael explains the difference between risk tolerance, risk capacity, and risk perceptions. Many people do not understand how much risk is needed to achieve their performance goals. Good planning is essential. He also notes:

The key point is that if perceptions are (or become) misaligned with reality, investors may engage in "surprising" behavior that seems inconsistent with their risk tolerance. For instance, an individual who is highly risk tolerant, but has the (mis-)perception that a calamitous economic event will cause the market to crash to zero, might still want to sell everything and go to cash. Even though he/she is tolerant of risk, no one wants to own an investment going to zero! In addition, the research suggests that some people may have better risk composure than others; in other words, some investors can keep their composure and maintain a consistent perception of the potential risks around them, while others have risk perceptions that are more likely to move wildly.

Another good treatment of risk comes from Seeking Alpha Senior Editor Gil Weinreich. He regularly raises good questions affecting both advisors and individual investors. His discussion of investment goals and risks highlights Eric Nelson, who cites the current fixed income risk to retirees:

Unfortunately, many people still invest as if bonds are priced to return 6% to 8% per year or more going forward. We continue to see significant inflows into bond funds and ETFs as well as balanced funds with a considerable allocation to longer-term bonds. These decisions are especially risky for retirees, whose greatest investment risk entails holding too much of their portfolio in assets that won't produce an acceptable long-term return, such as low-returning bonds.

 

Stock Ideas

 

Chuck Carnevale continues his analysis of high-quality dividend stocks, searching for those that are fairly valued. His discussion of Flowers Foods, Inc. analyzes the stock and also provides an important lesson.

David Van Knapp analyzes which of the "dividend contenders" might be at risk.

Eddy Elfenbein has a great annual stock list and frequent updates about those stocks and the overall market. His clever commentary is appreciated by all, including those who follow him on Twitter. This week he launched an ETF (CWS after the name of his blog, Crossing Wall Street). The ETF will hold his recommended stocks, which you can buy without making twenty different trades. The news is explained in this interview with Abnormal Returns. I also enjoyed this Bloomberg interview, which also includes some of Eddy's stock picks.

Peter F. Way's approach measures the hedging used by big-money players. This week he calls attention to biotech stocks finding 70 that are attractive to institutional investors.

Infrastructure stocks are poised to gain no matter who wins the election. Barron's interviews Jamie Cook, a top-ranked CSFB analyst. Knowledgeable investors can probably guess some of her key picks.

Our newest trading model, Holmes, has been contributing an idea each week, something we bought for clients a few days ago. I will mention it here, but you can see it sooner (along with other interesting ideas) if you read my new weekly column, the Stock Exchange. I have a "conversation" with disciples of our four trading models. Since each has a different personality and style, there are often disagreements – especially with me! While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas may be a good starting point for your own research. Holmes may exit a position at any time. If you want more information about the exits, just sign up via holmes at newarc dot com. You will get an email update whenever we sell an announced position. This week Holmes added several stocks, including CSV. See the Stock Exchange for a more complete analysis and ideas from the other experts.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are several great choices worth reading. My personal favorite is (once again) our winner of the "best of the week" honor (see above). I also liked the "secret to a good marriage" from Suzanne Woolley. Hint: This is a financial secret. How much is it OK to spend without talking with your partner? Answer for yourself before reading the article, which is both entertaining and quite important. (For guys, I advise not learning the cost of salons and something called a Mani Pedi. Mrs. Old Prof informs me that men also get Mani Pedi's and I am hopelessly out of date. She does, however have ideas about the appropriate spending limits. The ratio is about 5:1).

 

Market Outlook

Josh Brown, who expertly helps individual investors by revealing behavior of some pros, highlights the importance of the "career risk trade." Many managers are chasing the returns from the last twelve months.

 

Watch out for…

A bond bubble? Jim Cielinski looks at persistent buying despite valuations. He identifies four elements and produces this interesting graphic.

 

Final Thoughts

 

I have an answer for each of the three questions. On a personal note, this is a sweet spot for me. Given my combination of skills – top college debater, coach of the Michigan team, political scientist, and student of presidential debates --- this is a good topic for me. For most of these debates the expert commentators on TV were my colleagues as coaches and judges, from back in the day. Mrs. OldProf was originally amazed that they echoed my comments. Then she came to expect it!

1. Who will win remains in doubt, but the first debate will be crucial. It could represent a change in what is important. Most presidential debates have emphasized short sound bites to convey a message, regardless of the question. That is what the coaches teach: Get your message in there! Incorrect statements of fact have been pounced upon as gaffes. There is a long history. There is also an equalizing effect. Both candidates are on the same platform. The visual and emotional impact may be as important as the substance. One observer even suggested that we should watch with the sound off. (That would facilitate watching Monday Night Football at the same time).
2. Both candidates want to spend on infrastructure, which will be an economic stimulus. This will require compromise with Congress. Ostensibly a Republican would have an advantage, but there is dissension in the ranks. Initial decisions will include some executive orders, so there could be an immediate effect on health care and immigration.
3. The dynamic with Congress will be crucial. A new president needs to forge some compromises on spending, tax reform, trade, foreign policy, health care, and defense. Without knowing the Congressional results this is nearly impossible to predict.

Not on the list of question -- I expect a progression of reduced uncertainty.

1. This week we'll have more definition of the outcome.
2. After the election we'll know more about Congress.
3. After a few months we'll have more sense of the dynamics and the potential for compromise.

Political uncertainty has limited economic growth, earnings and stock prices. As the uncertainty is resolved, all will improve.

The Stock Exchange: Debate Rages Over Risk-on/Risk off.

Technical experts are a rich source of new stock ideas. Our trading models each specialize in a different time frame and level of risk. Before their weekly poker game, they spend a few minutes trading ideas. They like to call this their "Stock Exchange." I am the only human and the only one using fundamental analysis. This week we welcome Athena, whose wisdom helps her to know both when to hold 'em and when to fold 'em.

The group had a consensus on energy last week, but now has sharp divisions.

This Week's Ideas

Both trading and investing offer many ways to profit. Differing approaches, all sound in themselves, often lead to disparate conclusions. Technical versus fundamental, trader versus investor, short-term versus long-term -- all make a difference. Disciples of each become passionate. The Stock Exchange demonstrates that all might be winners in their own time frame.

Our experts are sharply divided this week. Some favor taking on risk, while our newest member, Athena, advocates a utility stock. Here are this week's top picks.

Felix

While I never boast about my careful and precise method, I hope everyone saw that my pick of gold (and especially RGLD) is off to a great start. I am a long term investor, and it is not too late for others to join me in gold. I see similar potential in mining, the sector I am featuring this week. I like many individual stocks in this group, including one that is owned by some famous activist investor. You can get the long-term picture by looking at the XME ETF.

[Jeff] Why do you like basic materials and gold? Do you think that the Fed and Chair Yellen are leading us into another round of hyperinflation?

[Felix] Excuse me? What is the Fed and who is this Yellen person? My investment success does not require me to waste time reading news!

[Jeff] Sorry. I forgot about thatJ

Oscar

Understanding sports is the key to my pick this week. The best NFL running backs are the ones who can wear down a defensive line. Carry after carry, they bust their way for short gains until they work up the momentum for a big run. In Biotech (IBB), I see a sector lined up in the backfield ready to break the plane for a touchdown. Check this chart of the past year:

 

 

Occasionally stalled, but with explosive potential – biotech looks like a player ready to hop off the bench and play the second half. You can see similar potential in individual Biotech stocks, like RARE.

 

 

All I can say? If I had to stake my fantasy team on that moving average trending back up, it would be a no-brainer.

[Felix] Too aggressive and too speculative.

[Jeff] Biotech stocks require a different perspective. A projected earnings multiple is not helpful, since many are "story stocks." We may not know which will come through, but the sector will be the source of the most important drug developments. Long-term investors can put a little away, but they should not expect regular gains on their quarterly statements. I think we will see a nice gain after the election.

Holmes

CVS has a very good chart! I reject all but 2% of the stocks in the universe I follow. I require plenty of data before reaching a conclusion. CVS rallied for 4 straight years barely touching it's 200-day MA reaching an all-time high 113. It has been backing and filling for last year. I see a possible double bottom. This is a nice risk reward scenario with a tight stop just below 89. These are the kind of setups one sees from careful sleuthing.

[Jeff] Double bottoms seem to be in the eye of the beholder. The stock has pulled back and it is now almost down to fair value. I agree that It is worth watching.

Athena

Some things are so obvious. You guys should pay attention to what is working! We have a nice stock with an uptrend and strong recent price action. I know a good chart when I see one!

[Jeff] If you absolutely must own a utility, this is not a bad choice. I do not like companies with a multiple of over 18 and an earnings growth rate below 3%.

[Athena] Who cares? Pay attention to what is working. If the market ever starts to reflect your thinking, I will sell and move on.

Questions

Last week's comments were all about current picks. Feel free to range more widely. If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments and address them to a specific expert if you wish. Each has a special expertise. Who is your favorite?

Cast of Characters

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not usually announce new picks, but he will answer questions, saying what he thinks about specific stocks.

Oscar is naturally optimistic and a bit excitable. He definitely likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

Athena trades more frequently than the others, but still limits risk. Her inspiration helps to find good ideas. Her excellent quant skills find attractive risk/reward opportunities. Her wisdom leads her to exit trades that are not working. Athena will provide a new idea each week.

Jeff usually has some comments about stock or market fundamentals. Unlike the other witty participants, he sounds like an old prof.

An Important Note to Readers

All of the characters (except me!) are models, carefully engineered and tested by one of the leading developers of the last thirty years. They are highly-modified momentum models, with different time frames and features.

I humanize them because it makes it easier to understand the characteristics in their design. I always remind readers that my posts are informational, not investment advice, but that is especially true here. While we are trading based upon all three models, we are always watching and can act quickly when necessary. The models are not suitable for all investors. If you like the approach, reach out to us and I will see if you qualify for one of the programs.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned.

 

Weighing the Week Ahead: Is the Long-Awaited Bond Correction at Hand?

The calendar has very little important data. The highlight is the FOMC announcement and press conference on Wednesday. Even though the Fed is not expected to change course, bonds have gotten much weaker, sending the ten-year note yield higher. This effect is gaining notice. Should we expect a further bond selloff?

Last Week

There was not much news, and it was another mixed picture.

Theme Recap

In my last WTWA, I predicted a week of wondering whether we should start fearing the Fed. That was the Monday theme, but it did not last long. Governor Brainard gave a very dovish speech right at the deadline before the blackout period. Many had expected a significant tone change from her. Perceived odds of a rate increase declined after that and continued with the weaker-than-expected data reports.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. The overall range, once again, is very narrow. Doug emphasizes the early-week volatility and generally soft data.

Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective. Here is a sample, showing the regularity of drawdowns since 2009, including 5% or more about twice a year and several over 10%. Keeping perspective is easier when you understand what is normal.

 

The News

Each week I break down events into good and bad. Often there is an "ugly" and on rare occasion something really good. My working definition of "good" has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The Good

• Initial jobless claims were 260K, continuing recent low levels.
• LA area port traffic increased in August. (Calculated Risk). This indicator may need a "reset" now that the Panama Canal is able to take more traffic. There will also be noise from the bankruptcy of a big shipping firm, leaving some cargo stranded.
• Inflation – both PPI and CPI remains at benign levels. It is not yet at the point that will attract aggressive Fed action, but is starting to reflect improvement in wages and the economy. Doug Short and Steven Hansen collaborate on the most comprehensive analysis of these data. Check out this deep dive!

• U.S. households are richer than ever. Scott Grannis reviews the latest updates (June data). While it is 2015 data, incomes also showed a big gain.

• Frequent indicators are stronger. New Deal Democrat's update of indicators that most people miss is a regular read for me. One excellent feature is the separation of long-leading, short-leading, and concurrent indicators. This is an excellent check on the more commonly discussed economic indicators. It requires a lot of work to provide information that would be difficult to compile on your own. Here is a key quote from this week's post:

  Now ALL but one of the long leading indicators are positive.  Interest rates for corporate bonds, treasuries, the yield curve, real money supply, real estate loans, mortgage rates, purchase and refinance mortgage applications are positive. The only negative is that mortgage rates have not made new lows for over 3 years.

   Short leading indicators turned a little more mixed.  Stock prices, jobless claims, oil and gas prices, gas usage, and as of this week the spread between corporates and treasuries, are all positive. Both measures of the US$ are now neutral.  Industrial commodities have joined the volatile regional Fed averages as a negative.

   The coincident indicators remain mixed. For once recently all measures of consumer spending are positive.  The BDI remained barely positive.  Rail, steel, the Harpex shipping index, and bank rates remain negative, with bank rates really spiking. Tax withholding was mixed.  Obviously I do not like a negative YoY tax withholding reading, but I suspect this will resolve next week.

• Las Vegas visitor traffic has reached a new record high. Bill McBride has the story. And this is even before the new direct flights from Beijing have begun.

The Bad

• Rail traffic had another bad week. Steven Hansen notes that it is still down 4.9% y-o-y if you remove coal and grain traffic.
• Industrial production dropped 0.4% missing expectations for a decline of 0.3%.
• The federal budget deficit is increasing as revenues falter. Scott Grannis has a good discussion. Various sources this week, including Barron's, noted that the election debate does not pay enough attention to this issue.

• Election uncertainty is holding back business investment, and it will not stop when the election ends. Duke's regular survey of CFO's reports that 1/3 will hold back on investment until there is information about how the new president will govern. Election expert Prof. Larry J. Sabato also expresses concern about the "strange race." This is a growing concern.
• Michigan sentiment missed expectations (89.8 v 91.5), but matched last month's final result.
• Retail sales declined 0.1% missing expectations of a 0.3% gain. Jill Mislinski covers this thoroughly. The effect on Doug Short's Big Four indicators is described in the quant section.

 

The Ugly

Corporate misconduct. Deutsche Bank via Bloomberg. "Aside from the U.S. probe into residential mortgage-backed securities, the lender also faces inquiries into matters including currency manipulation, precious metals trading and billions of dollars in transfers out of Russia". Wells Fargo creating two million phony accounts. (CNN). Exxon accounting issues. (Reuters). Bosch under investigation for possible help to VW in "Dieselgate." (Bloomberg).

Wells Fargo's CEO John Stumpf will be before the Senate Banking Committee on Tuesday. The fines and other penalties for corporate offenses sound large, but do not really force accountability. Eddy Elfenbein ponders what a Wells Fargo investor should do. (We also hold stock versus short calls).

Following up on last week's North Korea story – the Council on Foreign Relations has a collection of papers covering the key issues.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week's award goes to Chris Ciovacco (See It Market) for his great explanation of the VIX. Featuring a prior piece by Jeff Macke, he emphasizes that the VIX is not really about fear, but expected volatility.

The misunderstanding of this concept is costly for investors who see it is a leading "fear" indicator, as well as traders who misuse it for hedging. The entire post is worth a careful reading, but keep this chart in mind:

See also runner-up Adam H. Grimes with similar conclusions on the same topic.

 

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have a very light week for economic data, featuring the FOMC decision and Yellen press conference. While personally I watch everything on the calendar, you do not need to! I highlight only the most important items in WTWA. Focus is essential.

The "A" List

• FOMC decision (W). No policy change is expected. Will the statement and press conference clarify anything?
• Housing starts and building permits (T). Crucial element for stronger growth.
• Initial claims (Th). The best concurrent indicator for employment trends.

The "B" List

• Existing home sales (F). Not as important for the economy as new homes, but still a good read on the market.
• Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

FedSpeak will resume after the meeting with several participants on the calendar.

Next Week's Theme

Last week began with revisionist Fed thinking on Monday and a poorly-explained sell-off on Tuesday. I parsed the explanations which were basically inconsistent. Many relied on the lame "delayed reaction" argument. It is amazing how imagination can be used to make facts fit your favorite scenario. I tweeted a good CNBC sequence where the stock pundits (once again) said that markets were taking a cue from oil. The oil expert then opined that commodity traders were watching stocks!

True enough. Everything declined together on Tuesday, including the interest-rate sensitive names. Pundits were mystified by bond selling even though the FedSpeak was more dovish. Could it be? Regardless (but including) what the Fed does, I expect that everyone will be asking: Is the long-awaited bond correction at hand?

There is a key mistake in most commentary – the idea that the Fed controls all interest rates. "Davidson" (via Todd Sullivan) pursues a theme that I hope will be familiar to my readers.

When I began my career ~35yrs ago everyone talked about "The Credit Spread". Today, everyone talks about rates as if it is the rate, the short-term rate, and importantly the rate the Fed sets, the Fed Funds Rate. Today's discussion is universally about the next Fed Funds Rate hike as if the Federal Reserve controls the economy. The extensive economic data we have available has never supported the wide-spread belief repeated ad nauseam in every media that the Federal Reserve controls US economic activity. Actual control lies in the Free Market.

I have not been a fan of Jeff Gundlach on most of his predictions about stocks, but when a "bond guy" gets worried about bonds, we should probably pay attention. Robert Huebscher covers this in an article that has been extremely popular with investment advisors. Here is a key quote:

"This is a big, big moment," Gundlach said¸ and it won't pay to "be cute" by trying to benefit from short-term price movements, since the dominant trend will be higher rates.

"It pays not to squeeze the last bit of juice out of the orange," Gundlach said.

Brett Arends (who also has been no fan of stocks) is sounding a warning about the so-called safe investments.

JP Morgan seems to be on the same page.

As always, I'll have a few ideas of my own in the conclusion.

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 

The Featured Sources:

 

Bob Dieli: The "C Score" which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.

The recession odds (in nine months) have nudged closer to 10%.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has a number of interesting approaches to asset allocation.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli's enhanced aggregate spread, considering when it might first give a recession signal. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score.

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies.

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

Quant work on GDP was a key topic this week. The Atlanta Fed's GDP Now project shows a current forecast of 3%, a lot better than most expect.

Lipper explains why things might be stronger than they feel on the earnings front. This is a theme from Brian Gilmartin that we have been monitoring for months.

Mark Perry has a good idea about GDP measurement. Let's start by asking whether you think the world's "music well-being" has ever been better than it is now. Mark explains why it is currently awesome. Next take a look at how it is measured by GDP. Everyone will enjoy this chart, which makes obvious the error in using dollar sales as the main indicator.

 

 

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. Most readers can just "listen in." If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

• Understanding Risk – what we all should know.
• Income investing – better yield than the standard dividend portfolio, and also less risk.
• Holmes – the top artificial intelligence techniques in action.
• Why it is a great time to own for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions. What scares you?)

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar holds several aggressive sectors. The more cautious Holmes also remains fully invested. They now have a regular Thursday night discussion, which they call the "Stock Exchange." You are welcome to join in with questions or ideas.

Top Trading Advice

Brett Steenbarger is posting great ideas day after day. Traders should read his posts frequently. I sense another book coming! My favorite this week is about what you should do if you are in a drawdown.

Are other people, trading similar strategies, also losing money?

That will tell you quite a bit.  If you were making money and suddenly go cold and others in the same markets, with similar strategies are doing the same, then you know that it isn't simply a psychological issue.  Everyone did not suddenly lose discipline or become an idiot at the same time.  Rather, the strategy is not working under current market conditions, or it has stopped working altogether.

Simple, but wise and often overlooked by traders who start second-guessing themselves.

I also recommend this post on The Psychology of Dealing with Choppy Markets.

Most aspiring traders would save a lot of time and money if they asked Sam Seiden's question, Are You a Good Fit for Trading? (This was GEI's Investing Trading Academy's article of the week).

Adam H. Grimes has another take on psychology, considering how it is linked with experience and methodology.

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Chuck Carnevale's lesson about how to pick dividend stocks. I almost always suggest that readers take a look at his ideas, but this week's post is extra special. He provides a wonderful opportunity to test the tools at his wonderful time-saving and profit-building site. Anyone who is a do-it-yourself individual investor should set aside an hour or so to read the article and try out the method.

His example convincingly shows why entry price is important. A given budget permits purchase of more shares. Better value at the time of purchase gives you both extra upside on stock gains and also larger dividends. Take Chuck's challenge to try it for yourself.

Stock Ideas

 

Eddy Elfenbein's latest CNBC appearance explains the relationships underlying the gold trade, where someone bought $1 million worth of put options on a single gold stock. The discussion emphasizes the short run, reaching a different conclusion than Felix, who thinks long-term.

Our newest trading model, Holmes, has been contributing an idea each week, a stock we bought for clients a few days ago. I will mention it here, but you can see it a little sooner if you read my new weekly column, the Stock Exchange. I'll have a "conversation" each week with all three of our models. Since each has a different personality and style, there are often disagreements – especially with me! While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas may be a starting point for your own research. Holmes may exit a position at any time, and I am not going to do a special post on each occasion. If you want more information about Holmes and exits, just sign up via holmes at newarc dot com and you will get email updates. This week's Holmes added several stocks, including Solar City (SCTY).

Technology stocks are now favored by value funds. That is no surprise to me or to my readers! Barron's has the story. A subscription is required, but you can probably get it by putting the title or key phrase into Google.

Barron's also highlights homebuilder CalAtlantic (CAA). The company has been digesting a merger which helped to place it in some of the fastest growing areas.

The top 10 dividend stocks from Morningstar's Ultimate Stock pickers.

Peter F. Way uses his unique methodology to highlight Dow stocks with the best risk/reward profile. Here is one of several interesting charts:

OK, here is another….

You can get some great ideas from this approach.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. This was a really great post. There are several great choices worth reading, including my pick for best advice of the week. My personal favorite is the Harvard Business Review study of the cost of your inconsistent decisions. Unless you are a regular HBR reader (I listen to a lot of their podcasts) you would never see this story. Tadas does the heavy lifting for you.

Many readers would also enjoy his Saturday post with interesting lifestyle features. Mrs. OldProf liked the item on wine.

Market Outlook

Many people have described current markets as "complacent." That is not what I see. The fact that the trading range is tight can occur when there are intense feelings in a rough balance. There is plenty of negative market sentiment. Here is a typical popular column listing six worries.

This week I was struck by two excellent posts.

Brian Gilmartin summarized the "Delivering Alpha" conference, where nearly everyone was downbeat. For contrast, here are some notes from Market Folly. It will be interesting to review how well these ideas play out over the next year.

Joe Fahmy explains why the market will not correct when that is what everyone is expecting. His perception of the trading community squares with what I hear.

Watch out for…

Junk bonds. Marc Gerstein has a warning for "yield hogs."

Final Thoughts

 

Fueled by ill-informed reports from financial media, most investors think only of a single interest rate, controlled by the Fed. This is a costly mistake. It is important to monitor the entire yield curve.

The short end responds mostly to the Fed policy announcements. Most recently the Fed is unsure that their decisions can have the desired impact, so the resulting rate is imprecise.

The long end reflects (at least) five factors:

1. Expected future rate increases – the term premium;
2. Inflation, current and expected;
3. Economic growth;
4. The Fed balance sheet – estimates are that the current holdings have an effect of 1 – 1.5% on the ten-year note; and
5. Global interest rates, including policies from other central banks.

Those who attribute the long rate or the slope of the yield curve to a single factor are making a costly mistake. This is especially true for those whose favorite game is to make it all about the Fed.

Investment Implications

The dominant perception holds that the Fed is about to raise interest rates despite economic weakness, probably creating a recession. This is backwards. If rate increases are consistent with economic growth, it would be the "bear steepener" that I have been describing for some weeks. We should embrace short-term rate increases when growth is strengthening and the long rates are also moving higher.

Holdings to reduce or avoid include:

• Bonds and bond mutual funds. Alliance Bernstein warns that the one statistic you must know is duration of your bond holdings. Do you? That helps you see how much is at risk.
• Utility stocks and bond proxies.
• REITs and MLPs that are interest sensitive and without a tie to economic growth. Look for sectors benefiting from demographic changes – health care, senior living.

Holdings to emphasize include:

• Technology
• Banks
• Homebuilders

The consensus, even among the traditional bond advocates, is that the crowded bond trade (bubble?) has reached its end. As investors following the traditional 60-40 formula see absolute losses on their brokerage statements, where do we expect the money to flow?

Stock Exchange: The Experts All Like Energy

Technical experts are a rich source of new stock ideas. Our models, Felix, Oscar, and Holmes each specialize in a different time frame and level of risk. Before their weekly poker game, they spend a few minutes trading ideas. They like to call this their "Stock Exchange." Here is the cast of characters:

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not usually announce new picks, but he will answer questions, saying what he thinks about specific stocks.

Oscar is naturally optimistic and a bit excitable. He definitely likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

Jeff sometimes joins the discussion with some comments about stock or market fundamentals.

This Week's Ideas

My purpose is to show how different approaches – all sound methods – often lead to different conclusions. Technical versus fundamental, trader versus investor, short-term versus long-term -- all make a difference. I hope you will find the weekly discussion interesting and become a part of it.

Each member of the group, independently, comes up with an idea. To my surprise this week was all about energy.

Felix

I am liking oil and gas this week. I particularly like SM Energy (SM). There is a lot of movement and great long-term opportunity for more growth.

 

Oscar

I'm still holding onto Regional Banks, but my latest sector pick is Refiners. Just a glance at this YTD chart for CRAK and you'll see a strong element of seasonality in this sector. I don't think we're anywhere near this year's peak just yet.

Most stocks in this area have been quietly jogging through this low volatility period, waiting to break out into a sprint. I know I'll be watching when they cross the finish line. Will you?

Holmes

I do not talk as much as Felix and Oscar, but my stock picks are still ahead of the humans. Last week's bumpy ride has not changed my bullish outlook. Here is one I bought this week: Solar City (SCTY).

Jeff

The aptly named CRAK focuses on the key element for refiners, the crack spread. This tracks the difference in price between their input, crude oil, and the refined product they sell. When oil prices fell most people missed the opportunity in refiners. One way to keep an eye on this is to watch the forward curve on crack futures. Yes, there is such a thing. The spread declines seasonally into the end of the year, and looks nicely higher net year. Oscar might be disappointed in how long this takes.

Felix seems to think that SM Energy will return to the good old days when it traded 80. Time will tell. In last week's question about AAPL he thought the chart was too messy, but I liked the stock. I would point out who is leading on that question, but it is best not to talk trash around Felix.

Holmes picked Solar City, which is showing some volatility. Holmes is quick to exit trades that are not working.

Questions

Each week we will answer questions. Feel free to address any of us.

One reader noted insider selling in CAH. This can be an important fundamental factor, more typically when there is buying. Holmes does not consider it because the information is not released quickly enough to be helpful in his time frame.

Another reader suggested that the group needed a female perspective. That is interesting, since there will be a new member of the poker group soon. She is quick-thinking and fast-trading. She knows a good chart when she sees one.

An Important Note to Readers

Felix, Oscar, and Holmes are all models, carefully engineered and tested by one of the leading developers of the last thirty years. They are highly-modified momentum models, with different time frames and features.

I humanize them because it makes it easier to understand the characteristics in their design. I always remind readers that my posts are informational, not investment advice, but special emphasis is needed here. While we are trading based upon all three models, we are always watching and can act quickly when necessary. The models are not suitable for all investors.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned.

Weighing the Week Ahead: Should We Fear the Fed?

The calendar has little important data. Friday's sharp selling was widely attributed to the fear of a Fed rate hike in September. Is it time? Should we fear the Fed?

Last Week

There was not much news, and it was another mixed picture.

Theme Recap

In my last WTWA, I predicted a continuing discussion of the Fed and the timing of the first rate increase, combined with concern over a September market correction. The first part was pretty accurate all week, but the market remained quiet. The modest trading range ended spectacularly on Friday., The "C" word is now on the lips of many.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. The overall range, once again, is very narrow. Doug's take is that Friday was all about the Fed. He writes as follows:

Today's action essentially confirms the metaphor of an equity market infant nursing on mother Fed's breast. The selloff was triggered initially by hawkish remarks by the normally dovish Boston Fed President Eric Rosengren, a voting member of the FOMC. But more surprising was the announcement of an unannounced speech by even more dovish Lael Brainard at the open of the FOMC week, which runs counter to the general policy a silent Fed prior to the FOMC meeting end.

As you will see in today's "Final Thought," I have a very different interpretation, still consistent with the data.

Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

A Two-Question Quiz

1. The recent Purchasing managers index for manufacturing recently registered 49.4. Last week's "services" index came in at 51.4. Each data series has a long-term relationship with GDP. Which of these reports implies the higher rate of economic growth? Which one implies an impending recession? [See conclusion for the answer.]
2. Suppose you are in an NFL "survivor" pool. You just need to pick a team that will not lose that week. No point spread. What are your odds of making it through two weeks? You may pick the biggest favorite each week.

The News

Each week I break down events into good and bad. Often there is an "ugly" and on rare occasion something really good. My working definition of "good" has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The Good

• Initial jobless claims fell to 259K, down from the prior week and continuing recent low levels.
• The Beige Book was mildly positive, providing support for the modest growth scenario.
• Framing lumber prices remain strong. (Calculated Risk).
• Sentiment remains bullish. Dana Lyons looks at the ISE Call/Put ratio to refute the idea of a "frothy" market.

• Durable goods orders had a solid rebound from earlier weakness, increasing 4.4%
• The JOLTS report registered a new high in job openings and continued strength reflected in the quit rate. This shows the number of people voluntarily leaving their jobs. Josh Brown has a good discussion of this point. The labor market structure from the report is less encouraging. The ratio of unemployment to job vacancies confirms non-recessionary conditions, but also a mismatch between available jobs and workers. (Simple explanation here. Also a good chart via The Daily Shot).

The Bad

• Employment benchmark revisions showed a decrease of 150K jobs over a one-year period ending last March (BLS). While this is a preliminary report, it is usually a good estimate of what we will see in the actual revisions this coming March. Essentially, this means that the job growth over the one-year period ending last March was over-estimated by 150K jobs, described as 0.1% of the labor force. It is a much larger percentage of the reported net job growth. I frequently cite this report as the most accurate count, but one that arrives too late to be of interest to those in the news and financial communities. If you missed my challenging quiz on the employment report, please take a look.
• Rail traffic had another bad week. Steven Hansen (GEI) reports on the 5.7% decline for the month of August.
• ISM non-manufacturing dropped to 51.4. As Bespoke notes, this was the biggest monthly decline since 2008.

Here is some color from the actual report:

WHAT RESPONDENTS ARE SAYING ...

"Relatively stable August, with no sharp increase or decrease in sales or pricing. Labor availability and cost remains a very high focal point." (Accommodation & Food Services)

"Overall, the oil and gas industry remain in [a] 'wait and watch' mode. The price of oil has impacted investment considerably." (Construction)

"No significant changes to report. Still on track for expansion efforts to begin fourth quarter 2016." (Finance & Insurance)

"Still recovering from the current downturn in the renewable energy market which is expected to pick up in the fourth quarter." (Professional, Scientific & Technical Services)

"Stable with some increase in construction activity." (Public Administration)

"The business environment has softened a bit over the last month. There are now opportunities to fill in the marketplace." (Retail Trade)

"Midyear [is a] slow time for us, summer build is over, fall is historically light, holiday peak build September and October for peak time November and December." (Transportation & Warehousing)

"Good, but slowing from previous months." (Wholesale Trade)

 

The Ugly

North Korea is a multiple winner of my "ugly" award. The recent nuclear test is viewed as completely unacceptable by most of the world. Can leaders find an action that peacefully accomplishes widespread objectives? Will those having the most influence over N. Korea cooperate? These are important questions, beyond our normal concerns over investments.

Jonathan D. Pollack (Brookings) has a good explanation of why the recent test is different and more threatening than those in the past.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week's award goes to Wisconsin economist Menzie Chinn, who earned a belt full of bullets in a single article. The context is a post for a class in economics. Since so many current financial commentators take pride in not having taken Economics 101, it is a great illustration of why they are wrong! So many mistakes of this sort are made by financial pundits, including intentional misrepresentations. Prof. Chinn illustrates one of the most frequent errors – not using log scales in charts when they are appropriate. Note the deception it would generate in this example, which actually shows a constant rate of increase.

He also debunks the data conspiracy stories, using several links and good explanations. This post might be the single most profitable thing for investors to read this week.

 

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have another light week for economic data. While personally I watch everything on the calendar, you do not need to! I highlight only the most important items in WTWA. Focus is essential.

The "A" List

• Retail sales (T). The biggest report of the week. The odds of a rate hike will increase if this is positive.
• Michigan sentiment (F). Consumer confidence has been strong, helping to support the stock market.
• Initial claims (Th). The best concurrent indicator for employment trends. Quiet strength is the long-term trend, so a spike would be worrisome.

The "B" List

• Industrial production (Th). Volatile data with a big gain last month. Not much is expected, but this remains important.
• CPI (F). Still not important, but this number will start to approach the Fed's 2% inflation target as year-over-year gasoline prices stabilize.
• PPI (Th). See CPI above.
• Business inventories (Th). July data, but it is another piece in the Q2 GDP puzzle.
• Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

FedSpeak will enter the pre-meeting blackout period after Monday. Fed Governor Lael Brainard has been dovish, so her Monday presentation will get plenty of attention.

Next Week's Theme

Last week brought us more quiet for the first part of the abbreviated week. Friday was a very different story. The sharp decline, ending a two-month string of quiet days, commanded attention. What was going on?

The instant conclusion was fear of a September rate increase from the Fed. That sets the tone for next week. Everyone will be asking: Should we fear the Fed?

Normally I recommend spending very little time on yesterday's news. As I wrote a few months ago, investors do not get paid for this knowledge – only pundits who get to sound smart after the fact!

This week is a bit different. Having a good sense about what happened Friday is important to our advance preparation. Here is an abbreviated sequence of events:

• Stock futures were set up for a flat opening, just as we had seen all week.
• Boston Fed President Eric Rosengren, repeating a speech made in August, stated that gradually removing accommodation was the best way to extend the duration of the recovery. The Boston Globe states that this pushed the Dow 400 points lower.
• Stock futures moved lower by about ½ of one percent when the speech was reported.
• Since markets are not expecting a September rate increase, and only a 60% chance of one before the end of the year, the original move attracted a lot of discussion.
• When the Dow declined a little more, CNBC started running the headline that Fed fears were slamming stocks.
• Several commentators cited the possible end of the Fed support for asset prices. Art Cashin fed the fire, noting in mid-afternoon that if stocks were down 300 on just the hint, an actual increase might take them down 1000.

You will see plenty of commentary on these themes. Feel free to add your own thoughts in the comments, including anything I have missed.

As always, I'll have a few ideas of my own in the conclusion.

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Think risk first, reward second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 

The Featured Sources:

 

Bob Dieli: The "C Score" which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.

The recession odds (in nine months) have nudged closer to 10%.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has a number of interesting approaches to asset allocation.

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli's enhanced aggregate spread, considering when it might first give a recession signal. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score.

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he further explains the possible turning point in earnings. Most people will not understand this until it is too late to profit.

 

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. Most readers can just "listen in." If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

• Understanding Risk – what we all should know.
• Income investing – better yield than the standard dividend portfolio, and also less risk.
• Holmes – the top artificial intelligence techniques in action.
• Why 2016 could be the Year for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions or suggestions for new topics.)

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar holds several aggressive sectors. The more cautious Holmes also remains fully invested.

Top Trading Advice

Brett Steenbarger is posting many great ideas. Traders should make a daily visit. I sense another book coming! My favorite this week is How to Extract Greater Profits from Our Trading.

If we don't see the market gain a second wind after our having made an initial entry, the conditional probabilities of getting the move in the other direction continue to increase.  We are getting further confirmation that buyers can push the market no higher or sellers can push prices no lower.  It is when we see that our initial position is not getting torched and subsequent market behavior is in line with our thesis that we can add a second unit of risk to the trade.  We extract more from our trading by being largest when we're "rightest" and smallest when we're wrong.

Dr. Brett is also helping with the psychological aspects of your trading – Three Trading Techniques for Building Positive Trading Patterns.

Paul Tudor Jones: Decide on your stop point before you enter a trade. Finance Trends discusses this and some other advice from the great trader. Holmes is barking approvingly.

Another piece of advance preparation is asking yourself whether the prospective trade really has enough edge. Don't forget to keep the volatility of expected results in mind! Adam H. Grimes takes up this question and provides links to some prior related work.

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week it would be the WSJ warning about "structured CD's." (subscription required, but you can find it if you Google the title). Many unwitting investors are biting on a pitch that you can double your money in six years with no risk. Some of those needing early access to funds actually lose money on the CD. Performance data are not available for this product, unregulated by the SEC. The WSJ managed to get some results, and they are abysmal. 

Stock Ideas

Chuck Carnevale has some good lessons about how to select dividend stocks. For the buy-and-hold income investor he seeks continuity of the dividend as well as limited volatility in the underlying stock. His analysis is rich with stock ideas -- some to consider and some to avoid. I hope DIY stock-pickers are reading Chuck's stories closely. It is important to learn technique and analysis, not just follow someone else's stock picks.

Abba – no not ABBA – likes T. Rowe Price (TROW). His analysis is based upon a dividend valuation model. I also like the stock, but we write calls against the position to enhance yield.

Market Folly monitors the moves of big investors with good attention to the most recent moves. Warren Buffett now has nearly 80 million shares of Phillips 66 (PSX).

Ready for some biotech stocks? Bret Jensen serves up regular ideas in his forum. His most recent update includes a key stock in the news, Valeant (VRX), which we own as a trade for technical reasons.

Our newest trading model, Holmes, has been contributing an idea each week, a stock we bought for clients a few days ago. I will mention it here, but you can see it a little sooner if you read my new weekly column. I'll have a "conversation" each week with all three of our models. Since each has a different personality and style, there are often disagreements – especially with me! While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas may be a starting point for your own research. Holmes may exit a position at any time, and I am not going to do a special post on each occasion. If you want more information about Holmes and exits, just sign up via holmes at newarc dot com and you will get email updates. This week's Holmes added several stocks, including Cardinal Health Care (CAH).

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. This was a really great post. There are several great choices worth reading, including my pick for best advice of the week. My personal favorite is the timely and entertaining advice from Tim Maurer, How Fantasy Ruins Football (and Investing). He discusses several popular financial fantasies. He writes:

Fantasy: Gold is a good hedge against inflation. (Or a good hedge against currency risk, or a good investment. Just take your pick.)

Truth: Of the many traits often attributed to gold as an investment, the only one that really holds up is that the precious metal historically has risen in price when stocks are in deep decline. People tend to buy gold when they are scared (and sell it when they aren't). But good luck shaving off some of your bullion for bread when The Hunger Games start (or when any dystopian tween books series becomes a reality).

Felix disagrees. That is what makes a market!

I also really liked Ben Carlson's list of things he learned in his 30's, especially numbers 9 and 10 (negotiating and saving).

Gil Weinreich of Seeking Alpha takes a helpful look at the "retirement crisis." There is plenty of good advice. Gil's series is aimed at investment advisors, but has also attracted many DIY investors, including some who are quite skeptical. It is a good dialogue which figures to help both groups. I am trying both to share and to learn.

Market Outlook

The trade for the next 35 years? Short bonds and long equities! Rupert Hargreaves of ValueWalk reports on Deutsche Bank's advice and rationale.

Most investors are ill-positioned for this scenario. HORAN Capital Advisors reports on the continuing dramatic shift between stock and bond fund flows.

Final Thoughts

 

There really wasn't any fresh news on Friday, but there must always be an explanation. Consumers demand it! It is a requirement for news reporters. I am reminded of an old book from my student days –a description of how reporters covered a Presidential campaign. The news world was very different in those days. Without instant communications the various news services had quite different deadlines. The wire services had to be the fastest and Walter Mears of the AP was regarded as the best at determining the lead from a complex story. Everyone also wanted to know how the NYT was going to play any news. The Rolling Stone version of the story (from 1972) is an enjoyable read and captures the flavor. Why is it relevant now?

News executives expect solid work, usually judged by reports of other leaders in the field. If you are going to deviate from the accepted lead, you need some special analysis. This is great for investors if they are able to look a little beyond the obvious and tune out the noise. Remember the following:

• Simple dominates – even if it is simplistic.
• Any recent event is a candidate to be the cause.
• Support for popular themes and theories is encouraged. Oil prices were down over 2%, for example. For many this signals economic weakness. Ignore the recent increase in prices.
• Don't worry if the timing seems a bit wrong. You can explain that. The market was "digesting" the information. Or it was a "delayed reaction."
• And finally – make it into a big story!

A Reality Check

Not everyone bought into this theme. A number of investment managers questioned the logic. It is hard to sound intelligent when the market is plummeting, unless you have an instant explanation. I do not question Art Cashin's trader take. There was a lot of money available to traders who perceived the potential for a big directional move. The algorithms joined in, technical levels were violated, and many were waiting for a break from the recent trading range. Those who profit from making sure that people are "scared witless" (TM OldProf) piled on.

Investors have time to analyze and to think more carefully about the causal model. The trading community believes that the economy is weak and fears that the Fed will tighten rates at a bad time. Both elements are necessary. Not only does the Fed see a stronger economy; it is committed to start with modest moves. The early stages of a cycle where very low rates are increased is bullish for stocks and bearish for bonds.

The overwhelming majority of investors made no trades on Friday. Many did not even know what happened until it was over. The vast majority of others are not going to take any action next week. This is good. Investors who try to compete with traders are playing a game they cannot win.

Quiz Answers

1. The manufacturing index of 49.4, if annualized, corresponds to an annual increase in real GDP of 2%. The ISM non-manufacturing index of 51.4 similarly corresponds to real growth of 1%.

   One way to think about this is that the economy is still growing even when the secular decline in manufacturing is continuing.

2. About 50-50. Even a two-touchdown favorite in the NFL is only about 75% to win. .75 squared is your chance of winning both games. Why should you care? People naturally take apparently obvious events and turn them into sure things. They become way too confident.

Felix, Oscar, and Holmes Talk Stocks

Fans of the Odd Couple know about Felix and Oscar's regular poker game. While Holmes is a dog, everyone knows that they play poker as well. They have all agreed to take a few minutes away each week to talk with us about stocks. Here is the cast of characters:

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not make any picks, but he will answer questions, saying what he thinks about specific stocks.

Oscar is naturally optimistic and a bit excitable. He definitely likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

To provide occasional representation for those of the fundamental persuasion, I will sometimes include a human in the discussion.

 

This Week's Ideas

My purpose is to show how different approaches – all sound methods – often lead to different conclusions. Technical versus fundamental, trader versus investor, short-term versus long-term -- all make a difference. I hope you will find the weekly discussion interesting and become a part of it.

Felix

I see good value in precious metals. What to buy? Gold or silver? Metals or mining? Royal Gold (RGLD) is an attractive choice.

Question: Felix, what is your opinion of Apple (AAPL).

Felix: Too messy! It is barely acceptable.

Jeff: Earnings and cash will eventually lead the stock price higher.

 

Oscar

"Felix may be in it for the long haul, but there are plenty of ways to cash in faster! There is a football game tonight, for example. But you want to know about stock sectors. My pick of the week is Regional Banks (KRE). They started with an early slump in January but now there is a hot streak – just check the 50-day moving average! I don't want a floor for my portfolio; I want to blow the roof off!"

 

Holmes

I do not talk as much as Felix and Oscar, but my stock picks are ahead of the humans. This record market has my tail wagging! Here is one I bought this week: Cardinal Health (CAH).

 

An Important Note to Readers

Felix, Oscar, and Holmes are all models, carefully engineered and tested by one of the leading developers of the last thirty years. They are highly-modified momentum models, with different time frames and features.

I humanize them because it makes it easier to understand the characteristics in their design. I always remind readers that my posts are informational, not investment advice, but special emphasis is needed here. While we are trading based upon all three models, we are always watching and can act quickly when necessary. The models are not suitable for all investors.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned (individual banks rather than KRE).

Questions are welcome about both stocks and sectors. I will pass them along.

Test Your Employment Report IQ

It is Labor Day – a good time to think about jobs. Employment is the most important element in economic growth and also for future Fed decisions. Each month the employment situation report is the subject of intense discussion. It helps to understand the data.

This will be most effective if you attempt to answer each question before checking the answer. The quiz is a little wonky; if it were not, everyone would know it. If you are right on even half of these questions, you will be doing better than most of the "experts." No peeking!

For answers where a number is called for, take credit if you are within 25% of the actual answer.

Questions

1. If initial jobless claims are nearly 300K per week, and payroll employment gains are less than that per month, how can employment be getting better?
2. How many new jobs are created each month?
3. Is the "birth/death" model the most important method used by the BLS to account for new jobs?
4. How accurate is the estimate of new job creation?
5. What is the sampling error (i.e. "margin of error" defined as +/- 90%) for the monthly payroll employment report?
6. How many times is the original payroll report revised?
7. Do these revisions eliminate the sampling error?
8. Is it more accurate to look at "internals" like job growth in a sector, than to go by the overall change in jobs?
9. What is the aggregate annual impact of seasonal adjustments?
10. Do Fed members and political leaders know the results in advance?
11. What year was the high point in labor participation?
12. What was the level?
13. How many people who actually want jobs, whether or not they are looking, are currently unemployed?
14. What is the duration of unemployment?
15. Does the BLS have discretion in determining or announcing the monthly results?

Answers

1. Initial jobless claims are a report of job losses. The payroll employment report is a net number – gains minus losses for the month. This distinction is frequently missed, even by leading economists whom you see on TV.
2. Over 2.6 million jobs were created per month in the most recent report, Q4 2015. About 2.3 million jobs per month were lost. The net gain for the quarter was about one million, much smaller than the gross increase of 7.8 million. http://www.bls.gov/news.release/cewbd.nr0.htm

 

1. No. The BLS does not receive responses from those who have gone out of business, but it treats non-respondents like the rest of the sample. They make an assumption that enough new businesses are formed to offset those that dropped out. This is the "imputation step" which is four times as important as the birth/death adjustment.
2. The estimates of both overall employment and new job creation have been very good, but this still means deviations of 50K to 125K jobs each month. The chart below shows that most of the monthly variation comes from continuing businesses and is captured in the sample. Business births and deaths are largely offsetting.

1. The sampling error for the net change in jobs is about +/- 100K.
2. There are three revisions. The first two occur on the two months after the initial report. These reflect additional survey responses, not any sort of correction. More than a year later, the results are benchmarked to actual counts from state employment agencies. The Quarterly Census on Employment and Wages covers 98% of private employment, so this is a good count.
3. The first two revisions do not eliminate sampling error. The benchmark revisions are actual counts, not a sample, but the QCEW reports are not very current.
4. A lot of discussion is focused on the "internals" of the report. People never mention that each of these subgroups is part of the sample, and also subject to sampling error. Depending on the size of the group, it can be much larger (proportionally) than for the overall net job change.
5. This is a trick question and the easiest of the quiz. Despite the spinning you hear each month about seasonal adjustments, they are cited only when it proves the pundit's point. The aggregate annual effect of adjustments is zero.
6. The President, Vice-President, the Council of Economic Advisors, and the Fed Chair get the report the afternoon before it is announced. It is a tightly-controlled process, with results not even known until a day or so before Jobs Day. https://www.washingtonpost.com/national/jobs-day-an-economic-and-political-obsession/2012/03/09/gIQADZPW1R_story.html
7. The peak in labor force participation was in early 2000.
8. The level was about 67%. Looking only at those aged 25-54, the level was 84%.
9. The number of unemployed who want jobs and instead work part time or have become discouraged is 7.8 million, about the same as the number counted in the reported unemployment count, or over 15 million total. The oft cited much higher numbers of people "not working" include (among others) people who have retired, are still in school, or have chosen to work raising a family.
10. About 2 million people, or 26% of the total, have been unemployed for 27 weeks or more.
11. The employment reports are the result of a detailed process that is changed infrequently and only after great public debate. Partisan politicians are not involved in compiling the data. The language chosen is the subject of internal debate, but only covering a modest range of choices. It sounds like it is written by a committee with a limited vocabulary – and it is!

Conclusion

I hope you enjoyed the quiz. Whether or not you did well, you should now be a more discerning and skeptical consumer of jobs report punditry.

 

Sources

In addition to specific sources named above, much of the material here comes directly from the Technical Notes of the various surveys, including the following:

http://www.bls.gov/web/empsit/cestn.htm

http://www.bls.gov/bls/empsitquickguide.htm

Weighing the Week Ahead: Should We Expect September Mourning?

The abbreviated week's calendar has little important data. The economic news last week leaves open the timing of the next interest rate increase. As vacationing market participants yawn their way back to their desks and trading floors, what will be the focus? A look at the calendar and the end of summer will have them asking: Should we expect September mourning?

I borrowed the title from Alan Steel's excellent post on this subject. More from him in the conclusion.

Last Week

There was a lot of important economic news. The picture was mixed, but mostly promising. The Fed can move in September or delay until December.

Theme Recap

In my last WTWA, I predicted another weeklong focus on the Fed. I expected every economic data point to get special attention, parsed through the perceived eyes of the Fed. This was the story all week – even on the quiet Friday afternoon. I asked whether the Fed would get a signal to hike rates. At the end of the week, most were answering "no." I have had a good streak going on guessing the theme, but the week ahead is really a challenge.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. The overall range, once again, is very narrow. Doug's take is that the market liked the slightly weaker than expected report, observing as follows:

The "bad news is good news" syndrome once again reaffirms the market's primary dependence on Fed pampering via low rates. The index hit its 0.65% intraday high about 30 minutes into the session. Profit taking sent the index to its 0.13% intraday low in the early afternoon. But the buying returned, and the 500 ended the session with a 0.42% gain.

Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

Please Watch…

…for some upcoming events that might be interesting to WTWA readers.

1. It is Labor Day weekend. Like you, I am enjoying some family time. Because the employment report is so important to markets, I will publish a little quiz to test your Jobs IQ. It will not be easy. You may keep your results secret or else boast about your knowledge!
2. I am joining an outstanding group of fellow advisors in a webinar this week. It will be on Wednesday, September 7^th at noon EDT. (Sign up here). We meet regularly for our own benefit. This time our leader, Rob Martorana, felt that other might learn from the interchange. The subject is how to interpret financial news. The material is great, and I am looking forward to participating. Please join us if you can. If you miss it, check out the original article. If investors find this to be useful, we will do more.

The News

Each week I break down events into good and bad. Often there is an "ugly" and on rare occasion something really good. My working definition of "good" has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The Good

• Initial jobless claims remained very low at 263K and beat expectations. (Bespoke)

• Hotel occupancy remains at near record levels. (Calculated Risk).
• Withholding tax collections remain strong. (Barry Ritholtz).

  As the total dollar amount of Federal withholding taxes continues to increase, we should expect to see retail sales and sentiment continue their improvements. This has resonance for GDP as well as the Presidential Election.

• Factory orders rebounded nicely. Up 1.9%, the biggest gain in nine months. Steven Hansen offers a sharp dissent to the headline figure.
• Earnings revisions have improved. There is a regular pattern of decline in over-optimistic estimates. Few are experts in studying the pace of these changes and how it is likely to impact the market. That is why we read the work of earnings expert Brian Gilmartin, whose most recent post which explains about this difficult question.
• Personal income rose 0.4% in addition to positive revisions. Consumer spending also increased 0.3%.
• Consumer confidence reached an eleven-month high. See Doug Short's analysis for background, comparisons, and the best charts on the subject.
• Bullish sentiment remains low, a near-term positive for stocks. Bespoke provides this chart.

 

The Bad

• Auto sales fell to an annualized rate of 17 million. This was not far from expectations for most companies, but a decline nonetheless.
• Rail traffic continues to decline. Steven Hansen (GEI) does his typical comprehensive analysis.
• ISM index moved into contraction, registering 49.4 compared to 52.6 last month. Steven Hansen (GEI) has a comprehensive analysis including comparisons to the Markit PMI measure. It helps to consider the "internals" of the index calculation.

• Employment gains disappointed. I am listing this as "bad" even though most see the overall story as pretty neutral. (WSJ). I am listing the specifics, but all are within their normal sampling error bands. The bond market reaction was also neutral. Calculated Risk said a "decent" report, which captured mainstream sentiment.
  • The net increase in payroll jobs was 151K. While this still represents reasonable growth, it was significantly below the last two months and also below expectations of 180K
  • Private hours worked declined and hourly earnings increased less than expected.
  • Unemployment remained at 4.9% and labor force participation was stable.

• ADP reported private sector employment gains of 177K – reasonable but also a bit below expectations.

The Ugly

EpiPens. Rex Nutting gets to the heart of it: Saving lives isn't Mylan's business; maximizing profits is. The story has widespread implications. We all want to save lives. To do this there must be an incentive for drug development. When does this cross into exploitation? Should U.S. prices subsidize foreign drugs? It is an important issue on many fronts.

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week's award goes to Ben Carlson, who takes on the apparently compelling statistical link between the Fed and stock performance. Since 2008 more than half of the increase in the market comes on days of FOMC meetings. He notes that this argument was featured in the WSJ, but it shows up in various places.

What happens if you change the starting date of the analysis?

Ben points out that the relationship is mostly a result of 2008.

 

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have a light week for economic data. While personally I watch everything on the calendar, you do not need to! I highlight only the most important items in WTWA. Focus is essential.

The "A" List

• ISM services (T). Continuing strength in the service sector?
• Fed Beige book (W). Anecdotal evidence adds color to the data for the next FOMC meeting.
• JOLTS report (W). The Fed uses this to analyze labor market structure. It is less useful for employment growth.
• Initial claims (Th). The best concurrent indicator for employment trends, but less attention during "employment week."

The "B" List

• Wholesale inventories (F). July data but relevant for revision of Q2 GDP.
• Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

There will be some FedSpeak. There may also be news from the G20 conference. See Treasury Secretary Lew's presentation at Brookings for a preview.

Next Week's Theme

Last week brought us more quiet trading with no clear message from the data. As people slowly return from vacation, it is a natural time to review events. We will see plenty of stories about how September is the worst month for stocks. Everyone will be asking: Will September bring a market correction?

Michael Brush, writing at MarketWatch, has a typical example, Get ready for a 5%-10% stock-market drop. Expect more such predictions and advice to do something or other to avoid this kind of decline. This week's Barron's cover was similar.

Most expect the record streak of low volatility to end. Here are the top worries:

1. The calendar. This chart from Michael Batnick (who does not present this as a trade) makes the point.

1. The Fed. Some are worried that rates will rise. Others are worried that the Fed will keep rates too low.
2. Energy prices. Some worry about a sharp rebound. Others are concerned about another crash.
3. China.
4. Europe. The current focus is Italy. The last hot spots (Greece and Great Britain) are OK for now.
5. The US election. You can worry about either candidate or just the uncertainty.
6. Congress is back in session (see conclusion*). Note the shaded area of the VIX chart, marking the recent seven-week recess, perfectly coinciding with the record lows in volatility.

Feel free to add your own thoughts in the comments, including anything I have missed.

As always, I'll have a few ideas of my own in the conclusion.

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Think risk first, reward second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 

The Featured Sources:

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he expresses more confidence about growth in earnings.

Bob Dieli: The "C Score" which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.

The recession odds (in nine months) have nudged closer to 10%.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has a number of interesting approaches to asset allocation.

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli's enhanced aggregate spread, considering when it might first give a recession signal. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score. This week, as he always does after an employment report, Georg updated his unemployment-based recession indicator. No recession is indicated.

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. For most readers, they can just "listen in." If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

• Understanding Risk – what we all should know.
• Income investing – better yield than the standard dividend portfolio, and also less risk.
• Holmes – the top artificial intelligence techniques in action.
• Why 2016 could be the Year for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions or suggestions for new topics.)

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested, including several aggressive sectors. The more cautious Holmes also remains fully invested.

Top Trading Advice

Brett Steenbarger describes the three main causes of big drawdowns. See if you remember any of them from your own experience. Here is how to think about the diagnosis.

If you're in drawdown mode, it's important to ask if the problem is with your betting versus folding or if the problem is sitting at the wrong table or playing the wrong game altogether.

Dr. Brett has another lesson, showing how to milk information from data to find the best trades. Take a look at this chart and then read his analysis.

We have all had losing trades. The Trading Goddess discusses the best way to exit, including the thorny question of stops.

But as soon as you've entered the position, the price falls apart and forces you out of the trade when your protective stop is triggered.

Then, as soon as you're out of the trade, the stock swiftly reverses back up.

After running 5% to 10% higher over the next few days, you're left in the dust with no position and tear in your beer!

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Morgan Housel's final column at The Motley Fool. He has been the best advice choice many times. His work is consistently helpful to investors. He promises that he will keep writing in his new gig, and I hope that is true. This week's article reviews some of his key lessons. They are all worth careful study, buy I especially like this one:

Progress happens too slowly to notice; setbacks happen too quickly to ignore. The market quickly lost 38% in 2008, and it was huge deal. Books were written about it, and Congressional hearings were held. We'll be talking about it for decades. The market then slowly tripled from 2009 to 2015, and barely anyone flinched. You had to sit down and show people the numbers to get them to believe you. This is common: Recessions take place over months; recoveries take place over years. It can take decades for companies to become valuable, but bankruptcies happen overnight. Pain hurts more than the same level of gain feels good, but the duration differences between progress and setbacks helps explain why there are so many pessimists amid a backdrop of things getting better over time.

And also this one….

There has never been a better time to be an investor. Ever, in history. More people have access to first-class services than ever before. It's so important, and we don't spend enough time realizing how good it is. 

Stock Ideas

Chuck Carnevale continues his strong recent series with a look at the "Big Five" Canadian banks. He emphasizes the importance of finding a good entry price! This is a thorough analysis, and you should read it carefully before investing.

Morningstar updates the top buys and sells from their "ultimate stock pickers." This group was a "net seller" but still holds some favorites. Check out the full article for other ideas.

Holmes will begin contributing an idea each week, a stock we bought for clients a few days ago. I will mention it here and Holmes will also post it each Friday at Scutify.com. While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas may be a starting point for your own research. Holmes may exit a position at any time, and I am not going to do a special post on each occasion. If you want more information about Holmes and exits, just sign up via holmes at newarc dot com and you will get email updates. This week's Holmes made no portfolio changes. Danaher (DHR), which we bought last week, is still interesting and about the same price as our entry.

Energy

With a new trading range for oil prices there is renewed interest in energy stocks. Dan Dicker (Oil&Energy Insider – subscription required) recommends waiting until oil is closer to $40/bbl. He includes an interesting chart showing how some of the Bakken shale drilling sites developed. He writes as follows:

Oil wells cost money to drill and inevitably run dry. They need to be constantly replaced with fresh drilling to maintain output. Those drilling and maintenance costs sometimes overwhelm the returns of the oil being sold, as is the case this year and the previous two, and sometimes the returns greatly outpace the costs, as was the case before the bust in 2014.  We know that most of the independent U.S. oil companies operating in shale have bypassed this current cash burn problem in the short term by raising efficiencies – which lowers costs - and by slashing capex, which sacrifices the ability of potential future replacement.  

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are several great choices worth reading, but my favorite is this advice from Jonathan Clements. He explains that people are living longer and must take that into account in setting an investment horizon. He notes as follows:

…your time horizon may extend beyond your own life expectancy. Suppose you are age 80 and you have money you plan to bequeath to your 20-year-old granddaughter, who will then use the inheritance to pay for her own retirement. The investment time horizon for this money might be 50 years, over which the stock market will likely clock dazzling gains.

[Jeff] I agree with this analysis, but I always start by securing enough of a portfolio to assure against life-changing market results. One good place to start is with another source from Tadas, Tim Maurer. He warns against taking too much risk.

Market Outlook

Eddy Elfenbein, continuing to impress on his CNBC segments, explains 5 Signs that Stocks have Room to Run. We turn off the mute and TIVO back when Eddy is on, our highest indication of respect!

Strategy

Michael Batnick (MarketWatch) has a helpful article about what investors could learn from horse bettors. There is a list of ten great ideas, especially for value investors. I especially liked this one:

There is always the temptation to abandon your strategy when it's out of favor.

"If you begin espousing this approach, you are sure to suffer abuse from your fellow horseplayers. When one of them asks you who you like in a race and you say, 'I think the 4 is a bigger price than he should be,' the likely response is, 'So what? Who do you like?' Your cronies are apt to tell you that you should be betting on horses, not on prices, and after an inevitable stretch of watching some of their underlays win, you will begin to doubt yourself."

 

I wrote on a similar theme last week. You might enjoy Why Smart Investors Struggle to Beat the Market.

Ben Carlson explains the importance of rebalancing. If you do not regularly review and execute this strategy, you are missing out on a natural way of selling high and buying low. You are also taking too much risk!

Final Thoughts

Volatility will eventually increase, but there is no reason to expect it right away. Most of the reasons have been recycled all year. Let me comment on the new ones.

• The calendar. One pundit stated that the reason for weak Septembers was that people were worried about October! Alan Steel covers this topic in a witty fashion. He deals with "the hordes of deviant scribblers…who have made single variable correlations into a media business." His brief post has plenty of good advice, and you definitely won't stop reading after the first line about the prune juice and Viagra diet. Take some time to read his other helpful and entertaining posts.
• Rate increases. James Hamilton has a nice analysis of the concurrent moves of other economic indicators during rate increase periods.

  These 4 episodes have several things in common. First the inflation rate rose during each of these episodes and was on average above the Fed's 2% target, a key reason the Fed moved as it did. Second, the unemployment rate declined during each of these episodes and ended below the Congressional Budget Office estimate of the natural rate of unemployment, again consistent with an economy that was starting to overheat. Third, the nominal interest rate on a 10-year Treasury security rose during each of these episodes, consistent with an expanding economy and rising aggregate demand.

• Congress back in session. While the information is accurate, this point is a joke. Mrs. OldProf said that I should footnote and include this line so that everyone would know to laugh. I told her that readers of WTWA know a silly bivariate chart when they see one!

Fundamental factors are more important than the small seasonal effects. The latter often include a couple of large moves that skew the result. The chance of a correction is no higher than it was last month, or the month before.